Monday, May 23, 2016

American Capital: Agrees to Deal w/ ARCC, ARES, AGNC

Well this news was a bit anti-climatic, today American Capital (ACAS) agreed to a series of transactions with Ares Capital (ARCC), Ares Management (ARES), and American Capital Agency Corp (AGNC) that total up to a $17.40 stock and cash deal for the activist targeted BDC.  The deal represents about an 11% premium to Friday's close, the shares traded only marginally higher leaving the merger arbitrage spread at about 9.5% (ARCC traded down).  While the premium was initially a bit disappointing, the deal is a good one for all sides (including ACAS management) and creates a few interesting opportunities in some of the secondary entities around the deal.

  • Ares Capital Corp (ARCC), the largest BDC and externally managed by ARES, will pay ACAS shareholders $6.41 in cash plus 0.483 shares of ARCC.
  • American Capital Agency Corp (AGNC), the larger of the two ACAS managed mortgage REITs will internalize management and pay $2.45 in cash to ACAS shareholders.
  • Ares Management (ARES) will pay $1.20 in cash - presumably for the non-mortgage REIT related asset manager businesses (CLOs, PE Funds, and the orphaned ACSF).
There is some conflicting information on when the deal will close, the presentation and corresponding call mentioned end of 2016 (or six months was referenced a couple times on the call), while the press release stated 12 months.
American Capital's non-diluted NAV was $20.14 on 3/31, so despite the recent ~$600MM in announced asset sales at or above book value, plus the huge share repurchases below book value, most of that activity only semi-masked the management incentive compensation dilution, losing the deferred tax asset (change of control) and a cool $200MM in estimated deal related costs (unsure if this includes management's golden parachutes - see page 35).  The dangers of investing in BDCs.
The merger arbitrage spread is fairly wide for a deal that's almost certain to close as it has clear benefits for the acquirer and has been fully shopped by ACAS.  If the deal does close by year end as mentioned in the presentation/call that creates a very attractive annualized return.  I'll probably hold onto my shares a while longer and wait for that spread to close a bit.

Additional Thoughts:
  • The ACAS portfolio is a jumbled mess (middle market loans, private equity deals, and the asset manager), a small reason in comparison to overpaid management for the discount to NAV, but ARCC by contrast is much cleaner with a portfolio consisting mostly of leveraged loans that enable them to pay a high dividend, more of a BDC 2.0 that followed the original BDCs of the 1990s that ARCC has now swallowed up (ACAS, Allied).  Ares Capital is going to recycle the acquired portfolio and reinvest in more straight forward assets, the market places a higher value on simplicity (similar to what Gramercy Property Trust is doing with the Chambers Street merger), so I can see this being a slight win to ARCC shareholders.  Acquire a messy portfolio at a discount, hopefully sell most of the portfolio for the marked value, and then reinvest in something investors will pay up for like leveraged loans that enable dividends.
  • After the externalizing management trend of 2012-2014, it seems to be reversing into an internalizing management trend, similar to how conglomerates go in and out of style.  We saw Colony Financial acquire their manager Colony Capital and now the merged Colony Capital (CLNY) is buying Northstar Realty Finance (NRF) and its manager Northstar Asset Management (NSAM) only a short time after NSAM was spunoff from NRF.  Ashford Inc (AINC) and Fifth Street Asset Management (FSAM) are facing similar activist pressure regarding the inherent conflicts of interest between fat asset management fees and a captive permanent capital entity.  The ACAS news is positive for AGNC shareholders now that they will be internalizing their manager, and even better news for the smaller ACAS managed mortgage REIT, American Capital Mortgage Investment Corp (MTGE), as it seems likely MTGE (which will now be externally managed by AGNC) will be folded into AGNC.  Maybe they could sell the cute ticker to an ETF company for additional consideration.
  • The smallest of the ACAS captive entities is American Capital Senior Floating (ACSF), a BDC with just a $100MM market cap and trading at 85% of NAV, hard to imagine that Ares will keep this as a standalone entity, it could easily be folded into ARCC at something short of NAV and be a win for both sides.
  • Ares Management (ARES), the asset manager, is also making out nicely in the deal, they'll add about $4B in assets to their externally managed ARCC.  It's a backdoor way of justifying a capital raise for a BDC that's trading below NAV.  At a 1.5% base management fee that's additional $61.5MM annually (they are waiving $10MM in fees for the first 10 quarters post close), plus they get a 20% incentive fee on income as long as they meet their 7% hurdle rate, it's good to be the manager of a BDC.
Disclosure: I own shares of ACAS


  1. Are you adjusting for the dividends paid by ARCC at all? My comment on SA about it

    1. That might be the more correct way to think about it if you were going to short ARCC for a true arbitrage trade, but you'd also need to take it one step further and adjust the dividend down to match the ARCC shares you'd be receiving as an ACAS shareholder, so you multiple that 0.38 per quarter dividend by 0.483? But thinking about it from a current ACAS shareholder position, I'm assuming that ARCC's portfolio earns its dividends (sometimes not a safe assumption in BDC land) and that the dividend is relatively NAV neutral since BDCs are required to pay out 90% of earnings. But fair point, it knocks down the true merger arbitrage spread down some, it's far from my specialty, just a slightly salty ACAS shareholder here. Thanks for the comment.

    2. Great point on the divs. Someone else also made it on SA and I missed that part in my analysis.

      Also a great point that ARCC earns their dividend so perhaps there shouldn't be a discount. I think about it more in wanting to be conservative and any earnout of the dividend would just be gravy. Considering the larger premium (6.1% calc on 5/23 close) I am more interested and will look to establish a position.

    3. You made a good point. I was dialed in from a legacy ACAS shareholder perspective, is the spread wide enough with the dividends included for me to come in as a third party? Maybe not. But as a legacy ACAS shareholder, my inertia to sell now isn't that great, I'll wait for the spread to close a bit.