American Capital Strategies, Ltd. (ACAS)

gameguru (< 20) Submitted: 5/07/07 12:56 PM : Start Price: $39.05 ACAS Score: -35.70

I love it when a stable, well-managed, and growing company temporarily stumbles – those are the times when opportunity starts knocking.

American Capital Strategies recently missed earnings by a hefty amount, but lumpiness in earnings is to be expected from a company that makes its money through investments and may encounter sporadic realized gains, as well as fluctuations in unrealized gains. The earnings miss was attributed primarily to a $47 million write-down in unrealized appreciation of one investment (ASABiofuels, an ethanol production company), which remains a profitable investment despite this reduction.

ACAS was founded in 1986, became publicly traded in 1997, and is still run by its founding CEO, Malon Wilkus (55 years young). It is structured as a regulated investment company (RIC), and as such, is required to distribute at least 90% of its taxable income as dividends. Its investments range across many industries (from internet publishing to apparel to chemical manufacturers), and typically take the form of direct investments, entire buyouts, or mezzanine financing.

Management does seem to have a good nose for value, as the internal rate of return on all investments has been 16.5% since 1997 and 19.2% since 2002. Returns on equity investments have been even higher, at about 30% IRR. For the company as a whole, return on assets stands at 6% and ROE at 22%. Dividends have been increased regularly, with the latest a hike of 11%. Dividend yield currently stands at about 7.8%. Total return to shareholders has been about 22% annually since the IPO. In addition to these laudable performance metrics, management tends to present a lot of information with their releases, and appear to be very share-holder friendly.

Using a discount rate of 11.3%, and if you assume that this year’s anticipated dividend ($3.68) can grow for a mere 3% in perpetuity, the shares would be worth about $47 on that basis alone. My fuller valuation model on an earnings basis yields a valuation ranging from $48 with my most pessimistic assumptions (using lowered projections of $3.26 in earnings, 9% initial growth falling to 5% over 10 years, no growth thereafter), up to $60 with somewhat more optimistic assumptions. I think reality will turn out to be toward the optimistic end of the spectrum. At a recent price of $45.80, ACAS is trading at 1.28 – 1.40 times management’s projected 2007 net asset value (which ranges from $32.90 to $35.90). It currently trades at 1.5 times NAV.

For a list of investments, including business descriptions, type of investment, and the amount invested by ACAS:
http://www.americancapital.com/our_portfolio/our_portfolio.h...

Investors interested in ACAS would be well-served to review this TMF article by Stephen Ellis:
http://www.fool.com/investing/general/2006/11/01/american-ca...

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