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American Capital Strategies - Assessment

Valuation:

American Capital Strategies is an interesting company to value. The company itself is working to change the market's assessment of its business. Management has argued that it is incorrectly lumped in with the low-multiple BDC sector. They point out that their private equity business and asset management segment warrant multiples closer to groups like Fortress Investment Group or Blackstone.

The dividend has historically been reliable and steadily increasing at a compounded rate of 10.63% annually. Using the dividend discount model, I get an intrinsic value around $46-$52 per share depending on assumptions used. If I use their dividend as cash flow for the investor, my DCF values it around $46 - $48.

The company calculates net asset value at $35.54 per share so the stock is trading near a historically low price-to-book multiple (~1.2). Wall Street scuttlebutt suggests that book value may be marked down in the near future so the P/B may be shaky. But taking it at face value and using the historic average of 1.5 P/B multiple gives us a value of ~$53. 1.3 P/B gives us ~$46.

Tightening the range, I'm comfortable setting an intrinsic value around $48 - $52.

The Skinny:

One of the main reasons I'm researching American Capital is exposure to alternative assets, i.e. private equity. Of course, the granddaddy of all public "private equity" companies is Berkshire Hathaway. As much as I admire Warren Buffett, an investment in Berkshire is not attractive for several reasons. One could argue that human capital is Berkshire's greatest competitive advantage and with Buffett, Charlie Munger and Lou Simpson approaching the end of their careers, that advantage is in jeopardy. But the main reason is Berkshire pays no dividend.

American Capital is a value-oriented private equity company available for retail investment with a generous, reliable return through dividends. Share price appreciation has also been stellar. The management is shareholder-friendly. They have weathered one credit crisis, a recession and recently grown to record heights, never reducing the dividend even in rough waters.

So what's the problem?

The name says it all: "American" - too much exposure to the American economy and more specifically, to the US dollar. The company's loan portfolio is experiencing record low default rates. There is only one way to go from here. Taking a look at a few of their portfolio companies like AAMCO Transmissions or ASAlliance Biofuels (ethanol) suggests that many, if not most, of AmCap's portfolio companies have little international exposure. ECAS (Europe) only gives them 17% exposure. So we'll get little global downside protection if the US economy slows down, unlike most companies in the S&P 500.

ACAS' habit of following trends is troublesome (late to the dot.com, financial engineering, asset management and ethanol bubbles) but their operating history suggests they can more than compensate with their value-oriented approach to the capital markets.

The company has some ambitious plans in the works and plan to offload much of the current portfolio into private funds managed by their affiliates. This should free up their balance sheet while smoothing out their lumpy earnings with increased fee income. Their market position is solid, the transition to more asset management looks good and the operating history is quite impressive. But my concern is they will not be able to create value and return cash to shareholders faster than the government can debase the currency.

For that reason, I'm insisting on a large margin of safety before making an investment.

DISCLOSURE: Please see our portfolio page for all disclosures.

This report reflects the research and analysis I've performed on this company. It is provided for informational purposes only and does not constitute personalized financial advice nor an endorsement or solicitation to purchase stock in this or any other company. Please do your own due diligence or hire a financial advisor before making any investment decisions.

The author received no compensation and is not affiliated with the company reviewed in this report with the possible exception of being a shareholder. The author reserves the right to buy or sell the stock as deemed personally prudent without further notification














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