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.


Anonymous said...

Thanks for the clear-headed analysis as usual. Agree on the desirability of a buyout. Frankly, I doubt Wilkus will go for it- I think he's out to prove his detractors *way* wrong and assuage the pain he felt from that margin call in late '08.

Anonymous said...

" 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"

I don't think that's how they account for it since on their 10K it shows up as "Interest and Dividend income"

Jaded Consumer said...

ACAS' current 10-K continues to make reference to its consolidated financial statements.

Interest and dividend income do show up as interest and dividend income, sure. But that's not all the income. And neither is the capital gain/loss. There are also gains/losses from operations. For an example of a company that files consolidated returns and still has substantial interest, dividend, and other investment income, have a look at the annual report of Berkshire Hathaway ($5.2B in 2010, down from $5.5B in 2009).

With respect to portfolio companies that are owned 80% or more and for which a valid election was made to file a consolidated return, ACAS would be obliged to keep filing consolidated returns. Not every investment falls into this category; some investments are owned in such large part by co-investors that they could not be part of a consolidated ACAS return.

In past conference calls, ACAS specifically discussed the operating results of controlled portfolio companies as "flowing straight to the bottom line" of ACAS, indicating that consolidated return elections had been made with regard to at least some eligible companies. Unless ACAS undergoes a transaction that makes a company ineligible for consolidated treatment, the prior election should cause the returns to continue to be consolidated.

Anonymous said...

I don't think that the consolidation applies to ACAS because it's a RIC, unlike BRK which is a diversified company. Indeed if you look way back at the first annual report you will see uncosolidated some stuff, and thus the pre 1997 financials are not comparable. I'm pretty sure they use the equity method (which makes sense since they invest in companies as investments rather than to operate them as BRK does) if you look at their schedule of investments the way it flows through into the ACAS financials, some of it is credited to income, some of it is credited to FV of the carried company. Maybe it's just semantics on my part. You also need to consider how it flows through the cash flow statements. Some of these are non-cash items so they impact ACAS's cash position. Maybe a call to investor relations is in order, to find out exactly. In any case, the ACAS thesis remains NAV writeups!

Jaded Consumer said...

It may not be obvious which holdings' results are being consolidated, but the presentation materials continue to refer to "consolidated financial statements".

Notwithstanding any confusion regarding the accounting treatment given to operational results among ACAS' many listed investments, the investment thesis is surely that -- whether related to operational improvements, increases in comparable sales, or broad-based improvement in business conditions due to changes in the macro-economic environment -- NAV increases are likely to be the principal driver of share price pending resumption of a dividend.

Anonymous said...


Jaded Consumer said...

My reaction was that ACAS had found a way to raise money that didn't require it repay all the notes issued in the wake of its bankruptcy-avoiding debt restructuring, and didn't depend on the public's appetite for AGNC shares.

I'm more interested in what ACAS is able to do with liquidity in this market than the details of how it gains the liquidity: I want to see ACAS take advantage of the liquidity, pricing, and valuation issues that plague small private companies. It's this opportunity that brought me to ACAS, and I'd like to know how management is exploiting it. I don't mind that management does this quietly, so long as it's underway.