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Profit from this Former BDC Becoming a BDC Again

November 4, 2013 5:38 pm
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Business development companies (BDCs) are unique creations of Congress, much like real estate investment trusts (REITs). Both BDCs and REITs are required by law to pay out a high portion of income as dividends to shareholders in order to receive preferential tax treatment. As a result, both BDCs and REITs are owned by many seeking high yields. When a BDC changes its corporate status, as did American Capital (NASDAQ: ACAS), it is almost assured that the stock price will suffer.

That is what has transpired with American Capital due to the impact of The Great Recession.

To capitalize on tax breaks from portfolio losses, it changed its business status to a C Corporation. Speaking at the “Invest for Kids” conference in Chicago in late October, Steve Kuhn, of Pine River Capital Management, cited that and other factors for his expectations that American Capital will be trading for over $26 a share, up from about $14.50.

The Great Recession devastated BDCs.

Investing in middle market businesses, the holdings of BDCs like American Capital were crushed. In May 2007, American Capital was near $50 a share. By February 2009, it was trading for under $2.

When American Capital changed its corporate structure, it quit paying a dividend. BDCs are known for having robust dividends: Apollo Investment Corporation (NASDAQ: AINV) has a dividend of 9.40%, Ares Capital Corporation (NASDAQ: ARCC) pays at a rate of 8.78%, and the yield for Gladstone Investment Corporation (NASDAQ: GAIN) is over 10%. Without a dividend, American Capital had no appeal to income investors, especially when compared to BDCs like Apollo Investment, Ares Capital, and Gladstone Investment.

As Kuhn pointed out in his speech, BDCs trade a premium to the book value of the assets in the portfolio due to the dividend component. By contrast, American Capital is selling at a discount to its holdings as it does not have a dividend. If American Capital starts paying a dividend again, which Kuhn sees happening, then the share price should rise to a level like those for others in the BDC sector.

In addition to the rise from a dividend coming, American Capital has been buying back its shares and plans to continue. Already management has bought back 27% of the company stock. According to Kuhn, there are plans to acquire an additional 15%.

There is something for growth, value, and income investors in American Capital.

For those seeking value , the price-to-earnings growth is 0.44. Considered to be one of the most important indicators by investing legend Peter Lynch, for a fairly valued company it should be one (the lower the better). With a price-to-earnings growth ratio of 0.44, America Capital is grossly undervalued. With a price-to-book value of 0.75, it is selling at substantial discount by that measure, too.

Growth investors should pleased with the earnings-per-share growth this year of 25%. A rate that high is clearly unsustainable, but the analyst community expects earnings per show to rise by 15% over the next five years. For the last half decade, it rose by 3%.

There is great promise for income investors with American Capital with a likely dividend looming. Looking at the yields of other BDCs, there should be a healthy dividend. Combined with the value and growth features, it should total a robust total return American Capital for the future.

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