Deals

Gillian Tan is a Bloomberg Gadfly columnist covering deals and private equity. She previously was a reporter for the Wall Street Journal. She is a qualified chartered accountant.

Ares Capital's acquisition of American Capital deserves a warmer reception. 

The cash-and-stock deal, announced Monday, hasn't enthused shareholders of either lender: American Capital gained just 0.6 percent to $15.71 in early-afternoon trading, below the more than $17 a share that its investors are set to receive from the deal with Ares Capital, along with the sale of one of its units (American Capital Mortgage Management).  Ares Capital itself fell 3 percent, while its parent Ares Management, which is providing $275 million toward the deal and agreed to future fee waivers, added 0.9 percent. 

Some initial disappointment is understandable, especially for newer American Capital shareholders who hitched themselves to Elliott Management's bandwagon. The activist fund suggested last November that the lender could fetch "in excess" of $23 a share, which I said didn't look likely. Plus, reports that Ares Capital was competing for American Capital against the likes of Apollo Investment, Fortress Investment and Blackstone may have buoyed hopes of a richer takeover offer. 

Based on the value at announcement, shareholders will reap roughly 0.85 times American Capital's book value, which is more than what other such business development companies can hope for, absent a deal of their own. These lenders specialize in loans to small and midsize companies, often at higher interest rates than banks. 

By the Book
Some business development companies have struggled to trade at a premium to book value. The disparity between them could encourage future consolidation.
Bloomberg

Still, Elliott stands to make roughly 31 percent on the transaction , which may work out to an annualized return of 20 percent if the firm continues to hold its position until the deal closes within the next 12 months. Elliott and other American Capital investors can also expect additional returns since they'll end up owning roughly 26 percent of the combined company.

Moreover, the transaction has merits and, like Ares Capital's joint venture with Varagon Capital Partners, helps fill the gap caused by the wind-down of the $8 billion Senior Secured Loan Program that Ares Capital managed alongside a unit of GE Capital. It both prevents rivals from gaining scale and enhances Ares Capital's own competitive advantage by giving it a bigger balance sheet, which will make it a more significant player in the eyes of its private equity clients. 

Extending Its Lead
By acquiring American Capital, Ares Capital will be more than twice the size of its next closest BDC rival.
Source: Company presentations, filings

Shareholders should be cheering -- the combined Ares Capital expects to be able to originate and syndicate larger loans (and retain bigger slices of such deals), which should result in higher underwriting and distribution fees as well as better diversification of its holdings.   What's more, Ares Capital's dividend should be supported and potentially enhanced by its American Capital purchase. 

Paying Dividends
The deal for American Capital should enable Ares Capital to maintain its payout policy. Since going public in 2004, it has paid $17.55 in dividends per share.
Source: Bloomberg

The spread -- or the gap between American Capital's shares and the lump sum promised to shareholders if the deal closes -- may remain, considering there are a few obstacles to overcome, including necessary approvals from both companies' shareholders and the contingent deal for American Capital's mortgage management arm. But this is a deal shareholders should feel good about. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. American Capital shareholders were set to receive $17.40 from the transactions announced Monday, but due to a decline in Ares Capital's stock, this figure is now closer to $17.20.

  2. Based on an average buy-in price of $13.30

  3. The majority of these are already weighted towards relatively defensive industries like healthcare, power generation and business services

To contact the author of this story:
Gillian Tan in New York at gtan129@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net