Private equity funds typically serve the investing needs of pension funds, endowments or high net worth individuals. One of the few publicly traded management buyout and investment firms, American Capital Strategies (ACAS), offers investors an avenue into the reclusive world of private equity without the million dollar entrance fee.
ACAS invested $4.7 billion last year and approximately $3 billion through August in a variety of businesses ranging from New York-based Art Gallery Berry-Hill to Miami-based Pan Am International Flight academy. While ACAS does make its stock available to the general public, its ability to generate returns from a varied pool of investments is far from common.
As a publicly traded buyout and mezzanine fund, Bethesda, MD-based ACAS is in the business of buying and financing companies. Mezzanine financing is attractive to borrowers because it is treated as equity on their balance sheets which makes it easier for them to secure primary financing from larger banking institutions.
ACAS also invests in senior and subordinated debt and equity of companies along with other financing institutions. In return for these investments, ACAS expects healthy returns of 20% to 30% on funds invested, along the same lines as the rates of return sought out by non-publicly traded private equity firms like Kohlberg Kravis Roberts & Co, Blackstone Group and Texas Pacific Group.
American Capital Strategies' portfolio of companies provides cash in the form of interest, dividends, fees, principal repayments and sales of equity investments. ACAS also generates cash from the exit of investments as well as from the appreciation of investments held in its portfolio.
For the first six months of the year, ACAS reported an 88% increase in the value of its investments to $66 million over the same period a year ago. During the same time period, interest and dividend income increased 56% to $288 million while restructuring, equity financing and advisory fees increased 102% to $98 million.
American Capital Strategies' ability to raise and generate cash means that it does not have to raise capital to payout its healthy 7.9% dividend. Since the beginning of the year, ACAS stock has appreciated 17% before adding in dividends, which pushes its total return through October 31st to just below 24%. American Capital Strategies closed at $43.16 ahead of its earnings release.
ACAS reported that earnings for the 3rd quarter increased 96% from a year ago to $162 million. ACAS also announced that is was boosting its 4th quarter dividend by 4 cents a share to $0.88 per share, on the heels of bright future prospects in the U.S. and with its European subsidiary.
On a cautionary note, ACAS is trading near its 52-week high, suggesting that investors should wait for a pull back on the stock price before making an investment. ACAS is currently trading at 8 times trailing earnings with a forward PE ratio of 11.7, suggesting that its earnings outlook is slowing.
Remember that a forward PE ratio that is higher than a current PE ratio suggests that future growth will slow. The slowing earnings outlook may be the reason why institutional investors unloaded 9 million shares in the 2nd quarter after several months of upward stock appreciation.
Investors who are interested in smaller firms that focus on investments in energy companies may consider NGP Capital Resources (NGPC) and Prospects Energy Corp (PSEC). I'm a believer in residual income and these stocks know how to deliver, with yields of 6.5% and 8.9% respectively.
Big and small alike, investment opportunities do exist for the individual investor to step in the world of private equity, but I must stress the importance of taking time to understand how and in what these publicly traded firms invest. Information is available on these public-private equity firms, so before you invest, make sure you use it!