American Capital (NASDAQ:ACAS)
Citigroup US Financial Services Conference
March 06, 2013 2:50 pm ET
Malon Wilkus - Founder, Chairman, Chief Executive Officer and Chairman of Executive Committee
[Audio Gap] with Citi Research. I'm really pleased to have with us today American Capital. American Capital operates as a private equity firm and global asset manager which invests in both public and private companies. With us today from ACAS is CEO, Malon Wilkus; as well as the Vice President, Pete Deoudes. Let me turn it over to Malon. Thank you.
Thank you very much, and I thought I would go through a presentation on us, and I'm going to skip this first section. It will take us a little bit to skip. The first section is really our earnings presentation, and I'll start here to give you some background on American Capital.
We were founded back in 1986. We went public in '97, and we've become one of the leading managers of and investor in alternative assets. We have $18.6 billion of earning assets under management, of which $6.3 billion is on our balance sheet and $12.3 billion is in funds that we manage. We manage 5 private and this says 2 public -- 5 private and 2 public funds. The reality, as of the last 2 weeks, we've raised another 2.5 -- $2.8 billion of earning assets on top of the $18.6 billion and raised another fund, a CLO, that we've just recently priced. So we now have 6 private and 2 public funds and a total of $21.2 billion of earning assets under management.
When you include our levered assets under management, we're well over $125 billion of assets that we manage. And we do that with -- out of 8 offices, 340 employees and you can see that there has been a nice growth in our earning assets since 2008. So we did decline some from '07 to '08, and then -- and our balance sheet assets did decline, but they've been steady now for 3 years, and almost 4 years. But our funds that we've been -- our external funds that we've been managing has been growing quite dramatically. And in large part, that has to do with American Capital Agency and American Capital Mortgage, which are 2 REITs that we manage. And this is just showing the assets under management when you include levered assets.
So we have distinct competitive advantages, I believe, relative to other alternative asset managers. We have 31 investment teams. So highly diversified teams that cover a variety of sectors, both on working on the funds that we -- or assets that we have on balance sheet, as well as the assets that we have in our funds under management. So 100 -- over 100 investment professionals.
We have 34 members of what we call our FACT team of financial compliance and accounting. And that's kind of unique in our industry. Most firms use outside audit firms to go in and evaluate the financial performance of a company. We have our own team. They have kind of the skin in the game and so they take it very seriously. If we make an investment -- so our investment teams, of course, work with the CEOs and COOs of the company to evaluate them and then ultimately, if we buy them, they work with those closely to establish the business plan and the internal workings of the company. The FACT team works with the CFO and the controllers of these companies.
And then we also have an operations team. 15 members, 8 former CEOs and presidents and 1 former COO, a former CFO and even a 4-person supply chain management team. So this team of people are able to go in and run our companies. And if they get broken, they're able to go in and turn them around. They help to bring large-company expertise to these smaller companies. They bring lean management to these companies. They help outsource to Mexico or Asia, if there's a way to reduce their cost. And then, if something goes wrong, they're able to go in and actually run the company if necessary. Over the years, we've actually replaced about 55% of our CEOs. So this team is very, very active. We're very hands-on as a private equity firm.
We have a 5-person syndications team in our New York office. So we do our One Stop Buyouts of these companies and then post closing, we will syndicate out the senior components of the capital structure. And last year, this team syndicated $2.4 billion of financings for our portfolio companies, reducing the cost of our portfolio companies, and as well as in half a dozen cases, doing dividend recaps that would earn us a nice dividend. And so it's been a very powerful part of our team.
We have a large legal department and human resource department. So we're very unlike the typical private equity firm.
We -- you can kind of think of our company in 5 different business lines. So over on the extreme left, you have $2.5 billion invested in our Operating Companies. Those are the companies we control, that we acquired through our One Stop Buyouts and we invest all up and down the capital structure of those companies. We work with them for growth financing and add-on financings and recapitalizations after we own them. We have -- we're a generalist, but we also have certain industry specializations. So we have a specialty in health care products and services, and consumer products and services, industrial energy, special situations.
Next to that, to the right of that, is our Sponsor Finance and Direct Investments where we have $900 million invested at fair value. This is also investing in buyouts, except it's a buyout that's sponsored by some other private equity firm. They control the company, we don't. We're just a lender. We could do senior debt, sub debt, unitranche, equity co-investments, second lien, mezzanine, so forth. And of course, we have the same kind of industry expertise.
So the first 2 are buyout business and we call them our private finance business collectively. But we're one of the most experienced investors in buyouts. We'll talk more about that in a minute.
American Capital Asset Management is the third business line. We have $830 million invested there. That is where we manage these 8 different funds under management, and that includes agency -- funds that manage agency securities and RMBS and non-agency mortgages and residential mortgages, commercial mortgages and CLOs, and also private equity.
Next is European Capital, where we have $800 million invested. And you could think of European Capital the way you think of the first 2 business lines. So we do buyouts in Europe, and we do sponsored finance investing in Europe as well.
And then, finally, we have our Structured Products where we have 2 -- about $0.25 billion invested in CMBS, CLOs and CDOs. And at that fair value, they produce a great deal of income and have been performing well at that value.
This is another way to look at our -- both our revenue over on the left, and our fair value on the right. And so you can see the kind of assets that we have and how they're deployed and the revenues off of those assets. But to give you just another look at this, our operating companies, our controlled companies, represent $2.5 billion or 39% of our assets. But when you add to it the fact that we also control our asset manager, it's another portfolio company we control, now we're up to 52% of our assets. And then if you remember that European Capital, we also have buyouts that we control, we have about 65% of our assets in controlled companies. And that's completely unlike any other BDC out there. Virtually all of the other BDCs, and there's about 40 of them, are invested in senior debt and second lien and sub debt and some unitranche, and very little of it is invested in equities, very little of it is invested -- almost none of it is invested in companies that these BDCs control. So we're completely different from the rest of them and we've taken our own kind of unique approach to the private equity business.
And looking at this chart, so 65% of our assets are in companies we control, but with respect to equity stakes, it's about 50% of our assets are in equities. So one of the reasons we're not paying a dividend today, and we haven't since 2009, and the other BDCs do pay dividends, is that so much of our assets are in equities where we really don't earn that much income in the short term. We do try to, however, get much higher earnings in return on equity over the longer term through those equity stakes.
We're highly diversified in the -- largest segment there is the capital markets, which would be our asset management company. So we've got great industry diversification.
So let's talk about our private -- or let me talk about my -- our private finance business. We'll get to your questions as well. In fact, if -- you're welcome to ask questions along the way. I wouldn't mind it at all. We've invested $21 billion in over 370 companies since we went public. $11 billion of that amount was in 115 American Capital One Stop Buyouts. And then $8 billion was invested in 150 private equity buyouts that were sponsored by about 147 private equity firms. So those 2 -- those first 2, totaling $19 billion, are in buyouts. So there is, I think, there is no firm, no private equity firm in the world, or no firm investing in risk capital that has invested in more buyouts than American Capital. Not the big ones, you never see our buyouts in the front page of The Wall Street Journal. We're investing in middle-market buyouts. But we have invested in a tremendous number of middle-market buyouts and so have great expertise in that area. In addition, we invested $2 billion directly into companies for growth, recapitalizations, acquisitions and so forth. In our private finance business, we produced a 12% IRR on the $16 billion that we've invested, or that we've exited. And that's on a blend of about 1/3 senior debt, 1/3 sub debt and 1/3 equity. If you just look at the equity performance, it's at 24% IRR, which is really outstanding.
You can see this is all the One Stop Buyouts that we've done over the years in yellow and then the top slices there are the add-on acquisitions that we've done for those One Stop -- where we financed for those One Stop Buyouts. And the companies themselves probably have doubled that number of add-on acquisitions, but funded it off their own balance sheet. And then the blue is the investments in American -- that we've made periodically in American Capital Asset Management.
If you want to focus just on our buyouts, we have really an excellent returns. If you look at the bottoms of this chart here, you can see we've invested $11.5 billion in our One Stop Buyouts in a blend of senior debt, sub debt and equity, and starting on the left, the gold is the senior and the blue is the sub debt earning. The senior earned 9%; the sub debt 12%; and in green, the equity earned 18%; a blend of 14% returns. And we've gone and proven $9.8 billion worth of those numbers. So again -- and indeed, we did earn 9% on the senior, 12% on the sub debt and -- but we got a 28% return on equity and that's because we keep the companies until we could get the maximized return on the equity. And so the 18% return on all that we've invested in equity, in our buyouts would put us probably in the top quartile of performance in private equity. The 28% return on our exited investments in equity, and I think that's the most important, would put us probably in the top decile of performance in private equity. So we get a blended return of 15%. And by the way, this kind of investing where you're investing up and down the balance sheet, really mitigates your downside in the private equity world.
So our asset manager is managing, as I'd mentioned, at the turn of the year, $12 billion, but today, it's now managing about $14 billion -- $14.5 billion. And it starts over on the left at -- this is on Slide 39, in our American Capital Equity I, which is a private equity fund. We call it ACE I. And then below it would be ACE II. And so in 2006, we sold about $1 billion of assets, equity assets in around 90 of our controlled portfolio companies. And we sold it to a group of secondary investors and turned around and managed it on a 2 and 30 basis with that fund. So we still held 70% of the equity on our balance sheet. And so we were going to manage these companies in any case, but we were able to get another set of investors and sell them 30% of those assets. We sold it at the prior quarter's fair value, and we sold it at a gain. And we also earned then this wonderful management fee for doing so. And these are private -- finite-life vehicles that will slowly dissipate. Equity II was done in -- about exactly a year earlier. We sold it at even a larger gain of 17% stripped of all the equity that we had and about 90 companies. And so ACE I is actually performing extremely well, we're in the money on the carry. ACE II, which we sold at a higher gain, is not quite in the money, but close. And for 2007 private equity vintage, it would be considered a very well-performing fund.
We also manage European Capital, which we've discussed. And then we manage American Capital Agency and American Capital Mortgage. So we call it AGNC or Agency, and Mortgage, these 2 public REITs, and those have been growing tremendously. It was 4.5 years ago that we did the IPO of American Capital Agency. And today, it's a $12.5 million -- $13 billion market cap company. 1.5 years ago, we took American Capital Mortgage public. And today, it's $2.5 billion market cap.
And we think there is still great growth opportunities for both of those funds. We think not only is there a yield curve that's going to be attractive for some time, but we also think that rebuilding the whole private mortgage, U.S. mortgage market -- residential mortgage market is critical and there's a huge amount of work to be done. There's all sorts of different things that have to be done to rebuild that industry. It's been decimated and it will take 10 to 20 years to do it, and I think we have 2 great platforms to take advantage and to participate in that rebuilding.
And then we have our Structured Products and we're managing our CLO that we established in '07. We've created another CLO in the middle of last year. And we've just priced a third CLO this -- about 10 days ago. So these funds -- the 2007 CLO is performing tremendously well. It would be in the top decile of performance. And because of that track record, we've been able to attract more capital. And we are an ideal firm to be doing these CLOs. Because of our asset heaviness, we can warehouse the assets on our balance sheet before we take it to raise capital. And the lender or the investors and those CLOs much prefer to be able to see the assets before they make the investment.
In addition, if you want to raise capital in Europe in a CLO, you have to abide and be European compliant, which means you have to have -- the manager has to have skin in the game. So you have to own at least 15% of the equity. For us, that's easy to do, it's something we want to do. And for other CLO managers that are asset light, that would be very difficult to do.
So we have, being an asset heavy, in fact all of these funds required very substantial amount of incubation of assets on our balance sheet. ACE I required $1 billion, ACE II required $670 million. European Capital was several hundred million. American Capital Agency required $220 million of incubation of assets before we were able to take it public. And American Capital Mortgage required $40 million of our capital to take public. And the CLO is approximately $30 million each. So being asset heavy is critical.
And if you take Agency, and the $220 million that we invested there, you wouldn't want that asset class to be more than say 5% of your balance sheet. So to be able to do Agency, to every -- even just created, we needed to be about a $5 billion fund. And that's why we have the asset manager together with an asset-heavy balance sheet. Because the asset manager is managing alternative funds. Those alternative funds take a lot of capital to build and to create and to attract third-party capital.
Is there any questions as we go here? Feel free to jump in and ask any questions you like. European Capital, we founded in '05. We've already mentioned that it is -- does the One Stop Buyouts, as well as Sponsor Finance. It's now wholly owned by us. At one time, we had it public but we did take it private. And we have 49 employees in offices in London and Paris. We've done, through European Capital, $1.4 billion of One -- of 9 One Stop Buyouts and $2.9 billion in 90 private equity buyouts -- Sponsor Finance buyouts, and we've had, however, a somewhat disappointing returns. We've been through the worst recession since the Great Depression, first, and now we're back into another recession in Europe. So our IRR is at 3% and on a blend of senior debt, sub debt and equity; on the exited investments we have a 7% IRR. So we are working hard to turn that around and fortunately, this last year, the European Capital had about a 12% return on equity. In the last quarter, about a 20% return on equity. Our investment in European Capital last year had a 25% return on equity. So it is still -- and we're turning it around, but it has been very worthwhile to continue to do that work to capture those growth rates.
You can see European Capital only has a $7 million investment in Spain with respect to the Mediterranean rim. We have nothing in Italy, nothing in Greece and a $7 million investment in the largest pizza delivery company, very successful. So the most of our assets are in the U.K. and in northern -- in France and northern Europe, and the company -- in countries that have a AA or better rating.
Our Structured Products. We have $9 million -- we just invested $9 million in the fourth quarter there. But we have $247 million of total assets, $228 million of that was invested or is today invested in 25 CLOs of commercial corporate loans, we're invested in the equity of those CLOs, and they have performed very well. In fact, on our CLO business, we have reaped a higher return than we had intended when we first got in the business in '06 -- '05 and '06. It is -- however, in this category of our Structured Products, we have our CMBS investments. And our CMBS, which is currently valued at $18 million, it's cash flowing very nicely, doing quite well on that $15 million, but it is where we lost a substantial amount of the money that we lost through this last recession. So we reaped a negative 20% IRR on the CMBS investment. And so with all the other product lines that we had, we've done extremely well. But in that area, we did not.
Okay, so I think that is -- covers pretty much what I wanted to cover, and wanted to ask if there is any questions.
It there's no questions, I'll kick it off. When you talk to your portfolio of companies, what are you hearing about the underlying health of the economy?
We -- every quarter, we do convey what our private companies are saying or what we see from the financials of our private finance companies. And so for last quarter, we conveyed that there had been a modest aggregate revenue and a modest adjusted EBITDA growth, 3 months over year-over-year in our portfolio of companies. So we were very pleased about that because as you know, there was an anemic 0 basically GDP growth. In Europe, we also report that and there, in Europe, our companies had a moderate aggregate revenue increase and a modest adjusted EBITDA increase year-over-year. And that, I'm pretty surprised by because of the recession going on in Europe. So quite pleased with that.
Right. If there's no questions, I'll ask another one. What's the state of competition in the buyout industry? And where are you seeing the best risk-adjusted returns right now?
In the buyout business, there's a lot of competition today. So there's a lot of cash on the sidelines. Strategic buyers have a lot of cash to buy companies, and financial buyers also have a lot of cash. And some of them have it and they must use it or they're going to lose it. And so there's a lot of capital chasing good-quality companies that are for sale. And we -- and so it's been a great time to sell companies, and we have sold a tremendous number of companies. And I think I have a schedule of that, which we produced about $5.8 billion of liquidity.
Let me see if I can find that chart. Here we go. So since the third quarter of 2008, we produced $5.8 billion of realizations, and of the controlled companies we've sold, we sold them all at or above the prior -- our entry multiple -- EBITDA multiple. So it's been a super time to sell companies, and we've used, of course, those $5.8 billion of proceeds to pay down about $4.5 billion of debt, to buy back about $0.5 billion of our stock and to invest about $700 million in our portfolio of companies and in new companies. And we exited those companies on average at 1.7% above the prior quarter's fair value.
Great. And then can you talk a little bit more about your structure. I understand you're still a BDC but you switched from being a BDC RIC about 1.5 years ago. Could you just talk about the structure and why you switched from being a RIC and what that...
Yes, about 1.5 years ago the growth rate of our asset management company and of European Capital rose much higher than that of our debt assets, obviously, because we have equity in those other 2 companies. And so for -- that was the major reason, but there was, of course, a whole slew of reasons. But we no longer were within the diversification requirements of RIC. And so we started to report as a -- been under ordinary tax -- as an ordinary tax company. And that was actually a good thing because we would have lost our net operating loss carryforwards as a RIC. By then it had accumulated to a sizable amount. And as an ordinary taxpayer, we were able to keep that NOL.
So we, today, are a taxable BDC. We're still subject to the Investment Company Act and still subject to the variety of limitations of the BDC. And -- but even though we are a taxable BDC, we don't -- we haven't been paying taxes on a cash basis because we are -- we have our NOLs that are sheltering us from taxes. And that's working out just fine. We are able to retain our earnings as a taxable BDC as not compelled to pay out -- as a RIC you are compelled to pay out at least 90% of your income as dividends. So instead, we've been retaining our earnings, we've been using it -- or some portion of our earnings to buy back our shares. That's been incredibly accretive. We've been able to buy back $500 million of our shares and produce $1.09 in accretion, which equates to about $330 million of additional retained earnings.
Do you see yourself eventually paying a dividend again or that's out in the future?
We have NOLs that should take us several years into the future, after which we could very well structure ourselves to be able to re-RIC. But that's just one of several options. One is to continue to be a taxable BDC. Another is to possibly spin out the -- our mezzanine debt assets into an externally managed RIC BDC, and manage that through our asset manager, and then do a similar thing to -- with respect our European debt assets. And then the remaining controlled companies, we could elect to move then into being a diversified growth company, like a Roper [ph] or a Danaher and operate in that manner. To do that is a huge hurdle. We have to be able to consolidate and report our companies using -- being Sarbanes-Oxley compliant and report on a GAAP basis segment-by-segment in a consolidated manner. That is extremely difficult to do and to get all of our controlled companies being able to be public-reporting compliant.
We have set out a task to do that, so even if we are a taxable BDC, we could elect to report both on a fair value basis and on a consolidated basis on a segment-by-segment basis so that shareholders or investors can see through to our segments and see their revenues, their gross margins, their EBITDA margin, CapEx and cash flows. And so they can judge for themselves whether our fair value is appropriate or not. So we're working hard on that. We don't have a timeline when we -- or when we could ever do that. But it would be applicable whether we stay a taxable BDC, whether we re-RIC at some point because we could still have controlled assets that we might want to disclose in that fashion. And it would be required to do that if we elected or attempted to become a diversified growth company. Diversified growth company has substantial hurdles to get over. Any other questions?
I'll just wrap it up with one last question. Maybe just talk a little bit more about who you are competing with day to day in each of your businesses, the buyout business, the managed business.
In the buyout business, we're competing with, foremost, strategic buyers who are winning about 75% of all the bids to buy companies. The other 25% are private equity firms that we're competing with in the middle market. We are prepared to do variable sizable transactions. So the last one we did in December was $200 million for a company called CML, which is a company that provides chemicals and drugs -- produces drugs for the discovery process in the pharmaceutical industry. And that was a $212 million commitment on our part. We were prepared to go up to $700-million- and $800-million-size transactions. And so in many cases, there would be a lot of private equity funds who we wouldn't compete with if we were to do transaction of that size.
On the Sponsor Finance side, we're competing with 40 different BDCs and other mezzanine funds. Not all those BDCs would be able to do the size of Sponsor Finance investing that we do. We're prepared to go up to $150 million of investing and -- though we would probably syndicate out some of those assets so that we had a more granular pool of mezzanine assets.
Great. There's no other questions. We could just end it here. Thank you so much for participating.
Thank you very much. I appreciate it. [indiscernible]
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