najdorf

Re-examining My American Capital Strategies Position

I was also confused by Davy's point about the share price, but I think what he's saying is that the current share price could be an accurate estimation of future write-downs to book value, and if these writedowns come to pass the company would be over their legally-mandated leverage standard. If the share price is just an indication of speculative shorting and the book value stays where it is they should be fine.

I appreciate the level of detail in this article compared to many others I've looked at lately. You actually read the report and provided good numbers with interpretation, when most people just make emotional reactions. My one objection is to:

"FAS 157 has already been implemented and there is no catalyst (other than the failure of companies to make debt payments) to force management to write positions down further."

This is true as far as it goes, but it doesn't go very far. The failure of companies to make debt payments has always been and will always be the #1 risk of a company like ACAS. The investability and profitability of the company depends almost entirely on their ability to manage this risk. If you're trying to develop a rationale to hold the company, you should spend 90% of your energy here rather than 1%. The accounting stuff and short-term fluctuations don't matter all that much as long as companies keep making the payments. The writedowns are in large part an attempt to assess the default risk - are they accurate? It's hard to say because we're talking about high-yield investments in small, illiquid, private companies. It's probably even harder to predict than the mortgage market, since no individual mortgageholder has a big impact on a bank's finances, but a few of their larger positions could significantly hurt ACAS by defaulting.

Also, on the share repurchase issue, you won't see this company buy back shares unless the price is below book value, because they are a capital-gatherer, not a capital-returner. Look at the increase in shares over the years. They have to pay out earnings rather than reinvest them, so in order to grow (and raise management's compensation) they need to sell new shares, like a mutual fund. However, this practice is only really valuable to the company if they can trick someone into paying over book value for the shares (since selling new shares at .9 book value is a lot like writing down assets). In the past they were able to get investors at a premium price based on the yield before any credit losses manifested - good luck to them in this market. If the share price goes too low they may be able to help out existing investors by buying back shares below their value, but woe to all concerned if this buyback is followed by writedowns and dilutive capital-raising.

Review of Current Losing Positions: NZT, ACAS, SKM, GE

jjason: I think you're missing several of the points.

Your #3 is nice, but when the book value of a company is largely determined by a number that they make up for loans that may or may not be repaid and business interests that may or may not be profitable, it's concievable that the book value might drop in the future. The fact that the company can be bought for less than said book value is one indication that maybe their internal valuations aren't quite accurate.

Your #4 is also very nice, but companies love to make this claim when they write assets down and it's not always the case. If it's Warren Buffett noting a share-price decline in Coke, maybe you should believe him. If it's some guys telling me that their junk bonds and mortgage-backed securities totally won't default because those underwater homeowners and small companies paying 15% interest are risk-free money, I'm a little skeptical.

#5 really depends on your definition of "over-leveraged". What kind of rate are they paying on that debt? How well is it covered by income? If income craps out, how long before the debt eats up the equity and company has to raise capital at unfavorable terms?

#6 would be sweet if any evidence were attached.

I don't know why people can't just accept that risk and reward go hand-in-hand. You're not getting a risk free 15-20% yield when you buy shares today in companies like ACAS and ALD. You could make a lot of money or you could lose all your money. If you want risk-free you have to put up with Treasury yields.