Description

Allied Capital Corporation is a Venture Capital Company which specializes in small business loans, mezzanine financing, and commercial real estate loans. In a nutshell Allied takes capital from the equity market and utilizes it by providing loans to old fashioned (not internet or biotech, necessarily) small businesses. Allied makes money through charging high interest rates and demanding an equity kicker. They currently have over $1.2 billion dollars in their total portfolio.

ALLC is currently trading at 10x trailing EPS, yielding a fat 10% dividend. Over the last six months insiders have been buying shares all the way up to $19.25. Even more impressive is the rate Allied has been able to grow their dividend over time: from 94 cents in 1994 to 1.60 in 1999, over ten percent compounded annually.

Two major factors have contributed to the long term success at Allied. First, the team choosing from private financing alternatives is highly selective. Last year alone they reviewed requests for $12 billion in financing, and approved only $347 million. Allied has not been taken in by the get-rich-quick internet plays, instead staying true to their principles and investing in some brick and mortar plays which stand to gain from the internet. Second, the commercial real estate department has been able to consistently securitize lower yielding loans in the portfolio and roll the proceeds into higher yielding investments (ala Fannie Mae, the government backed mortgage lender). Last year Allied sold $86 million in loans yielding 9.5% and bought $246 million in non-investment grade commercial mortgage-backed securities yielding 14.6%. Because of economies of scale, Allied is able to take on some amount of risk if the return is there. In this case, the 14.6% yield is already factoring in 1% delinquency.

The key statistic on this company: a 13% yield on a $1.2 billion total portfolio, with only 130 employees. The company has been able to consistently raise its dividend, and the numbers are easy to extrapolate.

One caveat is the fast growth of the company’s total portfolio ($700 million at the end of 1997 to $1.2 billion at the end of 1999) and the fear that in the future it will be more difficult to find suitable private financing opportunities to maintain the present rate of return. To remedy this Allied has began financing leveraged buyouts, where a director or group of directors at a company wish to buy the entire company. These transactions are on average $30 million, three times the average private financing last year of $10 million.

Catalyst

Catalyst: Look for Allied to keep up its fantastic rate of return, using leveraged buy outs more and more on the private financing side, and opportunistically maximizing the yields on its commercial real estate loan portfolio. No catalyst here but time: by 2002 Allied will be spinning off a dividend of $2.22 (a 12.7% yield on today’s dollar), and have appreciated in price to $30 per share as earnings grow to $2.30 and PE comes in line as the market recognizes this company’s fantastic growth.