Skeptical About American Capital Strategies - But Not Enough to Stay Away

American Capital Strategies (ACAS), the largest Business Development Company ("BDC") and the only one in the S&P 500, has just reported 3Q 2007 earnings, and provided guidance for 2008. Regarding the latter, ACAS is projecting-with great confidence because most of the funds for distribution will be coming from already realized gains-$4.19 in 2008, versus $3.72 in 2007, a 13% increase. Comparing the IVQ 2007 dividend (just raised to $1.00 yesterday) to the IV Q 2008 projected dividend, the increase will be 10.0%, viz. the AA rating. We had previously expected a more modest 6% increase in 2008, given the summer credit crunch.

Our confidence in the ACAS projection is high, partly due to the fact that the Company's Net Operating Income from interest and dividends is covering 80% + of the dividend. Another confidence boosting factor is that ACAS has announced nearly 75 cents a share of realized gains spilling over from 2007 into 2008. Finally, ACAS has just announced a change in its dividend policy: all long term capital gains will be retained rather than a deemed distribution paid. This will leave ACAS with more spillover income to use to manage the dividend.

Long term we're still concerned about the level of non-accruing and non-performing loans at 5.5% of portfolio face value. We also are concerned about the increasing disparity between the dividend obligations (increasing due to ever higher pay-out per share and constant new stock issuance) and the Company's recurring portfolio income from yield investments and fees from managed funds. Management is confident capital gains will continue (albeit up and down) at a sufficient level to be a major contributor to the dividend. We're skeptical over the long term , but not enough to stay away.

Disclosure: Author has a long position in ACAS

NOTE: We rate high-yield dividend stocks on an A-D scale. A stocks are expected to increase their dividend over the next twelve months by 3-8% , AA by 8-13% and AAA by 13% or more.

• B stocks are not expected to increase their dividend by more than 3%.
• C stocks are expected to decrease their dividend.
• D stocks are not expected to pay a dividend