American Capital To Reduce Debt

In an effort to reduce its outstanding debt balances, American Capital Ltd. (NasdaqGS: ACAS – News) intends to prepay its debt in late November. In this connection, the company has issued a notice to the holders of its secured debt due in 2013 that it would prepay $107 million of the debt on November 29, 2010 on a voluntary basis.

This would reduce American Capital’s outstanding amount under this secured debt to less than $1.0 billion and would result in a drop in interest rates to the lowest levels on the remaining debt. Fixed rate notes of American Capital, which comprise 83% of the remaining secured debt, will have an interest rate (annual) of 7.96% while secured loans and floating rate notes will bear an annual interest rate of LIBOR plus 550 basis points, with a 2% LIBOR floor. The current rates are 1% higher than these rates.

In June 2010, American Capital issued this secured debt, due in December 2013, while refinancing the company’s $2.4 billion of outstanding unsecured debt at that time. However, in the third quarter of 2010, the company prepaid $200 million of the secured debt.

No scheduled amortization of the remaining secured debt would take place until June 30, 2013 following the voluntary prepayments. Following this debt payment, the company would be successful in reducing its debt by $3.0 billion from its peak experienced at the end of the second quarter of 2007.

Third Quarter Results

American Capital’s third quarter 2010 operating income of 17 cents per share was a penny ahead of the Zacks Consensus Estimate of 16 cents. The results were also ahead of the prior-year quarter’s earnings of 11 cents per share. Results were helped by a drop in operating expenses, though partially offset by a decline in interest and dividend income in the reported quarter.

American Capital’s asset coverage ratio increased to 230% from 206% in the prior quarter. The company repaid $407 million in debt during the reported quarter, which included $200 million of secured debt maturing in 2013.

Our Take

American Capital’s successful restructuring of $2.4 billion of debt in June has provided it with a sufficient operating flexibility and prevented it from filing for bankruptcy, which management had earlier cautioned about. The company also continues to de-risk its balance sheet through a number of initiatives. However, we think that limited accessibility to capital and increased funding costs have weakened the company’s strategic position in its sector.

One of American Capital’s competitors – Ares Capital Corporation (NasdaqGS: ARCC – News) reported impressive third quarter results on strong growth in investment income, which more than doubled from the prior year quarter.

American Capital currently retains its Zacks #3 Rank, which translates to a short-term (1?3 months) Hold rating. We have a Neutral recommendation on the stock for the long term (3?6 months).

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