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American Capital to Sell Operations; Moody's Upgrade Likely

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Putting an end to all speculations about possible sale or restructuring, American Capital, Ltd. announced the sale of its operations for $4 billion through two separate deals.  

New York-based specialty finance company, Ares Capital Corporation (ARCC - Free Report) , is set to acquire American Capital for $3.43 billion in a cash and stock deal. The deal will boost Ares Capital’s position as a major business development company in the nation and a direct lender to middle market companies. Upon closure of the transaction, shareholders of Ares Capital are likely to own around 73.9% while shareholders of American Capital will own the remaining 26.1% of the combined entity.

The deal however, excludes American Capital Mortgage Management, LLC, which is being sold to American Capital Agency Corp. (AGNC - Free Report) in a separate transaction for $562 million.

The combined deals value American Capital at $17.40 per share, reflecting a premium of 11.4% to its closing price on Friday.  

The Ares Capital's acquisition is subject to several conditions including American Capital and Ares Capital shareholder approvals. Also, the deal is subject to the completion of the sale of the mortgage wing of American Capital to American Capital Agency. Upon fulfillment of the conditions, the deal is expected to close within the next 12 months and be immediately accretive to Ares Capital’s core earnings per share.

Malon Wilkus, Chairman and Chief Executive Officer of American Capital stated, "Our shareholders should benefit immediately from the stable dividend offered by Ares Capital and the fee waiver support provided by Ares Management."

Financial advisors to American Capital were The Goldman Sachs Group, Inc. (GS - Free Report) and Credit Suisse Securities (USA) LLC.

A Surprising Move?

The latest move by American Capital, does not come as a surprise as in January the company had announced the conclusion of the initial phase of its strategic review and its plan to proceed with soliciting offers.

The Maryland-based private equity firm and asset manager announced the strategic review process last November stating that it will fully review alternatives including the sale of the company or partly sale of various business lines as well as review of its spin off plans. Interestingly, the announcement came in less than two weeks after billionaire investor Paul Singer's hedge fund Elliott Management Corporation voiced concerns over the proposed spin-off plans of American Capital.

The activist hedge fund, which currently holds around 14.4% interest in American Capital, had then initiated a campaign urging shareholders of American Capital to vote against the spin-off proposal, which it considered to be a “Poison Pill” ensuring hefty fee structures for management while minimizing shareholder rights. Apart from proposing the withdrawal of the spin-off plan, Elliott Management proposed several recommendations including setting up of a Strategic Review Committee to look for all available options in order to maximize stockholder value.

Elliott Management now “strongly supports” the latest deals of American Capital. In a statement, portfolio managers of the hedge fund, Jesse Cohn and Pat Frayne mentioned, “ACAS's streamlined portfolio will benefit from management by an Ares team that has a stellar track record of delivering shareholder value."

Moody's Stance

Following the announcement of the deals, Moody's placed American Capital’s B2 Corporate Family, B2 Senior Secured, and B3 Senior Unsecured ratings on review for upgrade.  However, the rating agency affirmed Ares Capital’s Ba1 Corporate Family and senior unsecured ratings and changed the rating outlook to negative.

On placing American Capital’s ratings for potential upgrade, Moody’s expects the transaction to likely reduce the possibility of default for American Capital’s creditors, considering the relatively stronger credit profile of Ares Capital. Also, Ares Capital anticipates repaying the outstanding debt of American Capital at the closure of the transaction.

Moody's stated that the revised negative outlook for Ares Capital reflects  the incremental risks to the company's operating performance and capital position from acquiring American Capital’s  higher risk portfolio of middle market debt and equity investments.  Also, Ares Capital is exposed to risks tied with the approval and completion of the deal, as well as integration of operations of American Capital.

American Capital currently carries a Zacks Rank #3 (Hold).

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