An American Capital Strategy for 2008

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Conservatism seems to be the name of the game at Income Investor recommendation American Capital Strategies (Nasdaq: ACAS).

On Wednesday, the company announced its results for the fourth quarter and full year of 2007, and gave its outlook for 2008. Taking the bear by the horns (can you even do that?), the company started with the assumption that the U.S. will slide into recession in 2008, leaving the company unable to raise any new capital. Far from pessimistic, CEO Malon Wilkus almost seemed excited to prove that the company will "continue to perform well in 'steady state' mode."

So what might this look like for investors? To start with, the company reiterated its 2008 dividend forecast of $4.19 per share. If it delivers, that would be a 13% boost from 2007, and a 12%-plus yield on the current stock price. The company has already gotten a head start bringing these dividends to fruition, too -- it announced the rollover of excess taxable gains from 2007, which will cover nearly two quarters of 2008 dividend payments.

This assumes, of course, that things don't go too far off the tracks for American Capital in the coming year. Though 2007 ended well on the whole, American Capital's portfolio took a hit in the fourth quarter. Overall, the company took a $417 million unrealized loss, primarily from the decline in value of its ownership stake in European Capital and mark-to-market declines for its commercial mortgage-backed and collateralized debt. So far, it appears that the losses the company has taken are primarily market-driven -- as opposed to fundamental-driven -- but that will certainly be tested if we do head into genuine recession territory.

American Capital finished the year with a net asset value (NAV) per share of $32.88, up 12% from the prior year. This puts the stock slightly above NAV, giving it a premium valuation similar to peers like Prospect Capital (Nasdaq: PSEC) and Allied Capital (NYSE: ALD), but above other business development companies like Apollo Investment (Nasdaq: AINV) and MCG Capital (Nasdaq: MCGC).

The valuation likely reflects the greater confidence that investors have in American Capital's portfolio and the management team's ability to navigate troubled waters. If American Capital's recession projection is right, the company will certainly have a chance to prove whether this confidence is warranted.

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