ACAS is a Bargain Worth Buying

American Capital Strategies (ACAS) is the largest publicly traded private equity fund in the U.S.  The company has invested $12 billion in debt and equity securities in 219 small to mid-sized companies.

ACAS is a limited partnership and is not subject to federal income tax on the portion of income and capital gains distributed to shareholders.

ACAS shares have declined from a high of 50, because investors misunderstood an accounting change and are concerned about the effect of the banking crisis.  The company must now comply with accounting statement 157 issued by the Financial Accounting Standards Board.  Statement 157 requires ACAS (and similar companies) to estimate the fair market values of investment holdings for all quarterly and annual reports.

Before the new rules and prior to the quarterly statement reported for the first quarter of 2008, ACAS used two accounting methods starting from date of purchase. One maintained the cost of an investment until the date of sale or redemption. While the other one used a sliding scale to increase the value of a holding to the date of anticipated sale or redemption.

Because of the new rule, new appraisals of ACAS’ holdings revealed the value of the holdings as of March 31 were $997 million, or $5.09 per share, below the values carried on the company’s books.  However, still following the new rule, ACAS will continue to hold investments until maturity and will receive the same amount at redemption as before the new rule.

Shareholders will continue to be paid dividends based upon the income and realized gains from the investments.  The company has increased the dividend for 10 straight quarters.  The dividend yield is a whopping 19.5% and will not be reduced during the next 12 months or more.

Management at ACAS is baffled by the low price of their stock.  They will buy back up to $500 million (12% of shares outstanding) while the stock is trading below the current book value of $28.70.  In addition, management has confirmed that the dividend will be increased again before the end of 2008.

ACAS seems to be unaffected by the current financial crisis and continues to grow at a steady pace.  ACAS recently raised the dividend to $1.00 quarterly and changed its dividend policy for the future.  From now on, distributions will be based on net operating income plus net capital gains.  (Previous distributions were based on net operating income only).  ACAS will save on tax expenses, and limited partners will receive larger distributions.  With its size, ACAS should be able to take advantage of better buying opportunities during the next six to 12 months.  The tighter credit standards at lending institutions will present better opportunities for ACAS during the next several quarters.

ACAS is clearly a bargain and well worth buying.