ACAS’ Survival Chances? Your Guess As Good As Mine

A reader emailed a question regarding ACAS:

“I really like you posts on ACAS. I have lost so much money on this wooffer that is
beyond pain. No, actually the pain is still there.

Without holding you liable in any way, shape or form, is this thing going under? If
you take a two year view and say that the US gives itself a good shake in 2009 and
shows signs of life after death, what is the recovery potential for ACAS?

I just don’t buy the 1930′s scare stories and get ticked off with people who should
know better spreading fear for fun. I am not American but have always been
impressed with the no-holds-barred grit that America always displays when it
realizes that it has a problem and fixes it. There is a long list of events going
back 30-years including S&L, LTCM, Enron etc where the SEC et al made a very
determined effort to fix things and largely did.

What do you think?”

Bob, thanks for the question and for reading. Before answering the question, readers should note I have sold my entire ACAS exposure at 70% loss and am no longer following the stock.

It took me two days after ACAS’ Q3 call to finally get my bearings and sell the stock.  Trying to answer your question back then was literally keeping me up at night and I finally realized that I couldn’t get a good handle on the probabilities going forward.  I broke down the key questions as these:

  1. What will ACAS’ leverage ratio be by YE and will they become forced sellers?
  2. Will they be able to pay investors the roughly $1.40 promised to shareholders by Sept 09?

My sense was that ACAS no longer has “majority” control over their NAV but rather, NAV will be dictated by what’s happening in the financial markets.  If the markets continued to drop (and they have, big time), it seemed likely ACAS would violate their mandated leverage ratio and debt convenants.  Also, keep in mind non-performing loans jumped two percentage points to 10.7% and this recession is just getting started. Seeing that management entered 2008 assuming a recession as the baseline case and still got blown out of the water, I lost confidence that ACAS could keep non-performing loans below the last recession’s high of 15%.  It seemed to me that the bullish case for ACAS as of Q3 rested mainly on a rising market and/or SEC suspending mark-to-market accounting which is a scary place to be.

As for the rollover payout to shareholders, September 2009 seems so far away but it is a case where either that dividend gets paid or their business doesn’t exist in its current form.  The fact this is even a concern should have told me all I needed to know and frankly, I’m not even sure why it took me two days to figure this out.

There were warning signs along the way, even in the beginning.  I knew they were trend-followers but decided their track record was good enough.  I had begun losing confidence in September when I jumped at the chance to sell out of my initial position at $24.30 but for bad reasons, refused to close out the Nov $22.50 put option at a loss (since it was out-of-the-money).  I didn’t maintain discipline and I paid for it dearly.

So whether it will survive or not, I don’t know and can’t put odds on it.  You may have a better handle and I won’t be surprised if ACAS taunts me one last time by recovering to previous levels.   I don’t like taking bets where I don’t know the odds of winning and don’t know the stakes for winning.  I remember Mohnish Pabrai’s foray with Delta Financial which had long-standing competent management but were victims of the unprecendented crisis.

Even if ACAS survives, what are their prospects going forward?  Forced deleveraging with a portfolio of illiquid, depreciating assets is a bad place to be if they get there.  Even if you don’t appreciate talk of “depression”, a severe recession is a distinct possibility and I would say more likely than not.  How will ACAS’ portfolio hold up in that?  Also, Wilkus was gloating about being taking advantage of widening credit spreads but now that ACAS is deleveraging, they will be unable to do so.  Finally, my investment thesis was based on trust in management (shattered) and the dividend (slashed and in question).  Once I’m wrong, it’s time to get out.

That was my thought process.  It could be utterly incorrect (as regarding ACAS so far, it has been) so read the disclaimer and remember, YMMV.

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6 Responses to “ACAS’ Survival Chances? Your Guess As Good As Mine”

  1. Thomas Simon Says:

    I agree with you analysis of ACAS. I was not as smart as you were and did not sell my relatively small position. I am wondering that a lot of the bad things that may be coming to them is not already priced in, and the present selling is more the result of forced selling by mutual funds and hedge funds (partially because the stock is now under $10 and a lot of funds can not hold sub $10, or sub $5 stocks).

    Rgds: Thomas

  2. andy dee Says:

    I don’t blame you for selling your shares, however, that’s not my course of action.

    ACAS’ NAV at the end of Sept was $24.43. Acquisition of EAS will add approx $1.25 to that. Right now you can by a share of ACAS for about 15% of that. I think buying shares below $4 is precisely what a self-proclaimed value seeker would do.

    My rationale for purchasing more ACAS at this time…(I own ACAS already at an average cost per share, including reinvested dividends, of $16.86.)

    If ACAS remains a BDC, and RIC, it will pay dividends of about 95% of NOI, probably annually. Next year there will be a payout of $300M, the residue of $518M, earned in tax year ending Sept 30 ’08, roughly $1.35/share. Going forward ACAS will payout something between 90 and 98% of NOI, say 95%. My assumption is that NOI in 2009 will approximate 70 cents a quarter, and therefore payout will amount to $2.65 – probably paid out by end of Sept 2010. So roughly, payout over the next 22 months will equal the price I pay for a share on Friday, Nov 28.

    What’s the likelihood I’m wrong about 2009 NOI? — there’s a finite chance for sure, especially in the event of a significant crash in the market, but in the absence of such, it is a good bet, imo.

    I believe ACAS is better prepared to survive this recession than they were in 2001-2002, precisely for the reasons Malon talked about on the Q3 CC — this time the portfolio companies are larger, have more EBITDA, better interest coverage, and fewer are in cyclical industries. I also disagree that ACAS is a trend follower, as you state. The FACT Team, the Operations team, their data base of opportunities, visibility, choice of deals, etc. make them the “class” of the BDCs.

    But suppose I’m wrong? What then?

    Well my assumption is that management will do whatever is necessary to have the entity survive this recession. And if they survive, they will thrive in the next upturn.

    What evidence do I have?

    It’s intuitive, not concrete.

    For years, or at least for as long as I’ve been a shareowner, Malon talked about ACAS’ record on dividends…”Never missed a quarter, never reduced”. It was a point of pride, and frankly one of the principal reasons I purchased shares. Well he’s had to swallow his words, and to his credit he has. His motivation? The viability of “his company”.

    I see Malon as identifying with ACAS…it is “his company”, and he will keep it “alive”…imo.

    I see a foreshadowing in his suspension of quarterly dividends of what might happen should the market and the economy continue in a deep and lengthy recession, and liquidity and credit continue to be issues. I think Malon will abandon the RIC or BDC requirements and restructure the company to survive.

  3. Recommended Readings - Nov 28, 2008 | Old School Value Says:

    [...] ACAS’ survival chances? Your Guess As Good As Mine presented by The Enlightened American [...]

  4. andy dee Says:

    BTW Troy Ward of Stiffel-Nicolaus spent a bit of time with Malon Wilcus as they traveled to 15 of SN’s clients. Ward wrote about it in his latest note, Nov 24, on ACAS. Without permission, but with thanks, here is a portion of the report…

    “We believe there are three potential structures that ACAS may evaluate.
    1. Remain a dividend paying BDC (pass-thru entity)
    2. Become a Taxed BDC (all else same but pay taxes and retain the earnings)
    3. Become a C-Corp (55% of assets must be control and must consolidate financials)

    “The first thing to understand is how the calendar works with regard to ACAS. Its tax year ends September 30th, and
    decisions regarding corporate structure/taxation extend from that date. For example in the tax year just ended
    September 08, ACAS has an additional $300 million it either have to pay out as a dividend or chose to be a tax-paying entity and pay taxes on earnings.

    “Paying taxes this year is very unlikely because if ACAS were to become a tax-paying entity it would have to pay taxes on all of the income it earned for that tax year, and much of that has already been paid out to shareholders in 2008 dividends. Based on management’s comments it appears the tax bill would be roughly $300 million which is the same amount ACAS is required to pay shareholders in dividends to avoid taxes this year. Hence we believe it is highly unlikely that ACAS would pay taxes for the tax year just ended, instead distributing the remaining $300 million as a dividend (more favorable for ACAS shareholders).

    “The decision becomes a bit more uncertain in the current tax year which ends September 2009. ACAS does not have
    to make the decision for that tax year until June 15, 2010; this is the last date to declare if they intend to distribute the
    earnings as dividends or pay taxes instead. If the market improves ACAS may choose to remain a dividend-paying
    BDC; in which case nothing changes and ACAS would distribute its earnings the same way it always has, through
    shareholder dividends.

    “Alternatively, ACAS could choose to be a “tax-paying BDC”, but we believe this is an unlikely choice. The structure
    would remain the same but instead of distributing dividends ACAS would pay taxes and retain the earnings. While this structure would allow ACAS to retain earnings (pay 40% tax and keep the rest) it does not change other structural limitations of the BDC model that we believe have proven to be quite burdensome in the current environment. Most notably is the mark-to-market of the asset base which has led to substantial volatility and adverse affects on the credit facility covenants. As a taxable BDC ACAS would also still be subject to the 1:1 debt/equity limitation, the treatment of preferred equity as debt and the restriction of issuing equity below book value. Based on this we do not believe ACAS will choose to become a tax-paying BDC as it doesn’t alleviate much of the current stress.

    “Finally ACAS could decide to change its structure completely and become a “taxable C-corp”. If the current
    environment persists (below book value and lack of ability to raise equity) we believe this could be an option for ACAS.
    It is worth noting that ACAS may be the only BDC that could realistically transform itself into a C-corp. The biggest
    hurdle for most BDCs would be having 55% of their assets in “control” investments and no more than 45% in
    “investments”. ACAS has approximately 50% control investments now from deals it closed in 2005-2007. While it
    would have to do some portfolio restructuring, reaching the 55% hurdle is not out of the realm of possibility, in our view.
    However just having control assets isn’t enough. The financial statements for all control companies must be
    consolidated, which would be a monumental task. Currently ACAS likely has the manpower to tackle an effort this
    large; however as we move through 2009 we suspect continued downsizing at ACAS which would likely cause staff reductions in its due diligence and accounting departments. The consolidation could and may happen but we believe the manpower needed will come from internal and external professionals. Beyond the complexity of consolidating the financial statements, we believe ACAS would likely also need to lower the overall leverage of the portfolio. ACAS portfolio companies are currently leveraged approximately 6 times EBITDA and ACAS has an additional $4.5 billion of debt. When consolidated, the portfolio company debt to ACAS would be eliminated, however ACAS has syndicated many of the senior pieces and slices of the equity in these buyouts to other investors/funds. While this may all be manageable, it appears to us that overall debt would have to be reduced and the complexity of a corporate conversion would be very high.

    “It is far too early for us to predict what structure ACAS will adopt in 2010, but it appears to us that these options are
    seriously being evaluated. The key takeaway is we do not believe ACAS will pay any dividends until potentially
    September 2010 (other than the required $300 million, or approximately $1.30/share, payable in September 2009).”

    I have two areas od disagreement with Mr Ward’s report.

    First, if a “C” corp is the only means to remain viable, ACAS will do what is necessary to get there. However, to imagine that what we have seen in the last 90 days will continue on throughout 2009 is to imagine one of Dante’s levels of Hell.

    Second, I think Troy got the key takeaway wrong…the key takeaway is that ACAS will remain viable, and ultimately will thrive…

  5. P-man Says:

    What are the chances of revising FASB 157 mark to market accounting becoming more realistic to a credit lockdown scenario?

  6. Davy Bui Says:

    Andy, thanks for your comments. I think they will help readers make a better-informed judgement one way or the other on the stock.

    P-man, I have no idea what the chances are on revising or suspending mark-to-market accounting. Part of my reasoning was that it seemed ACAS’ survival seemed more dependent on factors outside of their control than what they could control.

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