Valuations Haunt American Capital

It's no wonder the topic of valuation got a lot of play at American Capital's (ACAS Quote) annual investor day last week. The investment company continues to use some of the most questionable valuation methodologies in the public markets.

And it's why American Capital remains popular with short-sellers, with 15% of the stock sold short.

One of those short-sellers over the past year has been Greenlight Capital, headed by respected value investor David Einhorn, according to a person familiar with his thinking. Einhorn could not be reached for comment.

Einhorn wrote about his ongoing battles with another business development company he is shorting, Allied Capital (ALD Quote), in his new book Fooling Some of the People All of the Time.

Both Allied Capital and American Capital, which invest mostly in private companies, have been criticized by investors for using aggressive valuation methodologies.

Questioning Valuation

Most of American Capital's investments -- which include equity and debt investments in companies, along with various types of collateralized securities -- are considered Level 3 assets under FAS 157 fair value accounting, which means they are mark-to-model assets. This allows management to have a considerable amount of control over the valuations.

One example is the firm's investment in Scientific Protein Laboratories, a company that manufacturers key ingredients used for heparin, a blood thinner. Scientific Protein Labs has been identified as the seller of ingredients used in Baxter International's(BXL Quote) batch of heparin that has been linked to 81 deaths in the U.S. this year.

American Capital's investment in Scientific Protein Labs (referred to as SPL Acquisition in regulatory filings) had a fair value of $176 million on American Capital's balance sheet at the end of 2007. The valuation dropped to $141 million at the end of the first quarter, as American Capital wrote down the value of its preferred-stock investment from $41 million to $10 million. (The news story on the bad heparin broke in the first quarter).

But the firm's $131 million debt investment in SPL was essentially left untouched.