Thursday, September 9, 2010

ACAS: More Profitable Exits Hidden Within

American Capital Ltd. has a wholly-owned portfolio company, bought below book value in an all-stock transaction back when people thought ACAS was about to go down the drain, that specializes in the international markets. European Capital announced today having received £40 million (which is the same as €48 million for those watching at home – haha – okay, over $60 million cash) in prepayments of debt associated with a mezzanine transaction in which ECAS realized a blended return of 13.2%.

ECAS' realizations over the last 12 months now exceed €141 million (alright, $179 million). This, in a portfolio company that (despite having net assets with a "fair value" of $700 million) is listed on ACAS' SEC forms as having a "fair value" of $400 million. (see recent shareholder presentation) Assuming ECAS shares ACAS' objective of investing in exciting deals, the subsidiary would have been originating some exciting new opportunities – or stands on the brink of doing so. New deals with pricing based on post-crash market economics will have pricing more people can understand and trust, and the multiples contraction associated with the market collapse will make those deals extremely sweet as the markets recover. Owning ECAS at less than 60% of the value of its assets is also more mind-boggling when one considers how much of those assets are cash.

So ACAS has a few lessons to teach us: ACAS and its ECAS subsidiary are continuing to exit deals (and to do so at a gain), and the discounts built into ECAS (multiplied by the discount also present in ACAS) make some of these deals particularly exciting from a value standpoint. Panicked income investors who ran for the doors won't be back for maybe two years, if ACAS works hard to put off as long as possible its dividend-paying requirements, and that window will allow some nice fire-sale-priced purchase of a widely-diversified portfolio of companies that are generating a profit that should increase as ACAS' debt overhead drops and its spreads widen. The fact that ACAS gets to realize both leveraged debt return and capital appreciation as we come out of a depression will make shares bought at this level much more attractive down the road.

Since the prior owners – the income investors who used to own for the dividend – will remain on the sidelines for a few years, there could be a while before ACAS shows a NAV premium. However, the irrationality in the severe NAV discount should become evident over the next few quarters as ACAS – which won't face any tax expense or pass any to shareholders due to a combination of its BDC status and loss carryforwards from the depths of the crash – posts continuously-increasing NAV, NOI, ROI, and other metrics of interest to buyers. Oh, and pays down debt.

What's not to like? Cash rolling in, and the books cloud the fact from people reading the top paragraph. Exactly what I like to see: a deal, and a good reason the deal is widely missed.

An opportunity.

I'll be looking at volatility in ACAS as an opportunity to make bullish positions, but won't be trading the share's I've got. The road upward seems like it will continue for a long time – much longer than the horizon for dividends to resume.

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