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ACAS > SEC Filings for ACAS > Form 10-Q on 5-Nov-2012All Recent SEC Filings

Show all filings for AMERICAN CAPITAL, LTD

Form 10-Q for AMERICAN CAPITAL, LTD


5-Nov-2012

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (in millions, except per share data)

Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is designed to provide a reader of American Capital's financial statements with a narrative from the perspective of management. Our MD&A is presented in four sections:

•Executive Overview

•Results of Operations

•Financial Condition, Liquidity and Capital Resources

•Forward-Looking Statements

EXECUTIVE OVERVIEW

We are a publicly traded private equity firm and global asset manager. We invest in private equity, private debt, private real estate securities and other investments, technology investments, special situation investments and alternative asset funds managed by us. These investments constitute, in part, what are considered alternative assets. We provide investors the opportunity to participate in the private equity and alternative asset management industry through an investment in our publicly traded stock.

We primarily invest in senior and mezzanine debt and equity in buyouts of private companies sponsored by us ("One Stop Buyouts®") or sponsored by other private equity funds ("Private Equity Buyouts") and provide capital directly to early stage and mature private and small public companies. We refer to our investments in these companies as our private finance portfolio. Our primary business objectives are to increase our net earnings and net asset value ("NAV") by making investments with attractive current yields and/or potential for equity appreciation and realized gains.

We are also an alternative asset manager with our alternative asset fund management conducted through our wholly-owned portfolio company, American Capital, LLC. As of September 30, 2012, we had $118 billion of assets under management, including $112 billion of third-party assets, which includes $12 billion of fee-earning assets. American Capital, LLC manages the following alternative asset funds: European Capital Limited ("European Capital"), American Capital Agency Corp. ("AGNC"), American Capital Mortgage Investment Corp. ("MTGE"), American Capital Equity I, LLC ("ACE I"), American Capital Equity II,
LP ("ACE II"), ACAS CLO 2007-1, Ltd. ("ACAS CLO 2007-1") and ACAS CLO 2012-1,
Ltd. ("ACAS CLO 2012-1").

American Capital Investment Portfolio

We primarily invest in middle market companies, which we generally consider to be companies with revenue between $10 million and $750 million. Currently, we will invest up to $500 million in a single middle market company in North America. We also have investments in structured finance investments ("Structured Products"), including commercial mortgage backed securities ("CMBS"), collateralized loan obligation ("CLO") securities and collateralized debt obligation ("CDO") securities and invest in alternative asset funds managed by us.


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Portfolio Composition

As of September 30, 2012, we had investments in 136 portfolio companies totaling
$5.3 billion at fair value, with an average investment size of $39 million, or
0.6% of total assets. As of September 30, 2012, our ten largest investments at
fair value totaled $3.2 billion, or 51% of total assets, and are as follows (in
millions):

Company                  Product Line       Industry                     Fair Value       Cost Basis
American Capital, LLC    Asset Management   Capital Markets            $        803     $        123
European Capital                            Diversified Financial
Limited                  European Capital   Services                            743            1,359
WIS Holding Company,     One Stop           Commercial Services &
Inc.                     Buyouts®           Supplies                            276              219
Affordable Care          One Stop           Health Care Providers &
Holding Corp.            Buyouts®           Services                            248              161
Mirion Technologies,     One Stop
Inc.                     Buyouts®           Electrical Equipment                239               96
                         One Stop           Life Sciences Tools &
WRH, Inc.                Buyouts®           Services                            209              388
                         One Stop           Hotels, Restaurants &
SMG Holdings, Inc.       Buyouts®           Leisure                             184              196
                         One Stop
SPL Acquisition Corp.    Buyouts®           Pharmaceuticals                     181              167
                         Private Equity     Construction &
The Tensar Corporation   Buyouts            Engineering                         167              154
Paradigm Precision       One Stop
Holdings, LLC            Buyouts®           Aerospace & Defense                 129              151
Total                                                                  $      3,179     $      3,014

Our investments are composed of the following six product lines: (i) One Stop Buyouts®, (ii) Private Equity Buyouts, (iii) Direct and Other, (iv) European Capital, (v) Asset Management and (vi) Structured Products.

The composition of our investment portfolio as of September 30, 2012, at fair value, as a percentage of total investments based on these different product lines, is shown below:

[[Image Removed]]


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The type and aggregate dollar amount of new investments were as follows (in millions):

                                                        Three Months Ended       Nine Months Ended
                                                           September 30,           September 30,
                                                          2012        2011        2012         2011
Private Equity Buyouts                                 $      -     $   15     $      22     $   15
Investments in managed funds                                  -         40             -         40
Direct and Other                                              -          -             -         14
One Stop Buyouts®                                             -          1             -          1
Add-on investment in American Capital, LLC                    -         11            86         11
Add-on financing for acquisitions                             6         57             9         58
Add-on financing for working capital in distressed
situations                                                    -          2            17         21
Add-on financing for growth and working capital               -          2            16        101
Add-on financing for recapitalizations, not including
distressed investments                                        -          -            42         25
    Total                                              $      6     $  128     $     192     $  286

The amounts of our new investments include both funded and unfunded commitments as of the investment date.

We received cash proceeds from realizations and repayments of portfolio investments as follows (in millions):

                                                         Three Months Ended       Nine Months Ended
                                                           September 30,            September 30,
                                                          2012         2011        2012         2011
Principal prepayments                                  $      24     $   96     $     535     $  359
Sale of equity investments                                    56        127           145        218
Payment of accrued PIK notes and dividend and accreted
original issue discounts                                      42         16           149         89
Loan syndications and sales                                    -         10             -         16
Scheduled principal amortization                              14         11            35         28
Total                                                  $     136     $  260     $     864     $  710

Private Finance Investments

A majority of our investments have been to assist in the funding of change of control buyouts of privately held middle market companies, which we expect to continue in the future. A change of control transaction could be the result of a corporate divestiture, a sale of a family-owned or closely-held business, a going private transaction, the sale by a private equity fund of a portfolio company or an ownership transition. Our financing of a change of control transaction could either be for a One Stop Buyout® or for a Private Equity Buyout. In One Stop Buyouts®, we lend senior and mezzanine debt and make majority equity investments. As an investor in Private Equity Buyouts, we lend senior and mezzanine debt and make minority equity co-investments.

Our private finance portfolio investments consist of loans and equity securities primarily to privately-held middle market companies. Our private finance loans consist of first lien secured revolving credit facilities, first lien secured loans, second lien secured loans and secured and unsecured mezzanine loans. The loans typically mature in five to ten years and require monthly or quarterly interest payments at fixed rates or variable rates generally based on LIBOR, plus a margin. Certain of the loans permit the interest to be paid-in-kind by adding the interest to the outstanding loan balance and then paying it at maturity. We price our debt and equity investments based on our analysis of each transaction. As of September 30, 2012, the weighted average effective interest rate on our private finance debt investments was 11.3%, which includes the impact of non-accruing loans. As of September 30, 2012, our fully-diluted weighted average ownership interest in our private finance portfolio companies, excluding our investments in European Capital and American Capital, LLC, was 52%, with a total equity investment at fair value of approximately $1.6 billion.

There is generally no publicly available information about these companies or primary or secondary market for the trading of these privately issued loans and equity securities. We have exited these investments historically through normal repayment, a change in control transaction or recapitalization of the portfolio company. However, we may also sell our loans or equity securities in a secondary market transaction.

Our ability to fund the entire capital structure is a competitive advantage in completing many middle market transactions.


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We sponsor One Stop Buyouts® in which we provide most, if not all, of the senior and mezzanine debt and equity financing in the transaction. We may initially fund all of the senior debt at closing and syndicate it to third-party lenders post closing. We have a loan syndications group that arranges to have all or part of the senior loans syndicated to third-party lenders.

As a business development company ("BDC"), we are required by law to make significant managerial assistance available to most of our portfolio companies. Such assistance typically involves providing guidance and counsel concerning the management, operations and business objectives and policies of the portfolio company to its management and board of directors, including participating on the company's board of directors. We have an operations team with significant turnaround and bankruptcy experience that assists our investment professionals in providing intensive operational and managerial assistance to our portfolio companies. As of September 30, 2012, we had board seats at 55 out of 94 of our private finance companies and had board observation rights at other private finance portfolio companies. Providing assistance to our portfolio companies serves as an opportunity for us to maximize their value.

American Capital, LLC Investment

Our alternative asset management business is conducted through our wholly-owned portfolio company, American Capital, LLC. In general, subsidiaries of American Capital, LLC enter into management agreements with each of its managed alternative asset funds. As of September 30, 2012, our investment in American Capital, LLC was $123 million at cost and $803 million at fair value, or 15% of our total investments at fair value. The discussion of the operations of American Capital, LLC includes its consolidated subsidiaries. As of September 30, 2012, its third-party assets under management totaled $112 billion, including $102 billion of assets under management in American Capital Agency Corp. (NASDAQ: AGNC) and $8 billion of assets under management in American Capital Mortgage Investment Corp. (NASDAQ: MTGE), which are publicly traded residential mortgage real estate investment trusts ("REITs").

On September 6, 2012, ACAS CLO 2012-1 closed on the sale of $362 million of collateralized loan obligation bonds. ACAS CLO 2012-1 is externally managed by American Capital, LLC for an annual management fee of 42 basis points of total assets and 20% of the net profits of ACAS CLO 2012-1, subject to certain hurdles. American Capital, LLC purchased 70% of the non-rated equity tranche of subordinated notes in ACAS CLO 2012-1 for $30 million.

American Capital, LLC had over 75 employees as of September 30, 2012, including seven investment teams with over 25 investment professionals located in Bethesda (Maryland), New York, London and Paris. We have entered into service agreements with American Capital, LLC to provide it with additional asset management service support. Through these agreements, we provide investment advisory and oversight services to American Capital, LLC, as well as access to our employees, infrastructure, business relationships, management expertise and capital raising capabilities. We charge American Capital, LLC a fee for the use of these services. American Capital, LLC generally earns base management fees based on the shareholders' equity or the net cost basis of the assets of the alternative asset funds under management and may earn incentive income, or a carried interest, based on the performance of the funds. In addition, we may invest directly into these alternative asset funds and earn investment income from our investments in those funds.

The following table sets forth certain information with respect to American Capital, LLC's funds under management as of September 30, 2012:

                                                                                       ACAS      ACAS
                           European                                                     CLO       CLO
                           Capital        AGNC         MTGE        ACE I    ACE II    2007-1    2012-1
Fund type                  Private      Publicly     Publicly     Private   Private     CLO       CLO
                            Equity       Traded     Traded REIT   Equity    Equity
                             Fund        REIT -      - NASDAQ      Fund      Fund
                                         NASDAQ       (MTGE)
                                         (AGNC)
Established                  2005         2008         2011        2006      2007      2006      2012
Assets under management      $1.5        $102.2        $7.5        $0.6      $0.3      $0.4      $0.3
                           Billion      Billion       Billion     Billion   Billion   Billion   Billion
Investment types          Senior and     Agency      Mortgage     Equity    Equity    Senior    Senior
                          Mezzanine    Securities   Investments                        Debt      Debt
                            Debt,
                           Equity,
                          Structured
                           Products
Capital type                                                      Finite    Finite    Finite    Finite
                          Permanent    Permanent     Permanent     Life      Life      Life      Life

European Capital Investment

European Capital is an investment fund incorporated in Guernsey, which is wholly-owned by us. European Capital invests in One Stop Buyouts®, Private Equity Buyouts and provides capital directly to early stage and mature private and small public companies primarily in Europe. It primarily invests in senior and mezzanine debt and equity.

As of September 30, 2012, European Capital had investments in 58 portfolio companies totaling $1.4 billion at fair value,


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with an average investment size of $23 million, or 1.5% of its total assets. As of September 30, 2012, European Capital's five largest investments at fair value were $508 million, or 33% of its total assets.

The composition of European Capital's investment portfolio by product line as of September 30, 2012, at fair value, as a percentage of its total investments, is shown below:

[[Image Removed]]
As of September 30, 2012, 99.0% of European Capital's assets are invested in portfolio companies headquartered in countries with AA rating or better based on Standard & Poor's ratings as of September 30, 2012. As of September 30, 2012, European Capital's NAV at fair value was $866 million. As of September 30, 2012, our investment in European Capital consisted of an equity investment with a cost basis and fair value of $1,267 million and $651 million, respectively, and a debt investment with a fair value and cost basis of $92 million. As of September 30, 2012, we valued our equity investment in European Capital below its NAV as a result of applying several discounts to its NAV in computing the fair value.

Summary of Critical Accounting Policies

The preparation of our financial condition and results of operations requires us to make judgments and estimates that may have a significant impact upon our financial results. We believe that of our significant accounting policies, the following require estimates and assumptions that require complex, subjective judgments by management, which can materially impact reported results: valuation of investments; income taxes; interest and dividend income recognition; and stock-based compensation. All of our critical accounting policies are fully described in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2011.

See Note 3 to our interim consolidated financial statements in this Form 10-Q for further information regarding the classification of our investment portfolio by levels of fair value inputs used to measure our investments as of September 30, 2012.

RESULTS OF OPERATIONS

The following analysis of our financial condition and results of operations
should be read in conjunction with our consolidated financial statements and the
notes thereto.

Our consolidated financial performance, as reflected in our consolidated
statements of operations, is composed of the following three primary elements:

•        The first element is "Net operating income" ("NOI"), which is primarily
         the interest, dividends, prepayment fees, finance and transaction fees
         and portfolio company management fees earned from investing in debt and
         equity securities and the fees we earn from fund asset management, less
         our operating expenses and tax provision.


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