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==Key Trends and Forces== ==Key Trends and Forces==
=== Investors diminishing appetite for risk=== === Investors diminishing appetite for risk===
-As investors become less willing to invest in higher risk assets, demand for ACAS stock falls, as well as ACAS' ability to finance its transactions. A principal feature of the private equity industry is its extensive use of debt to finance transactions, usually in the form of [[high yield bonds]]. As investors with assets in the high-risk [[subprime lending]] industry lost money, investors have become more risk-averse to other high-risk assets; as a result, it has become more difficult for private equity firms and the investment banks that structure their deals to find buyers for these high-risk [[high-yield bonds]] (also known as "[[high yield bonds|junk bonds]]")<ref>http://www.reuters.com/article/marketsNews/idUKN2023115420070720?rpc=44&sp=true Reuters - Junk Bonds Fall on Subprime Concerns</ref> These bonds are critical to private equity firms' continued ability to finance their operations.+As investors become less willing to invest in higher risk assets, demand for ACAS stock falls, as well as ACAS' ability to finance its transactions. A principal feature of the private equity industry is its extensive use of debt to finance transactions, usually in the form of [[high yield bonds]]. As investors with assets in the high-risk [[subprime lending]] industry lost money, investors have become more risk-averse to other high-risk assets; as a result, it has become more difficult for private equity firms and the investment banks that structure their deals to find buyers for these high-risk [[high-yield bonds]] (also known as "[[high yield bonds|junk bonds]]")<ref>Reuters - Junk Bonds Fall on Subprime Concerns http://www.reuters.com/article/marketsNews/idUKN2023115420070720?rpc=44&sp=true </ref> These bonds are critical to private equity firms' continued ability to finance their operations.
===[[Interest rates]]=== ===[[Interest rates]]===

Revision as of 17:50, June 22, 2008

American Capital Strategies (NYSE:ACAS) makes investments of $5 million to $800 million in companies whose employees and management hold a large ownership stake, makes loans to private equity firms, and provides capital to public and private companies by issuing loans or in exchange for equity.[1] It is the largest U.S. publicly-traded alternative asset manager, having $21 billion in assets under management, and is the only one on the S&P500.[2] As ACAS manges a such a large amount of money , it is able to invest in larger companies as well invest in a wider variety of companies across many industries than compared to its competitors. ACAS has also less debt than its competitors (ending 2007 with a 0.7:1 debt-to-equity ratio).[3] With a lower debt-to-equity-ratio and diverse portfolio, ACAS less vulnerable to the volatility in earnings of the companies it invests in. ACAS is vulnerable to investors' diminishing appetite for risk as investors tend to consider stocks of alternative asset managers including ACAS to be riskier than those of most other industries; the cycliality of the American and European economies, since a slowdown in either economy would reduce the earnings of the companies it invests in; increasing interest rates as a result of the credit crunch as it would have to pay more to maintain its debt, or legislation increasing taxes on private equity fund managers as fund managers raise fees for its investors to make up the loss.

Company Overview

ACAS serves buyout markets--whether by private equity, employees, or management--and makes both early and mature-stage investments in both public and private companies. During an average week the company will have $30 billion of investment opportunities under review. From 2004 to 2007 the company had numerous opportunities to invest in subprime lending but chose to pass because the deals did not meet its criteria. 83% of American Capital's investments were in America and about 17% in Europe.

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American Capital is registered as a business development company (BDC), requiring them to payout most of their earnings to shareholders. The company seeks to be the leader in providing capital to middle-market companies, in many cases taking control of the company being financed. The company has also pursued a strategy to migrate much of their income towards asset management through the establishment of off-balance sheet private equity and debt securitization funds.

Its business consists of two primary segments: its investment portfolio and its alternative asset management business. ACAS targets primarily middle-market companies for investment, committing roughly $5 million to $800 million per company. As of year-end 2007, ACAS holds five funds within its alternative asset management business.[4] ACAS holds an extremely diversified portfolio with with portfolio companies in almost every sector.[5]

American Capital's main platforms consist of its investment portfolio and its alternative asset management businesses. The main distinction between these two platforms is that in its investment portfolio, ACAS commits mainly its own funds, whereas in its alternative asset business, ACAS raises funds from certified investors which it uses to invest and collects management and performance fees.
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American Capital's Investment Portfolio

With this side of its business, American Capital provides investment capital to middle market companies generally within the range of $10 million to $750 million. Historically, American Capital's provides funding to support management and employee buyouts (MBO's), in which the company's existing managers or employees acquire a large part or all of the company. American Capital generally invests senior debt; and mezzanine debt and equity for buyouts of private companies sponsored by American Capital or other companies. American Capital also provides capital directly to early and mature stage public and private companies as its portfolio companies. In total in its investment portfolio, ACAS has 219 portfolio companies with $22.8 billion in total revenues. American Capital also invests in structured finance investments, such as commercial mortgage backed securities (CMBS), commercial collateralized loan obligations (CLO) securities, and collateralized debt obligations (CDO) securities.[7]

American Capital's Alternative Asset Management

American Capital manages over $17 billion worth of alternative assets across five funds:

  • European Capital (LSE: ECAS) is a public traded investment company established in 2005 for pan-European equity, mezzanine, and senior debt investments with capital resources of €2.3 billion. This fund invests in and sponsors management/employee buyouts (MBO's), invests in private equity buyouts, and provides capital directly to private and public companies headquartered predominately in Europe. European Capital generally invests between €5 million and €500 million per transaction.
  • American Capital Equity I ("ACE I") is a $1 billion private equity fund managed by American Capital established in October 2006. ACE I purchased 30% of American Capital's equity interest in 96 portfolio companies.
  • American Capital Equity II ("ACE II") is a $0.5 billion private equity fund managed by American Capital established in October 2007. ACE II purchased 17% of American Capital's equity interest in 80 portfolio companies.
  • American Capital CLO 2007-1 ("ACAS CLO 2007-1") was established in 2006 and invests in broadly syndicated and middle market senior loans. American Capital purchased 55% of the BB rated notes and 70% of the non-rated subordinated notes in ACAS CLO 2007-1 and has $0.4 billion is total assets.
  • American Capital CRE CDO ("ACAS CRE CDO") is a commercial real estate collaterialized debt obligation trust that holds investments in subordinated tranches of CMBS trusts. This fund holds investment grade and non-investment grade notes and preferred shares of ACAS CRE CDO with $0.6 billion in total assets.

Dividends

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Return on Equity

Since 2003, ACAS has roughly been increasing its ROE. In 2007, however, its ROE fell due to a slowing economy.

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Low Debt to Equity Ratio

American Capital has a low Debt to Equity Ratio relative to most financial institutions. American Capital hedged its risk in 2007 by decreasing its ratio in response to a a slowing economy.

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Key Trends and Forces

Investors diminishing appetite for risk

As investors become less willing to invest in higher risk assets, demand for ACAS stock falls, as well as ACAS' ability to finance its transactions. A principal feature of the private equity industry is its extensive use of debt to finance transactions, usually in the form of high yield bonds. As investors with assets in the high-risk subprime lending industry lost money, investors have become more risk-averse to other high-risk assets; as a result, it has become more difficult for private equity firms and the investment banks that structure their deals to find buyers for these high-risk high-yield bonds (also known as "junk bonds")[11] These bonds are critical to private equity firms' continued ability to finance their operations.

Interest rates

Increased interest rates increase the amount ACAS has to pay in order to take on debt. If interest rates rise, the cost of borrowing becomes higher, so the gross required return necessitated by an investment becomes higher. As such, private equity firms would make undertake fewer investment opportunities. Also, increasing interest rates would encourage investors to put more money towards savings accounts instead of higher-risk assets. Likewise, investors would be less inclined to purchase ACAS stock.

Potential legislation

A variant of the Baucus-Grassley and Levin-Rangel bills in Congress if passed would raise the amount of tax private equity and hedge fund managers pay on carried interest. Fund managers would negotiate larger portions of the Carried interest carry]] away from investors to make up the difference. This increased expense to stockholders of overall management fees would reduce earnings.

The appreciating Euro relative to the U.S. dollar

The exchange rate would help American Capital bring better returns to U.S. stockholders as 17% of American Capital's portfolio is based in Europe.

The state of the American and European Economies

ACAS has investments across many industries in both the American and European economies. As ACAS hold a portfolio across many industries in both economies, their aggregate performance is largely reflective of that of the greater economy.

Competitors

Among publicly-traded business development companies, American Capital doesn't face much competition as this field is fairly small. Other firms include:

References

  1. ACAS Company Website - Our Business page
  2. ACAS company website
  3. ACAS Annual Report, page 5
  4. ACAS Annual Report, page 10
  5. ACAS Annual Report, page 7
  6. ACAS 2007 Annual Report, page 2
  7. ACAS Annual Report, page 10
  8. ACAS 2007 Annual Report, page 2
  9. ACAS 2007 Annual Report, page 2
  10. ACAS 2007 Annual Report, page 2
  11. Reuters - Junk Bonds Fall on Subprime Concerns http://www.reuters.com/article/marketsNews/idUKN2023115420070720?rpc=44&sp=true
  12. Allied Capital - Who We Are page
  13. Gladstone Company Homepage
  14. Apollo - Our Business page
  15. Prospect Energy Company homepage
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