American Capital (Nasdaq: ACAS ) is a business development company (BDC) that provides financing via mezzanine and senior debt to primary middle market companies as well as managerial assistance when needed. It also provides capital directly to privately owned and public companies, and it sometimes takes a small equity stake in the company. Essentially, it can be viewed as a way for investors to enter the highly lucrative but risky venture capitalist/private equity company space, with the requirement that 90% of its taxable income be distributed to shareholders. Shareholders (including this ex-shareholder) have done extremely well since its 1997 IPO, with a total return of 500% with reinvestment of dividends.
One thing that is commendable about American Capital is the wealth of information (including a newsletter!) it provides for shareholders, not only on its website, but also with the earnings releases. To touch upon some of the key numbers that investors should be looking at, the fourth quarter dividend was increased to $0.88 a share, 11% higher than last year. Realized earnings increased 41% to $1.14 a share, and net asset value per share (NAV), a key valuation measure for BDCs, grew 20% year over year to $27.96. It was an excellent quarter, and with American Capital investing $1.2 billion in the quarter, the future is looking bright.
The publicly traded BDC field is fairly small, ranging from Allied Capital (NYSE: ALD ) to Gladstone Capital (Nasdaq: GLAD ) , Apollo Investment (Nasdaq: AINV ) , Prospect Energy (Nasdaq: PSEC ) , and Ares Capital (Nasdaq: ARCC ) , among others. However, with the possible exception of Allied (which is a distant second), no single company has the scale and breadth of investments that American Capital has. This is evident when you consider that it recently collected $1 billion from private equity investors for an investment fund, and last year launched a company subsidiary to invest in Europe. That subsidiary is now funded with more than $2.1 billion in capital.
Potential investors and shareholders should also pay close attention to the pooled portfolio data that American Capital provides with the earnings releases. These charts pool the company's investments by year, and show how each pool is performing in terms of loan quality, internal rate of return (IRR), and portfolio valuation, among other factors. Assuming the firm exits all of its investments at current valuations, American has achieved a 16.2% IRR since 1997, and 19.2% IRR since 2001 -- both numbers I think any Foolish investor would be ecstatic with. And to keep management honest with regards to company valuations (a potential area for misrepresentation), the company has retained valuation expert Houlihan Lokey since 2003 to regularly evaluate portfolio valuations.
All in all, this is an extremely well run company, and one that I regret selling. Since the company is trading at one of the highest valuations among BDCs at 1.5 times NAV, it is difficult to justify future outperformance from these shares. Investors might be better served looking at skilled players trading at lower valuations like Prospect Energy and Ares Capital for potentially strong returns.