Adrian Day - Mon, May 23, 2016

Ares-American Capital Merger Positive for Long-Term Investors

Adrian DayInvestment adviser Adrian Day discusses the merger announced today between Ares Capital and American Capital.

This morning came the announcement that two of the Business Development Companies on our list would merge. Ares Capital Corp. (ARCC:NASDAQ, 14.66) will buy American Capital Ltd. (ACAS:NASDAQ, 15.70).

Ares will pay $6.41 in cash plus 0.483 of a share for each share of American Capital. In addition, American Capital Agency Corp. (a separate public company) will purchase its external manager, American Capital Mortgage Management, LLC (part of ACAS) for an additional $2.45 per share.

Modest price paid. . .
As is usual after such acquisitions, the acquirer's stock price fell, with Ares down $0.51 in the morning (while American Capital's rose). At the current price of Ares, the transaction is worth $15.94. On Friday's closing prices, the premium was a tad over 10%.

The transaction price is disappointing, given that Ares is buying American Capital at a significant NAV discount of almost 20%, with only a modest premium to pre-announcement stock prices, and particularly since American Capital had been selling assets at premiums to its carrying cost (over $1.1 billion in sales this year). Indeed, some blood-sucking West Coast ambulance chaser announced the possibility of a lawsuit half an hour after the conference call describing the deal finished (7:15 a.m. local time).

But creates even better BDC
However, for long-term shareholders it's a positive transaction. Ares is a great company; it's already on our list of current recommendations. By combining the two largest BDCs into a company more than twice as big as its closest competitor, Ares will add scale and diversification, giving it the ability to originate larger transactions. Ares acquired Allied Capital a few years back, and was very successful in consolidating that company and getting value out of its assets. The playbook will be much the same with American Capital, to rotate over time out of non-yielding equity investments and move into yielding assets, giving it the ability to increase its dividend over time.

Ares fully covers its dividend, and has spillover income amounting to $0.82 per share to make up any dividend short-fall in the near term. Ares management will also waive up its fee, up to $100 million, over 10 quarters.

Both sets of shareholders must approve the transaction, which is expected to close by the end of this year. American Capital's second-largest shareholder, Elliott Management, which launched an activist investment last year, supports the transaction.

We are holding American Capital. Given the decline in Ares stock, already an attractive holding, we will be looking for opportunities to buy more. The current yield is 10.4%.

One sale closes, another progresses
Sunridge Gold Corp. (SGC:TSX.V; SGCNF:OTCQX) closed the sale of its assets, de-listed its shares, and announced that the first distribution, expected this week, will be CA$0.36. The second distribution, anticipated within six months, and secured by a bank guarantee, is expected to be an additional 4 or 5 cents.

In accounting for the sale in our "Closed Positions" table, we will assume a total payout of $0.40. We will adjust our return once the second distribution has been made (depending on the amount and the U.S. conversation thereof). Our loss is aggravated by the weakness in the Canadian dollar; in U.S. dollar terms, we have a loss of 45% on the sale. (We will adjust once the distributions have been made.)

Reservoir Minerals Inc. (RMC:TSX.V, CA$8.57) exercised its right-of-first-offer to match Lundin's offer for part of Freeport's interest in the Timok joint ventures, with Nevsun fronting the cash, both for that and for exploration at Timok, now Reservoir's responsibility. If Nevsun's acquisition of Reservoir does not complete, these funds are immediately repayable.

Though there is no certainty of another offer, Reservoir remains undervalued and the risk/reward favors holding.

Adrian Day, London-born and a graduate of the London School of Economics, heads the money management firm Adrian Day Asset Management, where he manages discretionary accounts in both global and resource areas. Day is also sub-adviser to the EuroPacific Gold Fund (EPGFX). His latest book is "Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks."

Disclosure:
1) Adrian Day: I or my family own shares of the following companies mentioned in this article: American Capital, Ares Capital and Reservoir Minerals. I personally am or my family is paid by the following companies mentioned in this article: None. My company has a financial relationship with the following companies mentioned in this article: None. Clients of Adrian Day Asset Management own shares of the following companies mentioned in this article: American Capital, Ares Capital, Reservoir and Sunridge. Clients of Adrian Day Asset Management own over 5% of the shares outstanding of Reservoir. I determined which companies would be included in this article based on my research and understanding of the sector. Statement and opinions expressed are the opinions of Adrian Day and not of Streetwise Reports or its officers. Adrian Day is wholly responsible for the validity of the statements. Adrian Day was not paid by Streetwise Reports for this article. Streetwise Reports was not paid by the author to publish or syndicate this article.
2) The following companies mentioned in the article are sponsors of Streetwise Reports: None. The companies mentioned in this article were not involved in any aspect of the article preparation or editing so the expert could comment independently about the sector. Streetwise Reports does not accept stock in exchange for its services. The information provided above is for informational purposes only and is not a recommendation to buy or sell any security.
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