American Capital Remains Neutral

We are reiterating our ‘Neutral’ recommendation on American Capital Ltd. (ACAS - Analyst Report), following a detailed analysis of the company’s fundamentals in light of the current economic environment. Also, the restructuring efforts by the company have contriabuted to this stance.

In February 2012, American Capital announced the divesture of its portfolio company Aptara Inc., following the buyout of another portfolio company – CIBT Solutions Inc. – in January. In addition, the company is focusing on reducing risks from its balance sheet through a number of initiatives, such as repayment and restructuring of debt. We expect these restructuring initiatives to significantly improve its finncials over time.

Moreover, American Capital continues to see strong liquidity in its investment portfolio and is aiming to maximize the shareholders’ value through organic growth besides originating new and attractive investments. Further, the company looks forward to utilize opportunities in Europe as the latter goes through some difficulties, particularly in the capital markets and with respect to sovereign debt. Also, new investment opportunities in the U.S. are expected to emerge at tandem with an economic recovery.

American Capital remains an attractive pick for yield-seeking investors. Earlier in the first-quarter of 2012, the company extended its stock repurchases or dividend payments program, initiated in 2011, through December 2013. Moreover, Fitch Ratings lifted its outlook on American Capital to ‘Positive’ from ‘Stable’ – as part of its review of six Business Development Companies – based on the company’s steady earnings. The extension of the new share buyback program as well as the rating upgrade by Fitch raised our hopes for an enhanced investor confidence in the company.

On the flip side, we believe that American Capital’s earnings continue to be affected by the spread between the interest rate on investments and the interest rate at which it has borrowed funds. An increase or decrease in interest rates could reduce the spread between the investment rate and the borrowing rate, thereby adversely affecting the overall profitability.

Over the past years, the negative developments in the financial markets throughout the world have significantly impacted American Capital. The global financial crisis limited the company’s access to the debt as well as equity markets and resulted in considerable depreciation of its investment portfolio and overleveraging of balance sheet.

In the current macroeconomic environment, mergers and acquisitions were reduced, which adversely affected American Capital’s ability to continue generating additional liquidity through the sale of portfolio investments. The company also witnessed several payment defaults on its financial obligations. Although these situations are slowly easing off, we do not expect stability in the near term.

American Capital currently retains its Zacks #2 Rank, which translates into a short-term Buy rating. One of its peers, KCAP Financial, Inc. (KCAP - Snapshot Report) retains a Zacks #1 Rank (Strong Buy).