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American Capital Ltd.’s (ACAS - Analyst Report) fourth-quarter 2011 operating income of 24 cents per share outpaced the Zacks Consensus Estimate by 4 cents. Moreover, the results outshined the prior-year quarter’s earnings by 5 cents per share. The favorable outcome was due to a rise in fee and interest and dividend income in the quarter.

Including deferred tax benefit of $428 million, net operating income for the quarter was $229 million, or 67 cents per share, significantly up from $67 million or 19 cent per share in the prior-year quarter.

For full year, net operating income was $448 million, or $1.26 per share, significantly down from $204 million or 62 cents per share in the prior-year. Excluding deferred tax benefit, net operating income came in at $303 million, or 85 cents per share, surpassing the Zacks Consensus Estimate by 3 cents.

Performance in Detail

Total operating income was $160 million in the quarter, up 12% from $143 million in the prior-year quarter, attributed to higher fee income and interest and dividend income. Operating income also was above the Zacks Consensus Estimate of $136 million.

For full year, total operating income was $591 million, down 2% from $600 million in the prior-year, attributed to lower fee income and interest and dividend income. However, operating income outpaced the Zacks Consensus Estimate of $564 million.

Total interest and dividend income for the quarter was $149 million, up 12% from $133 million in the prior-year quarter. The weighted average effective interest rate on the company's private finance debt investments as of December 31, 2011 was 10.7%, up 40 basis points at the end of the previous quarter and 50 basis points higher than the rate as of December 31, 2010. Fee income climbed 10% year over year to $11 million.

Operating expenses remained stable at $76 million compared to the prior-year quarter, as decline in interest expenses was offset by higher general and administrative expenses.

As of December 31, 2011, non-accrual loans were $219 million, representing 8.7% of total loans at fair value, up from $173 million of non-accrual loans, indicating 6.6% of total loans at fair value as of September 30, 2011.

Net asset value (NAV) per share came in at $13.87, up 16% or $1.95 per share from NAV of $11.92 per share as of September 30, 2011. In spite of the volatile capital markets in the quarter, affecting valuations of investment portfolio, the overall underlying performance of the company’s portfolio companies continued to be positive. Management not only anticipates an improvement in the portfolio along with an economic recovery, but also expects to post a growth in book value.

American Capital’s asset coverage ratio improved substantially to 465% from 364% in the prior quarter. The company repaid debt of $1 billion and increased investments by $300 million while strengthening its balance sheet.

Share Repurchase and Dividend Update

During the third and fourth quarters of 2011, American Capital repurchased 17.6 million shares worth $134 million, at an average price of $7.61 per share.

In the prior quarter, American Capital adopted a new program for additional repurchases of shares or dividend payments through December 31, 2012. To begin with the new program, American Capital has planned to keep aside certain amount either for stock repurchases or dividend payments, quarterly. The quarterly amount will depend on the company’s cumulative net cash from operating activities in the prior quarters.

Further, cash and cash equivalents in hand, cumulative repurchases or dividends, debt position, investment plans and operational issues will also be the determining factors for the quarterly amount. Last but not the least, the current trading price of American Capital's common stock, financial liquidity and ongoing economic conditions will also be taken into consideration.

As per the company’s plan, if the price of American Capital's common stock trade at a discount to the net asset value of shares, the company will opt for share repurchase. On the flip side, if the price of American Capital's common stock trade at a premium to the net asset value of shares, the company will opt for dividend payments.

The authorization of the new share buyback program and resumption of dividend payments raise our hopes for enhanced investor confidence.

Our Take

Among American Capital’s peers, Fortress Investment Group LLC (FIG - Snapshot Report) and Ares Capital Corporation (ARCC - Snapshot Report), are scheduled to release their earnings for the fourth quarter of 2011 on February 28, 2012.

Recently, in January 2012, American Capital announced the divesture of its portfolio company CIBT Solutions Inc. (CIBT). The unit was acquired by ABRY Partners in mid-December 2011 for $215 million. The company has earned 15% compounded annual rate of return over the life of its total debt and equity investments, including interest, dividends fees and expected escrow proceeds. 

During the quarter, American Capital announced an investment of $10 million in order to support RBC Capital Markets Corp.’s syndication of $75 million Second Lien Term Loan financing. The loan financing will facilitate Permira Advisors LLC to acquire Renaissance Learning Inc.  Further, the company announced its plan to invest $15 million to support BMO Capital Markets' syndication of $100 million Second Lien Term Loan financing. The loan financing will help Teachers' Private Capital to purchase the majority stake of Flexera Software Inc.

American Capital has the capability to provide flexible financing solutions ranging from a variety of senior debt and uni-tranche to mezzanine and equity co-investments. Further, the company provides multi-currency funding with underwriting platform globally while boosting growth of portfolio companies. Such benefits provided by American Capital urge private equity clients to consider it as an investment partner, which in turn, helps in the company’s growth.

American Capital’s successful restructuring of debt provided it with sufficient operating flexibility and the company also continues to derisk its balance sheet through a number of initiatives including repayment of debt. However, we believe limited accessibility to capital and increased funding costs have weakened the company’s strategic position in its sector. Moreover, the improved portfolio performance is expected to continue along with the economic recovery.

American Capital currently retains its Zacks #3 Rank, which translates into a short-term (1−3 months) ‘Hold’ rating. Considering the fundamentals, we are also maintaining a “Neutral” recommendation on the stock.

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