Strangely, the stock market continues to allow a company to repurchase stock at a substantial discount to net asset value (NAV). American Capital, Ltd (ACAS)has completed a 52M share repurchase program for nearly $500M over the last 6 quarters at an average discount to a continuously soaring NAV of nearly 40%. The stock though continues to trade at a substantial discount even after having the ability to spend that much cash.
American Capital is a private equity firm and global asset manager. American Capital, both directly and through its asset management business, originates, underwrites and manages investments in middle market private equity, leveraged finance, real estate and structured products. American Capital manages $18.6 billion of assets, including assets on its balance sheet and fee earning assets under management by affiliated managers, with $117 billion of total assets under management (including levered assets).
The question remains why investors allow the stock to trade at the dramatic discount to the assets of the company. Especially considering signs exist that the company conservatively reports NAV.
Buyback and Dividend Plan
American Capital has one of the most appealing plans for handling the distribution of cash to shareholders. When the company transitioned to the C-Corp back in 2011, the Board of Directors came up with a plan to only pay dividends when the stock traded above NAV. The flexibility to buy stock when it trades at a significant discount to NAV is a very lucrative one.
Since the start of the buyback plan, the company has purchased 52.4M shares, or 15.2% of the outstanding shares. The average purchase price has been $9.46 and totaled $495M. The purchases have been $1.09 per share accretive to the NAV.
The average repurchase was done at a 47% discount to the current NAV. Though not nearly as big of a discount to the current stock price of around $13.84, the plan has worked brilliantly. The below table highlights how the stock gains can't seem to catch up with the increases in NAV regardless of the substantial buyback:
Soaring Net Asset Value
The NAV continues to soar as the stock price trickles higher. The NAV at the end of 2011 was $13.87. The NAV hit $17.84 at the end of 2012 due to a combination of earnings, stock buybacks, and portfolio company appreciation. The stock though continues to languish significantly below NAV. It would need to appreciate another 29% to equal the NAV as of the end of 2012. This NAV doesn't even factor in any gains since the new year.
An interesting point really highlighted in the and the analyst questions on the is the potential conservative valuations applied by American Capital. A prime reason for the significant stock plunge during the financial crisis was the NAV reduction by the company and non-accrual loans.
While the non-accrual loans are still being worked down, the substantial increase in NAV of portfolio companies during a meager economy suggests the company wrote down values too low. Or more likely the company was required to write the investments down below reality. One prime example is the European Capital portfolio company valued by American Capital at 75% of current NAV. Applying the $231M discount would increase the NAV of American Capital by around 5%. The Wells Fargo Securities analyst was very clear that he didn't understand why the discount remained that great.
One quick one related to European Capital. I noticed this quarter -- in the past, ECAS generally trended with its peer comps, the ICG being a pretty easy one in terms of price to NAV. Yet, this quarter we saw that valuation kind of relationship decouple a bit with ECAS still being held at 0.75 at NAV while ICG at the end of the quarter was 0.88-ish now even higher close to book today. Any reason for that deviation from historical trend?
Investors need to remember that NAV is based on tons of assumptions and estimates. No matter the intention, variations exist between different calculations. Another key point is that American Capital primarily owns portfolio companies as opposed to the debt investments utilized by most BDCs. The debt is not hit nearly as hard during a financial crisis.
At this point, with the European portfolio doing better than expected investors should eliminate the discount. The below chart from the presentation highlights the fair value of each investment portfolio versus the cost basis:
The chart highlights that outside the substantial valuation gains of American Capital Asset Management, the company is valuing assets at nearly $1.3B below the cost basis.
American Capital trades at a substantial discount to other BDCs such asMain Street Capital (MAIN) that trades substantially above NAV. The stock would need to more than double to reach that price to NAV levels. Other BDCs such as Ares Capital (ARCC), Fifth Street Finance (FSC)and Prospect Capital (PSEC)trade just above NAV. See chart below:
A major reason for the rebound in NAV was the strong gains in ACAM that manages the assets of publicly traded American Capital Agency (AGNC)and American Mortgage Corp. (MTGE)As the chart below shows, American Capital has had the largest NAV gain by far in the BDC sector over the last 2 years.
The stock continues to surge to multi-year highs and is finally becoming a leader in the BDC sector. It started the year around $12 and is already approaching $14. The stock has started showing some leadership over the last 3 months.
The following chart compares the stock to the BDCs over that time period.
American Capital continues to offer substantial value over investing directly in the competitors in the sector. While investors remain concerned about the ability of the company to execute or the lack of a dividend, it hasn't stopped the company from producing strong gains for investors in 2012.
The question remains whether it will rebound to trade at similar multiples of NAV as the competition. For investors buying now, the large stock buyback will juice gains even further the longer the stock remains undervalued by the market.
Disclosure: I am long ACAS.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.