Valuations Haunt American Capital

Breaking Down Profit Performance

This uncertainty is a problem given that the firm's earnings quality has weakened of late.

American Capital in early May reported an $813 million loss in its first quarter. The results were weighed down by $997 million of accounting markdowns. But even adding back those paper losses and adjusting for other items, the company reported negative operating cash flow of $10 million.

The company reported net operating income of $151 million from its portfolio investments, but 38% of that was from non-cash accrued interest income on payment-in-kind (PIK) interest and dividend payments to the company. PIK income generally results from financially strapped borrowers paying interest with more debt rather than cash.

Another hot topic surrounding American Capital is the control premium the company is applying to its majority interest in European Capital, a public company on the London Stock Exchange whose stock price has plummeted over the past year.

American Capital has avoided marking the full stock-price loss on its balance sheet since the firm applies a large control premium on top of the market-based loss of the investment.

In a November 2007 column, I raised the issue about how this control premium conflicts with FAS 157, unless American Capital is arguing for what would be a very aggressive interpretation of the rule. In a subsequent talk with Wilkus, the firm's CEO, I asked him to specifically correct sections of my article that were wrong, since he objected so vehemently to it. I never heard back from him on this issue.

American Capital officials did not return emails and calls seeking comment for this article.