American Capital Strategies (NYSE:ACAS) is the largest business development company in the U.S., with $15 billion in assets under management, and the only one in the S&P 500. that 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. As ACAS manages 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 many of its competitors. ACAS has also less debt than its competitors. With a lower debt-to-equity-ratio and diverse portfolio, ACAS is less vulnerable to the volatility in earnings of the companies it invests in. ACAS is vulnerable though 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.
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.
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. ACAS holds an extremely diversified portfolio with with portfolio companies in almost every sector.
The main distinction between its investment portfolio and its alternative asset management business is that in its investment portfolio, ACAS commits mainly its own funds, whereas in its alternative asset business, ACAS raises funds from investors to invest with and collects management and performance fees.
The Special Situations Group invests in troubled and distressed situations including operational turnarounds, auctions, corporate and orphan carve-outs, portfolio add-ons, complex management buyouts and provides debtor-in-possession (DIP) financing, exit, mezzanine for sponsored buyouts, second lien refinance, and direct lending to distressed companies.
The Second Lien Group offers secured and unsecured junior capital investments to support an array of financing needs across a variety of industries primarily, focusing on syndicated junior capital opportunities sourced through the loan sales desks of the market's growing junior capital arranger community. ACAS prefers to invest in manufacturing, services, and distribution companies. The firm also makes investments in companies that provide services or products to federal, state, or local governments, focusing on information technology for custom information technology solutions, technology and software enabling headcount reduction, technology and software enabling cost reductions in conducting transactions with or within government.
In 2009, ACAS incurred a net loss of $678 million on revenues of $697 million. This represents a turnaround from 2008, when the company earned $525 million on $1.05 billion in revenue.
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. 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.
American Capital manages over $17 billion worth of alternative assets across five funds:
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") These bonds are critical to private equity firms' continued ability to finance their operations.
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.
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 need to negotiate larger portions of the carry away from investors to make up the difference, which would make fund raising more difficult. Fewer assets under management slows earnings.
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.
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.
Among publicly-traded business development companies, American Capital doesn't face much competition as this field is fairly small. As of late though, it's competitors have been performing well in comparison. Its competition includes: