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Evaluating a Negative View on American Capital Strategies

My comment about selling equity at a loss can be understood this way. First realize that ACAS has the largest percentage of their total investment portfolio of any BDC in non-dividend paying equity. If they reduce that equity by selling companies they free up cash to get higher paying dividends. To be clear, you can not carry this too far. However, the thought is to move equity to dividend paying debt. Management actually said they were doing just that, and in fact last year indicated in trouble times they can sell some of their equity positions and get more NOI. ACAS by virtue of their large and diversified portfolio, as well as substantial assets where they control the sale event, can selectively exercise this strategy.

We should not expect that the buyers are stupid, they are smart aggressive firms looking to make a solid return as well. A large measure of the middle-market buyout business is what can you do with the company after you have acquired it, via cost reductions and importantly bolt-on acquisitions. ACAS has done a good job of just that. My bet is that they have a number of companies in their portfolio where they feel they can realize substantial gains, based upon their detailed knowledge of the market. This is why they were so emphatic about what their spillover taxable income will be into 2009. They made a point of putting it in their annual report. Again to be clear if we had perfect knowledge, then the stock would not be priced where it is. The overall business climate appears to indicate they have a good chance of success.

Lastly, the commentary from many other BDCs is reasonably consistent with their views on pricing and activity.

Evaluating a Negative View on American Capital Strategies

David is quite right in focusing on the dividend. This is the primary and maybe the only reason to own this stock. The discussion about asset valuations is a tired replay of the last cycle, and simply does not get at the underlying dividend producing power of ACAS. For example, ACAS has such a high percentage of its portfolio in equity rather than dividend paying instruments that they could actually sell businesses at a loss and increase the NOI substantially.

Along these lines the really important statistic is the assets on non-accrual, as that figure impacts dividends and cash flow. The shorts never discuss this, as it is in reasonable shape. I will tell you from other investments, that the assets on non-accrual is the key discussion factor for CSE, NRF, AHR, KFN, all best in class financial companies.

The shorts rely on the inexperience of retail investors. In addition, I believe most institutional analysts are focused on short term trading and really do not know how to make money or build wealth(I was an analyst for over 20 years and interacted with many many analysts).

The short argument is long in the tooth. The economy is improving, debt market liquidity is improving, and transactional volume will start to increase. With many marginal players, not able to get financing, this is increasingly a big boys game.

ACAS is focused on turning part of their portfolio into cash and gains. As the recent analyst day presentations, indicate, the company likely has numerous candidates that it has nurtured for years that can now be sold for substantial gains to rational buyers. If this goal is achieved, ACAS will enter 2009 with even better visibility on the dividend and an increasing NOI. While all this is going on the Company has the earnings backlog and ongoing earnings power, to make this a very reasonable risk reward scenario.

The shorts should be nervous -if ACAS announces another big capital gain, their whole thesis is sunk. This is why they replay such weak old stuff. Can you imagine a whole article on SPL which has been discussed for months.

I was an investor in ALD during the BLX situation, which was a much larger issue for ALD. After all was said and done, the dividend was increased, as well as the visibility. In a normal world, you would think that would stop the discussion. But it rattles on, over things that do not make real economic sense for the dividend.