I have written about American Capital (ACAS) several times in the past, recommending it here when it was trading at $6.50 on October 6, 2011, and here when it was trading at $9.68 on May 1, 2012. I have been loyal to this stock since I started accumulating in 2009 at a price below $2. It closed Tuesday at $ 14.30 and, given its substantial appreciation in the past 4 years, a reassessment is in order.
My general approach to the stock market grows out of my experience fishing with my father. He was a "bottom fisher" and we would sit there waiting patiently for bites which gave us quite a bit of time to talk, enjoy the weather, and share a few beers. For some reason, bottom fishing has become my approach to the market and I am always trying to find discounted equities and bonds. This does not mean that I eschew quality or growth - I just don't want to pay too much for them.
Anyhow, ACAS has continued to trade well below Net Asset Value (NAV), which - as of the close of the last quarter - was calculated at $19.04 a share. ACAS has become a complicated and diverse company and so it is important to understand its constituent parts. I generally consider ACAS as having seven elements which add up to its NAV. The table below provides the total fair value (in millions of dollars) of each element and the fair value per share (based on end of the quarter share count of 297.8 million shares); it also includes that information for ACAS borrowings.
|Fair Value||Per Share|
|Deferred Tax Asset||$452||$1.52|
All information is based upon SEC filings of ACAS. The net NAV does not total $19.04 due to rounding errors and the omission of some small miscellaneous items.
An understanding of ACAS and its likely future trajectory requires an analysis of each of these components.
1. Cash - This is simple enough. I have included restricted cash and I have also included interest and dividend receivables as of the end of the last fiscal quarter.
2. American Capital Asset Management (ACAM) - ACAM manages two agency mortgage REITs and also various CLOs and CDOs. Its assets under management have been growing rapidly as the popularity of its REITS - American Capital Agency (AGNC) and American Capital Mortgage Investment (MTGE) - has led to large public offerings of new stock. ACAM does not earn fees on the total gross assets these REITs hold but is paid based on investor capital. Because these REITs are very highly leveraged, this makes a big difference. The total assets ACAM has under management are now over $100 billion but ACAM is earning fees based upon a much smaller number. Still, ACAM is cranking out very solid earnings and has been steadily growing fee income. Barring a major economic dislocation, ACAM is likely to continue to grow fee generating assets under management and its valuation is likely to continue to increase.
3. European Capital (ECAS) - ECAS is also a candidate for fair value appreciation. ECAS operates somewhat along the lines of ACAS as a whole with a focus on Europe. Its current fair value includes two large discounts which may gradually disappear. First of all, ECAS is valued at a $142 million discount to the fair value of the assets it owns. This is apparently based on a going concern approach to asset valuation. Over time, the ECAS fair value should converge with the net asset value of its holdings. Secondly, ECAS holds debt instruments which are being carried at a fair value of $105 million less than their face value due to a "bond yield discount." Essentially, the yields on certain debt instruments are below current market yields for analogous instruments; as the debt instruments mature and are paid off, asset value will converge upon face value.
4. Structured Products - Structured Products are largely junior tranches in CLOs and CDOs. These took a beating during the Crash of 2008-09 but have recovered. In fact, in recent quarters, these junior CLO and CDO tranches have generally done well in the marketplace as credit quality has recovered.
5. Sponsor Finance - This includes debt instruments held by ACAS and issued by companies in which ACAS does not have a controlling interest. It includes a significant component of secured debt.
6. Operating Companies - This includes debt and equity holdings in companies which ACAS does control. It appears that there is roughly $1.5 in equity with the rest in debt. ACAS sometimes makes senior debt of operating companies available to other lenders and thus there is a limited amount of leverage in these numbers. The operating companies themselves are diverse in terms of both location and business orientation. ACAS has a good track record selecting and nurturing companies in this space.
7. Tax Asset - ACAS has tax loss carry forwards and thus can earn income and avoid paying taxes for a number of years. ACAS is unusual in the BDC community in that it is not a RIC (regulated investment company) and so ACAS is not subject to the rule requiring RICs to distribute 90% of income as dividends.
I think that a reasonable expectation is that ACAS will continue to experience growth in NAV per share due to the gradual decline in the ECAS discounts, increases in fair value for ACAM, accumulation of cash from dividends and interest on holdings, and share repurchases at prices below NAV. ACAS management appears to be very shareholder friendly and ACAS has been aggressively buying back stock with a substantial positive impact on NAV per share. ACAS has an announced policy of share repurchases as long as its stock trades substantially below NAV and this has worked out well for investors. I think that NAV should increase at $2.50- $3.50 per share per year for at least the next year or two and that share prices should increase somewhat faster as market cap gradually converges with NAV. I am still long ACAS at the current price and I think it remains a strong and promising investment.