Just 52 days after an activist took it to task, American Capital Ltd. (NASDAQ: ACAS) is ready to put itself up for sale.
This could be a defining moment for business development companies, which have seen their average valuations fall to less than 80% of book value. If you have any stake at all in BDCs, this is a story worth following.
Here's 3 things you should know now.
1. What's for sale?
American Capital has quite the collection of investments, last valued at about $7.1 billion. Luckily, at least $2.5 billion of its investments should be relatively easy to sell, have been sold, or have already been earmarked for sale.
Its largest investment as of September, $2.2 billion of senior floating rate loans, can be liquidated quickly. The company indicated it planned to have sold a "significant majority" of these investments by Dec. 31, 2015 in a filing with the SEC.
In addition, the company sold approximately $300 million of its $514 million CLO equity holdings in November to an American Capital-managed fund.
The real question marks are:
$1.5 billion of sponsor finance investments
$1.2 billion buyout investments
$1.1 billion asset manager
$556 million European asset manager
Other BDCs would be the perfect bidders for its sponsor finance and buyout investments. After all, sponsor finance (financing a private equity investor's buyouts) is what most business development companies do. Some also hold larger debt and equity stakes in small companies, which is what the buyout business is.
2. Some BDC interest?
At a minimum, it's fairly obvious who won't participate in the bidding, at least not now. An exec from Ares Capital (NASDAQ:ARCC) has already opined that Ares isn't interested in small acquisitions for small returns, despite its lingering reputation from its post-crisis acquisition of Allied Capital. (Given Ares' current 16% discount to book value, the market has already made that decision for them.)
There are a few interesting suitors, none of which are large enough to swallow American Capital whole. TPG Specialty Lending (NYSE:TSLX) previously offered 90% of book value for the entirety of TICC Capital, paid in TPG Specialty shares. TPG presumably has its hands tied up and would want a deal to take a good look at American Capital's garage sale.
Main Street Capital (NYSE:MAIN) and Triangle Capital (NYSE: TCAP) would be interesting as selective buyers, if only because they trade at monstrous 33% and 24% premiums to book value, respectively. However, as primarily lower middle market investors, it would likely change the scope of their portfolios if assets were acquired in meaningful quantities. Internally managed, neither necessarily have the incentive to grow their balance sheets for fees.
Finally, you can't rule out Golub Capital BDC (NASDAQ:GBDC), either, given its premium priced stock and its CEO's expressed interest in potentially acquiring "portfolio of loans," when prompted by an analyst on a recent conference call.
Importantly, though, none of the publicly traded BDCs above are likely to pay a "dumb money" price for any assets they buy. Investors give them a long leash, but won't tolerate a deal that prioritizes the size of a deal over the returns of a deal, lest they become activists targets, too.
Let's not forget who's in the driver's seat. Elliot Management effectively owns 10.3% of American Capital in the form of common stock and swaps.
3. Start the bidding
Historical evidence and simple logic suggests American Capital won't sell for fair value at September 30. Fully priced assets don't draw a crowd.
Some (albeit weak) indications of real value include:
- The sale of assets to an American Capital-managed private equity fund at a 10% discount to their most-recent fair value mark last year. (Debt investments will likely sell closer to their marks than equity investments.)
- The fact the company's board authorized repurchases, but only at a price of less than 85% of book value.
Adjusting solely for the shares repurchased in the most recent quarter, American Capital's book value should have grown by about $0.52 per share, to $20.96 per share.
Then we have the difficult-to-quantify value of employee stock options, which would immediately vest upon a liquidation, and the pace and scale of any repurchases beyond what's been authorized. If we pin the options for $1.31 of dilution, per the company's second-quarter presentation, then you can get to an NAV of about $19.65 per share.
From there, it's just a matter of the discount. If American Capital can collect 90% of NAV, then shares should liquidate at about $17.69 per share, or a premium of about 27% to Thursday's closing price. (Incidentally, that's $0.10 per share less than Elliot's "low case" in its presentation on the company.)
Is the that good enough for Elliot? We'll soon find out.