Thursday, February 21, 2013

On ACAS' 2012 Earnings

At Seeking Alpha, the latest Jaded Consumer article on American Capital is available: Understanding American Capital's 4Q2012 Earnings Announcement. (What's more, it's an Editors' Pick!)  Frequent commenter Not_My_Business returned to the theme that the company might unlock shareholder value through a restructuring that would spin off an interest-bearing-debt company, externally managed by ACAS, to pay dividends to shareholders (and create demand by dividend hounds). While I don't see this in the immediate future, the freedom to restructure in this fashion is exactly what I think keeps ACAS' debt:equity so low: it's interested in maintaining the freedom to do this (which secured creditors with an interest in the debt would veto).

One thing to like in spinning out some debt ACAS wants held for the long term is that ACAS can get a management fee for keeping funds from the permanent capital pool invested in suitably attractive debt instruments. ACAS can itself be a co-owner of this fund, making it like the pool ACAS sold years ago when it sold 30% of all its investments into a pool it managed – except that the pool is public, strangers can invest, and ACAS can raise money in it.

The problem I have with AINV isn't that it's an externally-managed fund, but that it combines high fees with willingness to issue equity below NAV. That's why I concluded Berkshire was a better use of capital. Berkshire has discipline, and AINV's management doesn't.

Assuming ACAS launches such a fund, it'd be interesting to see how it's valued by the market. The question is: if ACAS can syndicate debt from One Stop Buyouts into its public bond fund, will it fight as hard for deals that arms' length buyers would buy or will its managers settle for deals it can do this quarter? Without the constant pressure to get third parties to support ACAS' deals in the syndicated-debt market, what will ensure the deals have the metrics and prospects that will really perform for investors? Will we rely on ACAS doing deals more and more within specific spheres of expertise?  Will ACAS have some other method of keeping its managers demanding in their tastes for suitable risk-adjusted returns?

Can anyone remember the name of that search engine optimization company that ACAS invested in right before Google changed its algorithm and obliterated its business? We need to avoid more of that kind of boondoggle. ACAS needs a scheme to detect it early.  Investing in what you know is some protection – ask Berkshire – and the movement toward concentrating in areas of expertise like energy/infrastructure, and healthcare, may help ACAS in that direction. Does the plan go deeper?

UPDATE: Geosign collapsed weeks after ACAS' acquisition for $130 million plus affiliate money for a total of $160,000,000. Then, Bam! Google wised up to its business model – click arbitrage, selling Google advertising more expensively to Yahoo! – and killed it with algorithms that detected Geosign's violation of Google's Terms of Service. Rebellion Media Group, which apparently succeeded Moxy Media, which apparently received ACAS' part of Geosign's assets, was last listed with a fair value of $24.8 million. What a difference a few weeks makes. Remember Rule One.


Anonymous said...

" it's interested in maintaining the freedom to do this (which secured creditors with an interest in the debt would veto)."

Precisely. The new revolver,4-year term loan and realizations seem to be providing plenty of capital for new investments through 2013.

Also, (which you don't point out in this follow-up) is that the BLT's will also unwind in Q1-14. The BLT's represent a current complication in the spin-off scheme (like increasing leverage as you point out).

Finally, the spin-off could be a bond-fund concept or simply a BDC. In the BDC scenario (assuming the spun BDC is paying a div to support PPS>NAV), the new BDC could run 2nd's and use those proceeds to buy debt from ACAS's OSB's and other companies as well.

So many possibilities. Thanks for thinking about and posting some of the scenarios.

aocypher said...

Jaded, are you talking about Geosign in 2007?

Jaded Consumer said...

@oacypher -- Thanks! Geosign was the fastest implosion of assets I think I ever saw, certainly at ACAS. I appreciate your giving me the name I missed.

Jaded Consumer said...

@anonymous --

I kinda like the idea of ACAS creating a BDC full of debt instruments. It'd be like AINV – externally managed, and full of assets that produce payments on a schedule – but would avoid AINV's absurd overhead costs.