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American Capital Ltd. Earnings Are the Most Important in Years


American Capital Ltd. (NASDAQ: ACAS  ) is a Business Development Company unlike most others. It doesn't pay a dividend, and it invests primarily in equity, not debt.

When it reports earnings on February 10, it'll face some continued headwinds -- particularly the decline in assets in its mREITs -- but this quarterly report will undoubtedly be one of the most important in recent memory.

A new beginning
By far, the biggest problem with American Capital is that it's unnecessarily complex, divulging very little about its portfolio. When it does care to share, it's often spotty. It breaks out earnings for its asset management company, but it sheds very little light into the hundreds of other companies in which it also owns a stake.

This may be fitting for other BDCs, especially debt BDCs, where performance can be tracked with interest payments and performing loans. Equity investors, however, aren't guaranteed regular dividends. And without regular dividends, American Capital has no way to show its portfolio companies are actually making money.

Last quarter, that all changed. From now on, American Capital will structure its investments so its majority owned portfolio companies can pay regular dividends.

Now it's time to deliver
Currently, American Capital Ltd. only breaks out its earnings in chunks. We know that it made $25 million in dividend income from American Capital Asset Management, the company behind American Capital Mortgage (NASDAQ: MTGE  ) and American Capital Agency (NASDAQ: AGNC  ) and a handful of smaller funds. We also know that American Capital values that business at $861 million.

At $25 million per quarter, or $100 million per year in dividends, the asset management business is yielding over 11% per year.

What about the rest of the equity portfolio?

We know in the first three quarters of the year, American Capital earned $58 million in dividend income, excluding its asset management arm. That works out to about a 4% yield per year. That's about all we know.

Running the numbers
From a cursory glance, the asset management yields three times as much as the rest of the portfolio. This isn't a fair comparison, however. Most of its "other" equity investments can't pay a big dividend, or any dividend at all. The rights of other investors (debt investors) limit American Capital's ability to suck cash out of its companies. Since cash isn't flowing from its "other" companies to the parent company via dividends, we have no idea what these other companies are earning.

That's a problem. Luckily, it's a problem American Capital wants to rectify. This quarter marks the first time American Capital will break out dividends and interest earned from its majority owned portfolio companies.

Doing so is huge. Investors will have a better understanding of what those investments actually contribute. It may allow for American Capital to drum up support for its equity investments, and allow for a spin-off of its debt and equity portfolios to unlock value. Most importantly, it will help investors better understand a company that has consistently traded under book value in every year since 2008.

Transparency isn't the only reason for American Capital's depressed stock price, nor will it guarantee American Capital jumps 25% when it files its next quarterly report. It does, however, create a launch pad on which it can build. 

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Jordan Wathen

"The liabilities are always 100 percent good. It’s the assets you have to worry about." - Charlie Munger

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