Friday, August 19, 2011

ACAS: What's The Cash For?

At the end of last quarter, ACAS had repaid its debt to $1.642B (for a Debt:Equity ratio of 0.4:1) and held cash of $186m. Of that, ACAS has spent $40m buying 2m shares of its newly-public managed fund, MTGE. This leaves $146m, plus whatever it's generating from businesses.

Since ACAS hasn't been snapping up new companies – it's made a few add-on investments in existing portfolio companies and invested in its own subsidiary's IPO and paid down debt – one wonders what exactly ACAS is doing with its brainpower and assets. Holding pat shows confidence, but what about the thesis that economic chaos brings opportunity and that careful investment should pay huge rewards? One has to invest to get that, right?

The Jaded Consumer has a few ideas.

Share Buyback (Or Not)
First, there's been a bit of excitement over the fact that immediately following ACAS' announcement of a NAV exceeding $13, ACAS took a plunge with the rest of the market. ACAS could retire more than 10% of its shares – buying below NAV, thus driving up the assets per share dramatically – and still not run out of cash on hand. A no-brainer, right?

Look at the history. When ACAS' share price was slammed following the Panic of '08, ACAS didn't buy underpriced shares, it bought (to retire) its own underpriced debt. Buying shares doesn't lead to realized gains (imagine if it could treat issuance as a short, and close the positions it opened north of $40!), and offers no benefit to the bottom line. On a per-share basis, it is helpful; but it does nothing for the enterprise. In effect, paying people to retire their shares shrinks the company. As a BDC with aspirations to become a larger asset manager, one of the last things ACAS wants to do is to shrink the company. And look at the other side of the coin: if ACAS thought it worthwhile to issue shares to Paulson at $5.06 so recently, how could it pay a premium of over 50% to get those same shares back?

ACAS has faced below-NAV share price opportunities before. Years ago, before ACAS took ECAS private, analysts asked why ACAS would not use share buybacks to increase value. ECAS had traded below NAV from its inception, and anyone with a blank envelope-back could tell that buying ECAS shares below NAV would increase ACAS' stake in a valuable company with a steady dividend (both companies had to that point paid uninterrupted dividends). ACAS' reply was clear: ACAS was looking to grow its business, to grow ECAS, and to broaden ownership of ECAS in support of its plan to grow the whole enterprise. ACAS had no intention of reducing the size of its enterprise or of its assets under management.

But, the astute reader is surely pointing at the Jaded Consumer and laughing: that analysis is surely wrong, or outdated, or else ACAS would not have bought every share of ECAS when it took the firm private. Surely, something is missing, no? Alas, the explanation shows that nothing has changed.

ACAS did buy ECAS, but the ECAS shares were bought with ACAS shares, not with cash. The transaction did nothing to reduce the size of the enterprise. Because ECAS' discount was greater than ACAS' discount, the below-NAV issuance of ACAS to ECAS holders was accretive to ACAS. Yet, when the dust settled, no shareholders had been paid to stop being shareholders. They just held ACAS shares instead of ECAS shares.

Management Plans Massive Recapitalization
ACAS never wanted to have secured lenders. ACAS fought giving lenders a security interest in its portfolio like there was no tomorrow, and even as it was discussing the new debt agreement on quarterly calls, was already discussing plans to restructure debt to avoid having debt that doesn't move with the markets and exposing ACAS to leverage scares. ACAS wants out of its secured loans. If one recalls, ACAS built up cash during the aftermath of the Panic of '08 – eventually holding over a billion smackers while cash was king and hugely profitable mispriced-investment opportunities lay about the land like stranded fish after a receding tsunami. ACAS is once more quite possibly working on a strategy to address its capital structure issues – to obtain more flexibility than permitted under its agreements with its secured creditors – that will require money.

I don't think ACAS will be retiring equity.

What I dearly hope is that, if ACAS is foregoing panic-selling opportunities that offer decent companies at awful-company prices, its strategy for its cash is really slick. What is ACAS' distressed-opportunity team (the special situations group, mentioned here) doing, anyway? My principal thesis in ACAS is that illiquid privately-held companies trade in an inefficient market in which ACAS has opportunities to buy deals that just don't exist in efficient markets. If ACAS doesn't buy something with its money, what's it doing?

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