Here’s What an American Capital Ltd. Spin-Off Might Look Like


Flickr / Marcy Kellar.

Yesterday, American Capital Ltd. (NASDAQ: ACAS  ) suspended a nearly-3-year-old share buyback program. In the press release, it noted that it was assessing its corporate structure, leading me to believe that a spin-off is imminent.

The question is: what assets will be spun off, and what will a reorganized American Capital Ltd. look like?

From the horse’s mouth
American Capital’s fourth quarter conference call was loaded with questions related to a potential spin off. I went back to look.

In an exchange between an analyst and American Capital management, it became clear that American Capital Asset Management, the company behind American Capital Mortgage (NASDAQ: MTGE  ) and American Capital Agency (NASDAQ: AGNC  ) , is the real prized asset to be spun out.

I agree. American Capital’s asset manager generates relatively steady fee income primarily from its mortgage REITs. The asset manager has also been the single largest source of growth in its net asset value for several years running.

A one-step spin-off
On the fourth-quarter conference call, American Capital CFO John Erickson explained a potential spin-off:

“[T]he better way to think of it would be that you would spin out the BDC and leave the asset manager at ACAS. And ACAS really transforms itself to ACAM.”

This is a simple spin-off where American Capital spins out all of its portfolio investments in a new, publicly-traded entity. American Capital Ltd. then holds just one asset, American Capital Asset Management.

What it would look like
Let’s see what American Capital Ltd. would look like if it separated American Capital Asset Management from its other assets.

The asset manager is currently valued at $870 million. American Capital Ltd. also has a tax asset worth $414 million, which means that it would not pay taxes on the next $1.18 billion in net income at a tax rate of 35%.

Based on the asset manager's 2013 dividend of $105 million, it could generate tax-free earnings for investors for more than a decade.

Valuing American Capital’s asset manager
What’s American Capital Asset Management worth? American Capital thinks about $870 million, but it could be worth far more.

Traditional asset managers like T. Rowe Price trade at 16 times earnings. The same multiple would put ACAM’s valuation at $1.68 billion, nearly 2 times its current carrying value at American Capital.

Would investors pay 16 times earnings for American Capital Asset Management?

Potentially. Remember, asset management requires very little, if any, investment capital. Virtually all of the earnings could be paid out in the form of dividends, which, at 16 times earnings, would result in a yield of 6% per year. (American Capital Asset Management would generate about $0.35 per share in annual income by itself.)

The key is the mortgage REIT business. If American Capital Agency and American Capital Mortgage can reverse their recent course, and trade above book value, they could raise more capital, generating bigger fees for ACAM.

Growth, then, is only limited by investor appetite for high-yield mortgage REITs.

The Foolish bottom line
Spinning out the asset management business may be the best move American Capital has ever made in its history. The asset manager is a unique asset, one which may remain permanently undervalued if held with other BDC assets.

No one can say for certainty that the sum of the parts is worth more than the whole. But one thing is certain: there are many, many investors who would own the asset manager, but not the BDC. That typically sets the stage for a spin-off that creates enormous value for shareholders.

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  • Report this Comment On April 02, 2014, at 8:28 AM, NotMyBusinessBut wrote:

    Jordan,

    Thanks for the article .. but I think you have it backwards and miss a HUGE part of the spin-off scenario. Yes, absolutely, the name of the end-game is going to be ACAM becomes ACAS, that is the core .. but A LOT of the magic comes from what spins off to get there.

    For ACAS to be ACAM, it would no longer be a BDC and there was no question on the upcoming proxy giving management permission (which would be required). So ACAS to ACAM is the last step .. maybe sometime next year with the question on that ballot.

    If you read the 10k, and other filings, you'll find language that indicates a couple things.

    First, through ACAM they are planning to launch 2 new funds .. both probably private, but I think one has a chance to be public .. ACEI and ACE3.

    ACE3 is a private equity fund in the tradition of ACAS's previous ACE1 and ACE2. If/when launched, it would monitize a large swath of ACAS's held equity.

    ACEI (energy and infrastructure) has been in the news lately with investments and personnel placements. It was tagged to be a private fund too, but I think she's making too much noise for that and that it might be the first entity dividended or IPO'd out of ACAM this year.

    Next, the 10k talks about "BDC's" (plural) .. one focused on OneStopBuyout dedt (senior, private, middle market) ... and one on Mezzanine Debt (let's call it AC Private Finance ACPF and AC Mez Finance ACMF). Those could be dividend out to shareholders without proxy approval. From the 10k, ACAS gets an average of 10% on its private finance (even factoring non-performing loans) .. lever that up 1.8x and you have plenty of income to produce double digit returns to the new shares .. AND those would be managed by ACAM with likely a similair deal as the new ACSF (0.8%-1.0% fee on AUM).

    Then there is ECAS .. now performing well .. and also managed under ACAM. No reason not to relaunch that baby or hold it .. and after removing it's BDC status, consolidate ECAS thus allowing ACAS to write up the assets to full value (it is discounted now on ACAS's books).

    So, in the end ..

    ACAM manages:

    AGNC (public)

    MTGE (public)

    ACSF (public)

    ACEI (public - spin)

    ACPF (public - spin)

    ACMF (public - spin)

    ECAS (public - spin/or consolidated on ACAS)

    ACE1, ACE2, ACE3, multiple CLO's (private)

    THAT is the story .. yes .. and what's left is a dividend paying asset manager .. ACAM/ACAS .. but we shareholders get all these dividend paying goodies too!!!

    NMB

  • Report this Comment On April 02, 2014, at 6:51 PM, ferdiefor wrote:

    ACAS management lost so much gravitas they will never be valued with best of breed asset managers. PERIOD!

  • Report this Comment On April 03, 2014, at 8:35 AM, NotMyBusinessBut wrote:

    Oh geeze louize Ferdie .. are you still around trolling on ACAS?

    This coming from a fella who warned everyone from doubling down when ACAS was under $2 .. forgive us if we don't put much weight to your predictions when many of us are sitting on 10x-20x gains.

    NMB

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