Sunday, May 8, 2011

Apple: Still Ripening

After passing Microsoft in market capitalization, then in revenue, Apple has finally passed it in quarterly profit. This comes not in some quirk of seasonal doldrums or in the wake of some unusual charge-down, but in the very quarter Microsoft announced solid quarterly profit buoyed by record expansion of its server and tools business segment. Apple's profit – and MSFT's struggles in Windows OEM licensing (MSFT's profit surge was attributed to the Office franchise, not the the company's Windows division) – appear directly related to Apple's success against Microsoft's offerings in the netbook space. In a related move, Microsoft launched ads seeking to compare Apple's MacBook Air to underpowered Windows netbooks that are being crushed by iPads.

Netbooks aren't Apple's only success. The iPhone business has been cleaning up. In the United States, Apple's share of the smartphone platform market (as measured not by new sales, but by subscribers) was up about half a percent from 25% to 25.5% over the period Dec'10 to Mar'11, but its share of hardware share of all mobile subscribers gained 1.1% of the entire market, from 6.8% to 7.9% (a 16% gain from its position at the end of 2010). Other vendors sell some non-smartphone products, but Apple does not: as the market heads toward smartphones, it grows Apple's addressable market. Over the period, Apple gained on RIM, which lost smartphone share (from 31.6% to 27.1%) but due to shifts toward smartphones, lost only a tenth of a percent in the broader mobile hardware market.

One can look out into the future and wonder what effect some of the major competitive trends will bewhether "free" operating systems will really place hardware competitors in a position to compete with Apple on margins, or whether control of the OS will allow Apple to capture post-sales revenues that otherwise would be lost to the hardware vendors – but the near-term has a pretty clear outlook: Apple is trouncing the competition. Not by lowering prices in a bid for short-term share, but by raising quality to capture the most premium segment of a growing market. Very nice.

Tuesday, May 3, 2011

ACAS 1Q2011 Earnings Announcement: What It Suggests

ACAS has done it again: rather than succumbing to a dissolution in bankruptcy, it's announced another profitable quarter (presentation materials here).

First: the NAV. ACAS closed the quarter with a NAV of $11.97, up $1.26 (12%) from the prior quarter and $2.99 (33%) from 1Q2010. Honestly, this is better than a dividend: you get to defer the income until disposal.

Second: NOI. NOI isn't where ACAS gets most of its money, but it tells a story about the interest income ACAS earns and the success of operations that, due to the consolidated accounting that occurs at ACAS by virtue of its >80% ownership of its control investments, flow straight to ACAS' bottom line. NOI of 23¢ per share is up $0.04 from Q42010, and "includes ... $0.04 ... of non-recurring income related to the removal of investments from non-accrual status." (presentation, p.3) So, NOI is stable except that its non-accruing investment picture has improved over the quarter. Assuming that non-accruing investments going off non-accrual status means future investment performance, this is not really non-recurring in the sense investors care about: it's a prospect for better future performance.

The third thing is realized income. This number is quite different from SEC-reported income, because that number includes things like unrealized appreciation and other factors that readers don't think about as income. It's a useful metric at a Business Development Company because it drives the obligation to pay dividends. The prospect (obligation) for a dividend is looking clear out in the future: with $0.22 in net realized earnings over the quarter, ACAS is building a record that (when its tax loss carryforward has been exhausted) will lead to a dividend-paying requirement. And not a bad one, either.

During the quarter, ACAS paid down $517m in debt, including $300m in secured debt not due to be paid until 2013. The debt-to-equity ratio of 0.4:1 gives ACAS more freedom to do creative things going forward, as it hasn't got the noose of lender veto hanging over its fundraising and financial transaction structuring options.

The $269m in cash realizations show that ACAS is still liquid. Also, it's not involved in a series of equity fire sales: $206m came from principal payments. The exits, as usual, had little impact on overall portfolio characteristics; management offers a table to this effect on page 11 of the presentation materials.

What's ACAS doing for new investments? Slide 10 is educational: ACAS invested in three portfolio companies and provided another $97m for European Capital. ACAS is investing where it understands the business. The distressed opportunities ACAS is pursuing aren't easy to see from the high-level investor presentation (acquisition by a portfolio company?), but I like to see distressed opportunity investments. I'd like that more than the debt pay-down, frankly, though the debt pay-down may be a prelude to late-in-the-year transactions designed to obtain value from soon-to-become-worthless operating losses. I can imagine a structure in which shareholders exchange shares of old-ACAS for shares of new-ACAS that contain the exact same investments but some extra cash, while old-acas merges with a company that can use operating losses and deducts them. There's quite a bit of transaction cost for something like this, but if there are enough millions for someone to make, the transaction cost will be easily worth the price of admission for the buyer. The rumor that GE Capital is interested in ACAS is less interesting than the details of management's current hypotheses regarding mechanisms by which to glean value from the loss carryforwards.

A look at ACAS' loans on non-accrual (p.6 of the presentation) shows that past-due loans at cost have plummeted. ACAS' loans are either on non-accrual, or they're paying on time. The now-nearly-binary nature of ACAS' loan performance (Performing? Y/N) helps us assess ACAS' loan portfolio performance a bit. ACAS has $3.4B in loans at cost, of which 0.7B are on non-accrual. The non-accrual loans represent a bit less than were reported last quarter at cost. This may be a number to watch; non-accrual loans that begin performing again are a potential source of future value. This quarter, loans coming off non-accrual were worth 4¢ per share, for example. I'd like to hear what management says about the extent of this possibility.

Years ago, ACAS' management used to harp on conference calls about how the market should be valuing the company as an asset manager rather than as a heap of assets. ACAS has been working to grow assets under fee-based management – first in private funds, then in ECAS and AGNC – and although ACAS took ECAS private, it's had AGNC issue quite a few shares (in accretive, above-book-value issuances) and appears set to launch a new public fund under the symbol MTGE. Currently, ACAS' $6B in assets are being dwarfed by $37B and growing assets under management (presentation, p.24). Between AGNC and MTGE, the managed-assets column will be almost all mortgage investments. What that tells the Jaded Consumer is that ACAS is getting a lot of mileage out of its mortgage investment team. Raising the deal size is a way to better leverage the same research and market-modeling costs. Management fee doesn't scale with head count, but is linear with net assets. Every above-book issuance at AGNC is a pay raise at ACAS.

Upshot? Until the dividend resumes, I think the NAV tells the story. And that story is good. I really don't want the buyout-at-$15 rumor to be true, I want a few more quarters of this kind of NAV increase. More than a few.