Tuesday, August 2, 2011

ACAS: NAV Up Again In 2Q2011

American Capital announced its 2Q2011 quarterly result, and the result is more of the same: secured debt decreased ($100m repaid; ACAS has a debt:equity ratio of 0.4:1), and net operating income increased (to $71m, 145% above the year-ago quarter). But this is not the metric that most interests me as ACAS recovers from the liquidity crisis that crushed the valuation of its portfolio assets and share price. The single metric that most impacts my assessment of ACAS' recovery is the increase management is able to achieve in net asset value.

This quarter, management increased NAV to $13.16, up 10% from $11.97 in 1Q2011 and up 44% from $9.15 in 2Q2010. This valuation increase still shows some undervaluation in assets, though: ACAS claims the value of its investment in ECAS is $933m, though the value of ECAS' assets (over which ACAS has complete dominion, just as it has dominion over ECAS itself) is $1.035B. (Note that the gap between asset value and ACAS' claimed "fair value" is decreasing; it's just not yet at parity.)

One might try to draw some conclusion from ACAS' realized losses and compare them to ACAS' unrealized gains. A familiar meme among critics and a repeated question in conference calls is whether ACAS is selling its winners to look good and getting stuck with a portfolio of losers. The fact that ACAS is able to achieve $179m in realizations is nice, but the fact that this resulted in a realized loss of $177m strongly suggests that ACAS is reclaiming unproductive capital from investments whose thesis didn't survive the crash and isn't sticking investors with dogs in the name of making a quarterly number. The realized loss is a decrease from the year-ago quarter, but ACAS realized a gain last quarter. Which brings us to ...

... what games ACAS might be playing with its books. As suggested by management previously, ACAS has just announced that it had, or by the deadline would have, failed a RIC test. Intentionally failing a RIC test was one of management's schemes to roll forward operating losses whose value would otherwise be lost to ACAS and its shareholders. Losses are a tax asset: they offset taxable income. Losing the loss would really suck, and the failed RIC test preserves the perishable asset for next year. Management said at the same time that it expected to meet the RIC test in the future: this is a tax planning stratagem, not some kind of business failure. What does that mean? ACAS may be accelerating losses into this year when they are available so that it will make the most out of its carry-forward opportunity. We usually get an opportunity to see how the quarter's business has affected the portfolio mix, but there's strong reason to doubt that with investments as illiquid as ACAS', there's a lot of power to move the timing of deals in a transaction pipeline. I don't think we'll see that the quarter's business has really changed the overall numbers for the whole ACAS portfolio, even if ACAS management were trying to rush losses and working to bargain up gains in a way that would slow their transactions into a later reporting period.

The quarterly announcement discusses things like unrealized appreciation (can't complain about $587m in unrealized appreciation, can you?) and net earnings ($410m), but these things don't affect its eventual obligation to pay a dividend on resumption of BDC status (that is driven by taxable income, not SEC-reported "earnings"). For the time being, the metrics that have my attention are NAV (what the company is worth) and NOI (what the company earns without swapping assets around). The NOI increase has definitely shown the increases I expected following the debt restructuring, and I look forward to viewing it as a barometer of the success of the company's portfolio companies.

With respect to the NAV and NOI, ACAS has one strategy that has bourne some interesting fruit. Over the last year, ACAS has grown assets under management not only by holding them while value recovered, but by having controlled companies issue equity to new investors. American Capital Agency's issuance has been accretive to shareholders of AGNC (i.e., has raised AGNC's NAV at each issuance), and has boosted ACAS' assets under management – and thus ACAS' management fees, a source of NOI. Whether the public has an appetite for shares of American Capital Mortgage Investment Corp will determine whether ACAS can use MTGE to effect more of the same.

The breadth of the portfolio companies' business across industries and geographies makes it sensitive to broad macro-economic conditions, which is why management's prediction of success bears the qualification "if the economy continues to recover." I think long-term bets are in favor of recovery, and especially as ACAS has 0.4:1 debt:equity and is no longer in debt covenant default, there's very little reason not to regard ACAS as a long-term investment. Indeed, I bought some during the quarter for my niece. This is the niece whose mother sold the AAPL I recommended ten years ago, because her broker told her it had already moved up. This ACAS purchase is an account I won't be handing over to my sister's broker.

See you next quarter :-)


Anonymous said...

So why the &*#$ is it getting hammered today?! I am completely baffled.

Jaded Consumer said...

Over the last week or so the whole market has been hammered, and with it all the comparables against which ACAS' portfolio companies are compared for valuation. Today in particular, the Dow, NASDAQ, and every holding I have in any industry are all down. Considering that ACAS employs leverage -- and for all I know may still have special margin requirements dating from its days as a penny stock a few years ago -- it's unsurprising that ACAS is receiving vicious treatment in the market.

I've never pretended to be able to time stocks, but I like ACAS' 8-quarter streak of increasing NAV and the fact that the NAV increase has shown several double-digit quarters -- that is, double-digit NAV growth not just on an annualized basis but within the reported quarter. Consequently, I have confidence that management is capable of executing its plan and am not particularly concerned about the very near term.

Back when ACAS was in technical default and bankruptcy loomed, the doomsday vision of ACAS had more credibility. Today, I think we're seeing ACAS as a reflection of leveraged exposure to the general market conditions. Of course, 0.4:1 is less leverage than ACAS had a few years ago. And with ACAS' NOI up, the prospects seem very slight for failing to meet interest payments or run into trouble with secured creditors that would make patient waiting impractical.

I'm looking at a research report now that shows ACAS as +101.43% since the researchers last downgraded it. Nice, eh? Gotta love those fine minds who write research reports.

Jaded Consumer said...

UPDATE: Another reason ACAS may be getting hammered is that Zacks wrote (while recommending ACAS as a Rank 2, that is, a short-term buy) that ACAS would not be resuming a dividend soon. While obvious for some time to anyone familiar with the way dividends are calculated for a BDC, this may have seemed like "news" to gadflys buzzing past the article and concluding ACAS had some kind of financial problem.

What ACAS gets from its loss-carryforward (which it's maximizing with the failed RIC test) is the ability to keep what it brings in. Keeping what it's already got prevents it from paying money to borrow capital for investment.

The other issue that may be creating a sensation among those not paying close attention is that a "failed" RIC test could easily be read as a "failure" rather than being perceived as a tax stratagem.

In short, if the selling keeps up we have an opportunity to buy on a senseless dip. After all, NAV is heading north. Even if the markets are a beauty contest in the short run, they are (according to Buffet, anyway) in the long run a weighing machine. If management keeps executing like it has the last couple of years, the NAV growth will eventually win out.

Anonymous said...

I agree with all this, and I had thought about the dividend statement by Zacks, but continue to be shocked that the market is giving less credit to the NAV growth. And, not EVERYTHING was down today - MasterCard up 13%.

Great analysis as usual, though.

Jaded Consumer said...

No, not everything is down. Just everything I held at the time I wrote. Although by close of market, ACAS was no longer down >70¢ and several of my other holdings had actually turned positive on the day.

This morning, though it was a wash of red for everything I held.

Congratulations on your Mastercard :-)