Tuesday, February 26, 2013

ACAS' Discount and Aquisition Prospects

Over on at Seeking Alpha, the article Understanding American Capital's 4Q2012 Earnings Announcement has attracted an interesting comment by Not My Business. It suggests that ACAS' discount (relative to Net Asset Value per share ("NAV")) makes it attractive for an outsider like GE Capital to acquire. Buying ACAS below NAV would deploy capital at attractive returns, so why not?

The funds management contracts described in SEC filings by ACAS' managed funds MTGE and AGNC seem to make change in control a situation in which managed capital clients can depart with the managed funds. It'd be awful for American Capital Ltd. (ACAS' funds-management subsidiary) to lose all its funds management business overnight. The fact that ACAS' funds-management subsidiary is also ACAS' largest single holding (by "fair value") seems to act as a poison pill for ACAS: unfriendly takeover could destroy a significant and growing funds-management business that contributes both to NOI and to NAV.

So, maybe a buyer wants to buy a managed funds from ACAS, in the same spirit of the transactions years ago when ACAS sold a 30% stake of its whole portfolio to investors who wanted ACAS' management of funds. If someone like GE wanted to buy a portfolio from ACAS, ACAS would want to make good money on it rather than to sell it for a song. Would GE want to pay ACAS to manage funds for it? I haven't seriously considered this, but my first impression is that GE Capital has managers whose pride and confidence would work against pitching to their superiors – as their capital deployment idea – the idea of paying of third-party managers to do things they themselves theoretically do for their salaries.

If ACAS restructured so that it had a big externally managed bond fund – and that fund traded below NAV – then I can see institutions becoming interested in buying at a discount for a margin of safety. But this wouldn't be a purchase from ACAS' inventory, it'd be a purchase of shares of a company that's paying ACAS a management fee based on assets' "fair value". It would, in essence, be like an investment in MTGE or AGNC (which early in their lives both traded below NAV, too). 

ACAS would like to have institutions interested in its managed funds, of course. So restructuring to place investment holdings into an externally-managed, publicly-traded BDC seems an interesting way to attract institutional interest, and broaden demand for ACAS-managed funds.

If AGNC and MTGE offer any example, the new fund would likely trade at a NAV discount until its dividend is seen as reliable.  One way for ACAS to create this structure might be to raise new money in a new investment vehicle, then buy the assets from ACAS at "fair value" to get them off ACAS' books and onto the books of the new entity. ACAS could participate in the deal by supplying capital for the new entity just as it did with AGNC and MTGE (each of which ACAS since exited). Once the fund traded at a premium to NAV, ACAS could exit and deploy its returned capital elsewhere, while continuing to enjoy funds-management fees.

Some questions would be: will lenders require ACAS to guarantee debt? Will the new BDC get lending terms as good, without the additional safety of the funds-management business and the equity of the portfolio companies? Real roadblocks could kill the idea, even if it were of interest to shareholders.

But I don't see ACAS being bought out. I believe management wants to stay in the funds management business, and that the fallout of a buyout would wreck ACAS' value in a hostile takeover.  I much more credit the idea of ACAS restructuring to allow asset classes the market might value favorably to stand apart from the parts of ACAS that are historically not accorded much value (e.g., non-dividend-paying equity). The restructuring has some good precedent in the development of ACAS' funds-management business through AGNC and MTGE, and serves as a plausible model for future fundraising in an environment that prices ACAS' own shares below NAV.

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