The market has become so obsessed with dividends that a company buying stock at a 40% discount to net asset value (NAV) is often questioned for not paying dividends instead. In fact, American Capital, Ltd. (ACAS) recently announced completing an 11.4M share buyback in Q3 that will undoubtedly be questioned on the next earnings call.
The company bought the stock at an average price of $10.99, for a total cost of $125M. Considering the substantial purchases below book value, the transactions will add over $0.20 to NAV. A smaller buyback in Q2 at a slightly higher discount to NAV added $0.20.
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 $17.2 billion of assets, including assets on its balance sheet and fee earning assets under management by affiliated managers, with $101 billion of total assets under management (including levered assets).
Instead of re-hashing the past, this article will just summarize that the company changed into a C-Corp for the tax year ended in Q3 2011 in order to take advantage of substantial NOLs. These substantial losses in portfolio companies nearly caused the company to go bankrupt in 2009 as the stock wilted to below $1.
Now the company has rebounded with strong gains from portfolio companies including publicly traded American Capital Agency (AGNC) and American Capital Mortgage Investment Corp. (MTGE). The company gets over $20M per quarter in management fees from these two popular stocks.
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.
The amazing part is that Wall Street doesn't appreciate this plan, no matter how logical it is. Just review the Q2 earnings call and note the amount of analyst questions regarding reverting back to paying dividends.
All companies should have flexible capital allocation plans established. Unfortunately, the nature of the dividend concept has forced companies into a structure of paying consistent dividends no matter the benefits to shareholders. Not to mention that outside of REITs, MLPs, or RICs, companies tend to pay dividends substantially less than financially feasible as to not be forced into reducing payouts in the future. A big taboo on Wall Street.
Including the Q3 buyback mentioned above, the company has purchased 43.6M shares, or 13.7% of the outstanding shares. The average purchase price has been $9.00 and totaled $392M. Through June 2012, the purchases were $0.65 per share accretive to the NAV.
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. Based on Q3 stock buybacks, earnings, and likely portfolio asset appreciation, the NAV could easily top $17. The stock though continues to languish significantly below NAV at $11.57. It would need to appreciate another 47% to equal NAV.
Another interesting point is that American Capital trades at a substantial discount to other Business Development Companies (BDCs) such as Ares Capital (ARCC) and Main Street Capital (MAIN). This chart highlights the NAV discrepancies over the last year.
Any investor investing over the last year can't complain too much. The stock has moved higher virtually every month in that time period. Anybody holding longer term would clearly be disappointed as the stock traded around $50 back in 2007.
The following chart compares the stock to the portfolio companies and the BDCs over the last year.
American Capital offers substantial value over investing directly in the portfolio stocks or competitors in the sector. While investors remain concerned about the ability of the company to execute or the lack of the dividend, it hasn't stopped the company from maintaining a similar gain for investors. Going forward though, American Capital has the ability to outperform the sector due to a substantial valuation discount.
Additional disclosure: Please consult your financial advisor before making any investment decisions.