Please ensure Javascript is enabled for purposes of website accessibility

American (Re)Capital

By Christopher Singley, CFA – Updated Apr 5, 2017 at 9:22PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The business development company makes a rare share repurchase.

On Monday, TMF Income Investor pick American Capital Strategies (Nasdaq: ACAS) announced its plan to repurchase half a billion dollars of its own stock. That's an attention-getting announcement, since share repurchases by business development companies (BDCs) like American are as rare as hen's teeth. 

Though there are probably others, only one previous example springs to mind. MVC Capital (NYSE: MVC) returned some funds to mutinous shareholders in 2002, following the implosion of its original tech-bubble business model. However, American Capital is an investing gorilla, not dot-com roadkill, which makes this repurchase plan even more unusual.

BDCs are usually sellers
Congress established the BDC structure in 1980 to encourage an efficient flow of capital from the public stock market into small private businesses. As part of that encouragement, business development companies can avoid paying corporate income tax, as long as they distribute at least 90% of their taxable income to their shareholders. The hefty dividends BDCs pay prevent them from retaining earnings, so if they want to grow their portfolios, they usually need to raise money by selling more stock to the public -- just as Congress intended.

So one expects successful BDCs to be serial equity issuers, as exemplified by the prodigioussecondaryofferingsofAmericanCapital. The company raised more than $2 billion from stock sales during 2007 to fund a brisk pace of new investments. American's stock offerings priced at an average of nearly $44 per share, or about a 33% premium to the adjusted book value I calculated in my last article on ACAS.

So why is American buying?
It sounds like a puzzle: If American Capital is growing rapidly, and it's not retaining earnings in the traditional sense, then how can it shrink its equity capital base through stock repurchases? In fact, ACAS is transforming its business model from a pure BDC into more of an asset manager, giving the company access to other sources of capital besides the public stock market.

Over the past two years, American Capital has raised almost $2 billion by seeding three private equity funds, and it's gained another $1 billion from securitizations. At the same time, its core investment portfolio has grown so large and so seasoned that ordinary loan repayments and exit transactions (such as sales and recapitalizations of portfolio companies) provide a substantial source of cash to recycle back into the business. Such diverse funding sources give American more flexibility than most BDCs to take advantage of opportunities, as demonstrated by its current buyback plan.

ACAS stock is cheap, and repurchases add value for shareholders. Yesterday's closing price of $31.21 per share offers a discount to my own estimate of ACAS's net asset value. Obviously, long-term shareholders win if the company sells stock at $44 and buys it at $31. Buy low, sell high -- sounds like some sort of a plan.

Further Foolishness:

American Capital is an Income Investor recommendation. Discover our full lineup of dividend dynamos with a free 30-day trial subscription.

Fool contributor Christopher Singley manages investment accounts that own ACAS stock. MVC is a Hidden Gems recommendation. The Fool's disclosure policy is worth investing in.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

MVC Capital, Inc. Stock Quote
MVC Capital, Inc.
MVC

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
329%
 
S&P 500 Returns
106%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 09/24/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.