P-man, I have no idea what the chances are on revising or suspending mark-to-market accounting. Part of my reasoning was that it seemed ACAS’ survival seemed more dependent on factors outside of their control than what they could control.

“We believe there are three potential structures that ACAS may evaluate.
1. Remain a dividend paying BDC (pass-thru entity)
2. Become a Taxed BDC (all else same but pay taxes and retain the earnings)
3. Become a C-Corp (55% of assets must be control and must consolidate financials)

“The first thing to understand is how the calendar works with regard to ACAS. Its tax year ends September 30th, and
decisions regarding corporate structure/taxation extend from that date. For example in the tax year just ended
September 08, ACAS has an additional $300 million it either have to pay out as a dividend or chose to be a tax-paying entity and pay taxes on earnings.

“Paying taxes this year is very unlikely because if ACAS were to become a tax-paying entity it would have to pay taxes on all of the income it earned for that tax year, and much of that has already been paid out to shareholders in 2008 dividends. Based on management’s comments it appears the tax bill would be roughly $300 million which is the same amount ACAS is required to pay shareholders in dividends to avoid taxes this year. Hence we believe it is highly unlikely that ACAS would pay taxes for the tax year just ended, instead distributing the remaining $300 million as a dividend (more favorable for ACAS shareholders).

“The decision becomes a bit more uncertain in the current tax year which ends September 2009. ACAS does not have
to make the decision for that tax year until June 15, 2010; this is the last date to declare if they intend to distribute the
earnings as dividends or pay taxes instead. If the market improves ACAS may choose to remain a dividend-paying
BDC; in which case nothing changes and ACAS would distribute its earnings the same way it always has, through
shareholder dividends.

“Alternatively, ACAS could choose to be a “tax-paying BDC”, but we believe this is an unlikely choice. The structure
would remain the same but instead of distributing dividends ACAS would pay taxes and retain the earnings. While this structure would allow ACAS to retain earnings (pay 40% tax and keep the rest) it does not change other structural limitations of the BDC model that we believe have proven to be quite burdensome in the current environment. Most notably is the mark-to-market of the asset base which has led to substantial volatility and adverse affects on the credit facility covenants. As a taxable BDC ACAS would also still be subject to the 1:1 debt/equity limitation, the treatment of preferred equity as debt and the restriction of issuing equity below book value. Based on this we do not believe ACAS will choose to become a tax-paying BDC as it doesn’t alleviate much of the current stress.

“Finally ACAS could decide to change its structure completely and become a “taxable C-corp”. If the current
environment persists (below book value and lack of ability to raise equity) we believe this could be an option for ACAS.
It is worth noting that ACAS may be the only BDC that could realistically transform itself into a C-corp. The biggest
hurdle for most BDCs would be having 55% of their assets in “control” investments and no more than 45% in
“investments”. ACAS has approximately 50% control investments now from deals it closed in 2005-2007. While it
would have to do some portfolio restructuring, reaching the 55% hurdle is not out of the realm of possibility, in our view.
However just having control assets isn’t enough. The financial statements for all control companies must be
consolidated, which would be a monumental task. Currently ACAS likely has the manpower to tackle an effort this
large; however as we move through 2009 we suspect continued downsizing at ACAS which would likely cause staff reductions in its due diligence and accounting departments. The consolidation could and may happen but we believe the manpower needed will come from internal and external professionals. Beyond the complexity of consolidating the financial statements, we believe ACAS would likely also need to lower the overall leverage of the portfolio. ACAS portfolio companies are currently leveraged approximately 6 times EBITDA and ACAS has an additional $4.5 billion of debt. When consolidated, the portfolio company debt to ACAS would be eliminated, however ACAS has syndicated many of the senior pieces and slices of the equity in these buyouts to other investors/funds. While this may all be manageable, it appears to us that overall debt would have to be reduced and the complexity of a corporate conversion would be very high.

“It is far too early for us to predict what structure ACAS will adopt in 2010, but it appears to us that these options are
seriously being evaluated. The key takeaway is we do not believe ACAS will pay any dividends until potentially
September 2010 (other than the required $300 million, or approximately $1.30/share, payable in September 2009).”

I have two areas od disagreement with Mr Ward’s report.

First, if a “C” corp is the only means to remain viable, ACAS will do what is necessary to get there. However, to imagine that what we have seen in the last 90 days will continue on throughout 2009 is to imagine one of Dante’s levels of Hell.

Second, I think Troy got the key takeaway wrong…the key takeaway is that ACAS will remain viable, and ultimately will thrive…

ACAS’ NAV at the end of Sept was $24.43. Acquisition of EAS will add approx $1.25 to that. Right now you can by a share of ACAS for about 15% of that. I think buying shares below $4 is precisely what a self-proclaimed value seeker would do.

My rationale for purchasing more ACAS at this time…(I own ACAS already at an average cost per share, including reinvested dividends, of $16.86.)

If ACAS remains a BDC, and RIC, it will pay dividends of about 95% of NOI, probably annually. Next year there will be a payout of $300M, the residue of $518M, earned in tax year ending Sept 30 ‘08, roughly $1.35/share. Going forward ACAS will payout something between 90 and 98% of NOI, say 95%. My assumption is that NOI in 2009 will approximate 70 cents a quarter, and therefore payout will amount to $2.65 – probably paid out by end of Sept 2010. So roughly, payout over the next 22 months will equal the price I pay for a share on Friday, Nov 28.

What’s the likelihood I’m wrong about 2009 NOI? — there’s a finite chance for sure, especially in the event of a significant crash in the market, but in the absence of such, it is a good bet, imo.

I believe ACAS is better prepared to survive this recession than they were in 2001-2002, precisely for the reasons Malon talked about on the Q3 CC — this time the portfolio companies are larger, have more EBITDA, better interest coverage, and fewer are in cyclical industries. I also disagree that ACAS is a trend follower, as you state. The FACT Team, the Operations team, their data base of opportunities, visibility, choice of deals, etc. make them the “class” of the BDCs.

But suppose I’m wrong? What then?

Well my assumption is that management will do whatever is necessary to have the entity survive this recession. And if they survive, they will thrive in the next upturn.

What evidence do I have?

It’s intuitive, not concrete.

For years, or at least for as long as I’ve been a shareowner, Malon talked about ACAS’ record on dividends…”Never missed a quarter, never reduced”. It was a point of pride, and frankly one of the principal reasons I purchased shares. Well he’s had to swallow his words, and to his credit he has. His motivation? The viability of “his company”.

I see Malon as identifying with ACAS…it is “his company”, and he will keep it “alive”…imo.

I see a foreshadowing in his suspension of quarterly dividends of what might happen should the market and the economy continue in a deep and lengthy recession, and liquidity and credit continue to be issues. I think Malon will abandon the RIC or BDC requirements and restructure the company to survive.

Rgds: Thomas