American Capital (ACAS) Reports 2Q12

American Capital (ACAS) reported 2Q12 earnings after the market close 7/31/12 and held the conference call at 10 CT on 8/2/12. It is a good report and our investment thesis remains on track.

After successive quarters of consistent improvement the company remains an attractive investment in my view trading at a 38% discount to the improving book value of $16.62/share; a 54% discount to our original estimate of longer term value ($18.87/share); and a 56% discount to an updated estimate of $23.27/share should historic book value multiples return. These discounts are still available after a 41% increase in share price since posting our investment thesis on 1/16/12.

The best way to monitor this investment is to track net asset value (NAV) or book
value increases. These will eventually be reflected in share price increases as business development companies tend to sell for a multiple of about 1.0X book value and ACAS pre crises multiple averaged 1.4X. The share price to book value discount will shrink over time.  The 2Q12 book value per share is $16.62, a 6%, or $0.91 per share, increase from the 1Q12 book value of $15.71.

Management continues to allocate capital to the benefit of shareholders. Recall during
3Q11 ACAS adopted a program to provide for repurchases of shares when the price
of ACAS common stock is at a discount to the book value then shares are repurchased. When the price of ACAS stock is at a premium to book value cash dividends are paid. During the 2Q12 ACAS repurchased 9.1 million shares at an average price of $9.34/share. A total of 9% of the company shares were purchased over the past four quarters.

Business development companies (BDCs) typically pay the bulk of their earnings to
shareholders as dividends. So the BDC analysts on the conference call usually question
the share repurchase vs. dividend policy. CEO Malon Wilkus responded in part, “That
when you are trading below book you have just tremendous economics by buying back those shares and when you are trading above book, it makes sense to pay out income to the form of dividends.”

This is just smart capital allocation. Management is using available cash to buy common stock at $9.34/share (2Q12 repurchase price) that represents $16.62 of underlying assets (2Q12 book value). That means as shareholders, for every $1 dividend we forgo this quarter we get $1.78 in ACAS assets. That increases the book value even further and eventually our share price. The quarter to quarter mentality of Wall Street wants the dividend restored ASAP to get an immediate bump in share price.

As a patient long term investor, I hope the share price stays low longer so management can continue the share repurchases at this large discount on our behalf. I can be patient; after all how many 78% return investments are out there? It also gives us more opportunity to invest in an attractive value proposition by buying more shares. So as a long term patient investor I was glad to read: “During the quarter, we reaffirmed
and extended our stock repurchase program through December 2013,” said John Erickson, Chief Financial Officer.

Operationally the company is doing well in a difficult market environment. From earnings announcement here:

CEO Malon Wilkus summarized operations as follows:

  1. “NAV per share grew by $0.91 for the quarter to $16.62, delivering a 23% annualized return for the quarter.
  2. In the past three months, both our aggregate U.S. portfolio companies and our aggregate European Capital portfolio companies experienced moderate revenue and EBITDA growth, year over year.
  3. Despite concerns over the troubles in Europe, European Capital’s Euro-denominated  NAV held steady.
  4. The fair value of our investment in European Capital was primarily impacted by a decrease in the stock price to NAV of comparable public funds and negative foreign currency movements.
  5. Our asset management business, conducted through American Capital, LLC, which is now our largest portfolio company investment at $806 million at fair value, ontinues to thrive, producing increased dividend income while diversifying the income streams atAmerican Capital.
  6. Having raised a combined $644 million of equity for American Capital Agency and American Capital Mortgage during the quarter, we are pleased that we were able to
    grow its existing funds under management and look forward to developing new funds for it to manage.”

2Q12 Financial Summary:

  1.  Net operating income (NOI) of $0.29 before income taxes per diluted share, or$97 million a $26 million increase over Q2 2011 and $0.58 NOI after income taxes per diluted share, or $194 million.
  2. A $0.40tax benefit per diluted share related to change in tax treatment of preferred stock dividends, or$132 million.
  3. A $0.04net realized earnings per diluted share, or $12 million; a $189 million improvement over Q2 2011.
  4. Net unrealized appreciation was $0.67 per diluted share, or $225 million; a $362 million decrease over Q2 2011.
  5. Net earnings of $0.71per diluted share, or $237 million; a $173 million decrease over Q2 2011.
  6. Cash proceeds of $332 million from realizations on businesses sold.
  7. $191 millionof securitized debt repaid.
  8. 9.1 million shares repurchased during the quarter, totaling $85 million, of American Capital common stock at an average price of $9.34; $0.20 accretive to NAV per share.
  9. Book value (NAV) of $16.62 per share for an increase of $0.91 per share, or 6% over Q1 2012.

The full release, conference call and earnings presentation are available here.

On July 19, 2012 ACAS also announced the planned refinancing of secured debt. Plans are to refinance its existing recourse debt with two new senior secured credit facilities. The proceeds will also be used for working capital and general corporate purposes. This refinancing was not discussed during the conference call but we can infer it will increase ACAS financial flexibility by eliminating objectionable covenants and reduce interest expense incurred in the restructuring of the company during the crises.

Disclosures:

I am long ACAS.

The information contained herein is provided for informational purposes only, is
not comprehensive, does not contain important disclosures and risk factors associated with investments, and is subject to change without notice. The author is not responsible for the accuracy, completeness or lack thereof of information, nor has the author verified information from third parties which may be relied upon. The information does not take into account the particular investment objectives or financial circumstances of any specific person or organization which may view it. Nothing contained within may be considered an offer or a solicitation to purchase or sell any particular financial instrument. Any investment can be very risky and is not suitable for everyone. You should never enter into an investment unless you can afford to lose your entire investment. Always complete your own due diligence
. Before making any investment, investors are advised to review such investment thoroughly and carefully with their financial, legal and tax advisors to determine whether it is suitable for them.

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Provalum LLC. All Rights Reserved.

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