An activist appears: Elliot Management wants to take American Capital (NASDAQ:ACAS) in a new direction. The activist group announced that it effectively controls 8.4% of American Capital's shares outstanding and wants the company to reconsider a previous plan to break the company in two by splitting its investment assets away from its wholly owned asset-management company.

What Elliot sees in American Capital
Elliot Management takes issue with a number of long-standing problems at American Capital, citing expense issues, operational problems, and an ineffective board of directors as reasons for the company's depressed share price. At the time it put together its presentation, American Capital traded at a 28% discount to its diluted net asset value of $19.72 per share, giving it one of the lowest valuations in its industry.

Elliot's plan calls for American Capital to dial back its recent portfolio growth, using balance-sheet assets to fund share repurchases at a discount rather than new debt and equity investments at full price. This is a common argument, and one that's hard to argue against.

Elliot calculates that if American Capital deployed half as much cash toward repurchases as it spent buying new investments, American Capital's net asset value would have grown $3.61 in 2015 alone.

Furthermore, Elliot notes that American Capital may run into trouble after it spins off its assets into a new BDC. The activist points out that the contract between the new BDC and its manager can be terminated with only a 60-day notice. It opined that the situation may develop into something like what we've seen at TICC Capital, where its existing management team is having a very hard time convincing its shareholders that it should sell its management agreement to another manager. If the asset manager loses that contract, the value of American Capital Asset Management (what will remain after the BDC is broken away from American Capital) will be severely impaired.

American Capital's rose-colored glasses
American Capital appeased the market by announcing that it will put out its projections for the asset-management business when it holds a conference call with analysts. However, the projections appear to be more in line with a "blue sky" projection than a base case. Importantly, it called for a 27% and 8% increase in the fee-earning AUM for its planned BDC and existing mortgage REITs by 2018.

Based on the notes in the presentation, it believes it can grow its mortgage REITs in the future, even though fee-earning assets have declined in all but one year since 2012. Its projections for its BDCs are built on a fee of 2% annually for the planned American Capital Income spinoff -- an increase from 1.75% in its preliminary proxy filing -- which suggests it is willing to spinoff a BDC that simply won't be competitive with recent BDC IPOs.

Assuming that the BDC will grow slightly as it adds leverage also assumes that it won't be pressured to repurchase shares or realize credit losses, neither of which seem like reasonable assumptions. The fee structure almost certainly guarantees a trading price below book value and thus calls for repurchases after the spin.

In short, the Elliot proposal -- scrapping the spinoff, buying back stock, and taking a very close look at American Capital's expenses -- is not only reasonable, but it may also be preferable. That's especially true now that an activist has enough skin in the game to throw a fork in American Capital's uncontested plans. Many BDCs, American Capital included, are highly complicated portfolios managed for compensation. This won't be an easy or quick proxy fight, should it happen.