A long time friend of mine and fellow writer here at Seeking Alpha, Brett Moll, and I often share investing ideas. In particular with Brett, small cap stocks as well as companies undergoing dramatic turnarounds often take a front seat in his research. Since I seem to take interest in larger cap stocks, oil and gas companies, and options, sometimes our investment philosophies clash. Oddly enough, somehow we both seem to make money despite our differences, but that doesn't mean we never exchange heated text messages throughout the day. I prefer to call it a healthy and honest discussion.
Our latest topic of debate was American Capital Ltd. (ACAS). Since I never invest based solely on anyone else's research results or opinion, I had to do my own research despite Brett's long position and recommendation. After all, Benjamin Franklin once said: "An investment in knowledge pays the best interest." Following those words, I decided to dive head first into ACAS myself.
Summary of Assets:
ACAS is global asset manager for over $20 B of assets, which includes assets on its balance sheet and fee earning assets under management by affiliated managers, with $117 billion of total assets under management in mainly the US and Europe. Most notably, these assets include American Capital Agency Corp. (AGNC), which has roughly $10 B of net book value, and American Capital Mortgage Investment Corp (MTGE), which has roughly $1 B of net book value.
In the latest 10-Q, ACAS had over $5 B of investments in 127 companies, ranging from sectors including auto components, IT services, pharmaceuticals, etc. I created this pie graph to display the wide array of industry exposure:(click to enlarge)
Using different financial instruments but mostly common stock, ACAS has a complicated mixture of investments, many of which are "level 3", which means they "cannot be corroborated by observable market data". This is to be expected in a BDC, and perhaps is the cause of the stock's discount to NAV. (click to enlarge)
It seems ACAS's portfolio is fairly well rounded, and is run more like a mutual fund than a BDC.
My thoughts on NAV and Dividend:
ACAS doesn't pay a dividend, but is instead buying back an immense amount of stock, which in my view is the main cause of the NAV increasing. The company is utilizing a tax shield as a C-Corp. that should carry through 2014, then the company could reinstate a dividend, which at current FCF levels could yield north of 9%/share.
In Q3 2013 alone, management repurchased 13.4 M shares, producing $0.29 in accretion to NAV per share. Take note ACAS net NAV grew $0.26, or $.03 less than the share repurchase contributed. Therefore, we can assume NAV of the existing portfolio itself actually decreased by $0.03 in the quarter. Management has repurchased over 25% of stock in the last 2 years, and the repurchase program has been extended through December 2014.
While suffering from a BB- credit rating, ACAS is highly dependent on interest rates and credit quality ratings. However, some say the company's ratings are set to improve going forward, so the future is looking bright considering possible Fed action. There is also talk of the dividend being reinstated sooner than later, as the company's discount to NAV should decrease once the dividend is reinstated; a catalyst many investors are anticipating. Hopefully, subsidiaries AGNC and MTGE can survive the pending rate increases going forward, as ACAS is linked to their performance. In the recent quarter, ACAS took a $119 M writedown due to a reduction in projected management fees from the managed mREITs.
BDC's are risky businesses in general, but ACAS seems like a great option within the sector. With share repurchases destined to grow NAV, the company seems to be on cruise control until the big catalyst occurs; dividend reinstatement. I also view ACAS as a less risky thus preferable route to indirectly gain exposure to AGNC.
Additional disclosure: I am long NLY-D