American Capital Ltd. (ACAS), American Capital Agency Corp. (AGNC): Meet The Cash Cows

In 1991, rapper Naughty By Nature released a single called “O.P.P.,” inspired by a conversation with a drug dealer, who said he was “down with O.P.M. — other people’s money.”

While I don’t intend to draw corollaries between finance and peddling drugs, managing other people’s money is a big — and profitable — business.

This company’s down with O.P.M.
American Capital Ltd. (NASDAQ:ACAS) is a business development company with a less-than-stellar track record. After trading for more than $40 per share in 2007, the company’s business model nearly collapsed in 2009, when it faced a technical default on some of its debt financing.

Today, shares have only partially recovered from their highs. The memories of the financial crisis are embedded in the company’s balance sheet. The company has a deferred tax asset of $455 million stemming from deep losses during the financial crisis.

For American Capital Ltd. (NASDAQ:ACAS), there is one big bright spot in its portfolio of companies. Its American Capital Asset Management subsidiary is minting money by managing eight different funds.

Meet the Cash Cows
American Capital Ltd. (NASDAQ:ACAS)’s public funds are its biggest breadwinners, equal to nearly 80% of all fee-earning assets under management. American Capital Agency Corp. (NASDAQ:AGNC) and American Capital Mortgage Investment Crp (NASDAQ:MTGE) manage leveraged mortgage investments worth more than $105 billion.

Source: American Capital second-quarter earnings presentation.

For American Capital Ltd. (NASDAQ:ACAS), that means massive fees. American Capital earns management fees of 1.25% from American Capital Agency Corp. (NASDAQ:AGNC) and 1.5% from American Capital Mortgage Investment Crp (NASDAQ:MTGE). Fees are assessed monthly on adjusted shareholders’ equity, so even though the two mortgage REITs are well off their highs, American Capital continues to collect roughly the same level of management fees.

In the latest quarter, American Capital Asset Management paid a $29 million dividend back to American Capital Ltd. (NASDAQ:ACAS), which is equal to $116 million per year on a run-rate. The dividend matches adjusted earnings before interest, taxes, depreciation, and amortization, according to the second-quarter earnings presentation.

Valuing this subsidiary
American Capital Ltd. (NASDAQ:ACAS) ascribes a $981 million valuation to its asset manager, after writing it down by $75 million in the most recent quarter. The parent company believes that it may be more difficult for its mortgage REITs to collect new fee-generating assets in a rising-rate environment.

Even still, a valuation of $981 million seems more than fair. Assuming American Capital Ltd. (NASDAQ:ACAS)’s asset manager merely stagnates to pay dividends of $116 million annually, a $981 million valuation implies a theoretical 11.8% annual return.