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American Capital Lags EPS Ests

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American Capital Ltd. reported third quarter 2012 operating income of 22 cents per share, lagging the Zacks Consensus Estimate by a penny. However, the results compared favorably with the prior-year quarter’s earnings of 19 cents per share.

The favorable outcome was attributable to top-line growth, followed by decreased operating expenses reflecting better expense management. Moreover, new investments and reduction of debt acted as positives. Yet, increase in non-accrual loans was a negative for the quarter.

Net operating income for the quarter came in at $71 million, up from $65 million reported in the prior-year quarter. Net earnings were reported at $196 million, or 60 cents per share, against a net loss of $464 million or $1.34 per share in the prior-year quarter.

Performance in Detail

Total operating income was $154 million in the quarter, up 18% from $130 million in the prior-year quarter, due to higher interest and dividend income. Additionally, operating income surpassed the Zacks Consensus Estimate of $142 million.

In the quarter under review, total interest and dividend income was $142 million, up 21% from $117 million in the prior-year quarter. The weighted average effective interest rate on the company's debt investments as of September 30, 2012, was 11.1%, increasing 10 basis points from the end of the previous quarter. Yet, fee income dipped 8% year over year to $12 million.

Operating expenses declined 2% year over year to $64 million. The fall in expenses was a result of significant decline in interest expenses, partially offset by elevated salaries, benefits and stock-based compensation and higher general and administrative expenses.

As of September 30, 2012, non-accrual loans were $252 million, representing 12.5% of total loans at fair value, up from $243 million of non-accrual loans, indicating 12.3% of total loans at fair value, as of June 30, 2012.

Net asset value (NAV) per share came in at $17.39 in the quarter, up 5% or 77 cents per share sequentially. In spite of the volatile capital markets affecting valuations of investment portfolio in the quarter, the overall underlying performance of American Capital’s portfolio companies continue to remain positive. Management not only anticipates an improvement in the portfolio along with an economic recovery, but also expects to post an enhanced book value.

American Capital’s asset coverage ratio improved substantially to 769% from 661% in the prior quarter. The company repaid securitized debt of $150 million and increased investments by $6 million while strengthening its balance sheet. Moreover, the company recorded $136 million of cash proceeds from realizations of portfolio investments.

Share Repurchase and Dividend Update

During the third quarter of 2012, American Capital repurchased 11.4 million shares worth $125 million, at an average price of $10.99 per share. Since the beginning of the new repurchase program, adopted last year, the company repurchased 43.6 million shares of common stock for $392 million at an average price of $9.00 per share.

Developments During the Quarter

In August 2012, American Capital announced the completion of the refinancing of its total recourse debt. The secured debt was being refinanced by a new 4-year $600 million institutional term-loan facility with a LIBOR floor of 1.25%.

American Capital also obtained a new 4-year $250 million senior secured revolving credit facility. This credit facility included a 3-year revolving period and has the option of expanding up to $375 million.

The new term-loan facility was priced at LIBOR plus 4.25%, while the revolving credit facility was priced at LIBOR plus 3.75%. Further, the term loan facility has a first lien on some non-securitized assets of American Capital, while revolving credit facility has a first lien on some non-securitized loan assets of the company.

Owing to the strong demand along with the support of a wide range of debt investors, the new loan facility acted as a positive for the company. Moreover, these transactions augmented the company’s capital position and reduced interest expenses.

Our Viewpoint

American Capital’s successful restructuring of debt empowered it with sufficient operating flexibility. Moreover, the capital deployment by the company raises our hopes for an enhanced investors’ confidence.

The company is also capable of providing flexible financing solutions ranging from a variety of senior debt and uni-tranche to mezzanine and equity co-investments. Further, American Capital provides multi-currency funding with underwriting platform globally, thereby boosting growth of its portfolio companies. Such benefits provided by the company compel private equity clients to consider it as an investment partner, which in turn, helps it diversify.

Though the improved portfolio performance is expected to continue with the economic recovery, we believe low interest rate environment and global cues might act as headwinds in the upcoming quarters.

Shares of American Capital currently retain a Zacks #3 Rank, which translates into a short-term (1−3 months) Hold rating. Considering the fundamentals, we also maintain a ‘Neutral’ recommendation on the stock.

Among American Capital’s peers, Ares Capital Corporation (ARCC - Free Report) is expected to release its third quarter 2012 results on November 5, 2012.

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