American Capital Start-Up Stake Unwinds

In the first nine months of 2007, American Capital paid out $2.72 per share in dividends and reported earnings of $5.50 per share. But the company only reported $2.45 per share of net operating income, or the money earned from ongoing investments.

Net unrealized appreciation -- marking up investments -- boosted earnings per share by about $2.06. Another $1 per share of earnings came from realized gains on investments.

The financials show that American Capital cannot cover its dividend other than by marking up its books or by selling off investments. Wilkus, the company's CEO, points out that the firm has always been consistently able to cover its dividend through ordinary taxable income, which excludes stock-option expenses.

On Monday, American Capital reiterated that it expects a 13% growth in its dividend in 2008 and announced the authorization of an ongoing $500 million share buyback plan.

However, when investments start running into issues -- such as with Geosign -- the dividend coverage issue becomes even more worrisome.