Frozen Credit Markets Bullish for ACAS

Add ACAS Calls

PLAY: Buy the ACAS May 25 Calls (DQS EE) at or under $2.70, good for the day. Place a protective stop limit at $0.90 and implement our scaled-selling technique as your position achieves gains of 50% (and greater).

Dear Bottarelli Research Member,

Before our very eyes, the pillars that have held up our entire financial sector are crumbling. In many respects, you can argue that the reckless actions of our financial institutions over the last 18-36 months have brought the financial sector to its knees. Take one look at the events that occurred in September 2008, you’ll clearly see that the culminating effects of these actions are now hammering the market all at once.

• 9/7: Freddie and Fannie are taken over by the U.S. government.
• 9/14: Merrill Lynch is purchased by Bank of America for pennies on the dollar.
• 9/15: Lehman Brothers files for bankruptcy.
• 9/16: AIG is bailed out by the U.S. government for $85 billion.
• 9/19: Henry Paulson proposes $700 billion bailout plan.
• 9/26: Washington Mutual fails, marking the largest bank failure in U.S. history.
• 9/29: Wachovia is sold to Citigroup for pennies on the dollar, House rejects bailout plan, Dow drops 780 points (largest single day loss in the history of the financial markets).

Year to date, the Dow has lost 20.2%, the NASDAQ has lost 21.5%, and the S&P 500 has lost 20.7%. And in the process, many of the largest and most prestigious banks, brokerage houses, and insurance companies have gone belly up.

As a result of this mismanaged greed, you now have rampant mistrust within the banking sector. And unfortunately, this means that lending right now has virtually come to a halt. College loans, business loans, car loans, and home loans have all come to a screeching halt. And because of this, it’s quite clear that we’re ushering in an entirely new financial landscape — one that will change the way lending will be done forever. And as you’ll see, this leads to an opportunity of a lifetime for this small company. After all, I’ve isolated the one company that will emerge as the winner in this whole credit mess.

You see, the banks and lenders who were smart enough to stick to their “old-style” lending practices (which required good credit, steady income, and money down — fancy that!) will soon emerge as the next big winners in the financial sector. And because of this, I think we have an incredible opportunity to own LEAPS options on a company called American Capital (ACAS – NASDAQ).

American Capital is the only private equity fund in the S&P 500. They’re also the largest alternative asset management company on the S&P 500.

Both directly and through their global asset management business, American Capital originates, underwrites, and manages investments in private equity, leveraged finance, real estate, and other structured products. They currently have $20 billion in capital resources under management, and they typically invest $5 million to $800 million per company in North America.

Now I admit: ACAS is involved in lending, but their style of lending is completely different than anything you’ve seen before. You see, most of their lending is done on commercial-type paper, and it’s only done if a company agrees to their flexible financing terms. Unlike a typical bank, for example, ACAS takes an equity participation in combination with any monies they lend to a business. This stacks the odds for success squarely in their favor.

After all, this lending model allows ACAS to package up their equity stake and sell it off for a profit whenever they find a suitable buyer. This way, ACAS doesn’t have to wait until a loan’s maturity to ultimately cash out. They can sell for a profit at any time! These flexible terms have allowed them to achieve strong business operations throughout our recessionary business environment.

In terms of performance, American Capital shareholders have realized a total return of 266% since the company’s IPO, which comes out to an annualized return of 13%. But more importantly, ACAS is a company that’s able to provide liquidity to small businesses in times where home prices have fallen over 10% (the most since the Great Depression) and equities have collectively fallen 20% (or more) across the world.

Now that the financial crisis has spread to almost every asset class, you’ll see a new wave of financing going forward. This means that American Capital will have the pick of the litter on middle-market businesses ranging from $10 million to $800 million per transaction.

Since no other financial institution is willing to provide capital to these types of private companies, this opens up a tremendous investing opportunity for ACAS investors. After all, the recent financial weakness has caused shares of ACAS to push lower — and we’re going to scoop them up for dirt cheap.

It gets better: ACAS pays a very handsome dividend, which urges investors to hold onto their position. As I write, this company is kicking out an 18% dividend, which is remarkable in today’s environment. Plus, they just announced strong earnings, and they’ve been adding some extremely high-growth business ventures to their arsenal.

Not only that, but their P/E is very attractive (currently under 8!) and the stock has just bounced off its lows of the year. At a time when standard lending companies are putting a complete halt to further lending, ACAS can swoop in, pick from the cream of the crop, and choose only the very best companies to have in their business portfolio. And remember, all of their deals come with their flexible financing terms.

I firmly believe that the global lending practices have changed forever. Private funding will now be the answer. By taking equity positions and charging for their monies, ACAS has the best of both worlds. Going forward, you’ll quickly see that ACAS represents the next wave of winners that’ll come out of this financial crisis. Their asset quality, combined with their 18% dividend, is more than enough to warrant a strong investment thesis. Add in their $4.51 billion market cap and their forward P/E ratio of 7.74, and you can see that adding ACAS shares to our LEAPS ledger represents the best “crisis = opportunity” play you’ve ever made. Therefore, let’s add longer-dated LEAPS on ACAS now!

PLAY: Buy the ACAS May 25 Calls (DQS EE) at or under $2.70, good for the day. Place a protective stop limit at $0.90 and implement our scaled-selling technique as your position achieves gains of 50% (and greater).

LOOKING TO NEXT WEEK: Considering the economic troubles here in the U.S., you better believe it’ll be a disastrous holiday shopping season for retailers. That’s why I’m considering adding put LEAPS on trendy retailer Urban Outfitters (URBN – NASDAQ). Currently trading at a P/E ratio of 27, URBN’s valuation looks awfully high and unsustainable (especially when you consider that their competitors like Abercrombie & Fitch and Bebe Stores currently trade at respective P/E ratios of 7.49 and 12.92).

Another LEAPS candidate is puts on the Retail HOLDRs (RTH), which is a basket of retail plays that includes Amazon.com, Wal-Mart, Home Depot, and Best Buy.

I’ll have more on this strategy next week. But until then, here are your weekly updates.

UPDATES

Excel Maritime March 15 Calls (EKN CC): Has the bottom been set?Our EXM calls have already traded as high as $4.80 this week, good for a 26.32% gain from our original $3.80 entry price.As I mentioned, the dry bulk shipping sector has the ability to make major price swings, and hopefully we caught EXM right as it’s turning the corner. Hold.

Apex Silver Mines January 2010 2.5 Calls (YSB AZ): Very quietly, there is a supply/demand imbalance occurring in silver. You see, silver investment represents an extremely tiny market. In major world cities, you often find only one large bullion trader. And according to industry experts, these top traders are currently sold out of silver. This is exactly why silver is such a bargain right now — and why a company like SIL is in such a strong position. Silver is not only a great way to protect your assets, but it’s also undervalued and scarce. As soon as Wall Street catches on to this, I predict that silver shares will make strong upside advances. And SIL has the potential to blast off. Hold.

General Mills April 70 Calls (GIS DN): Consumer staple companies like GIS continue to hold their water in the midst of the market turmoil. Our calls have once again turned profitable, so be sure to lock in the second half of your profits at the 50% level at $6.00 or above. Lock in profits at or above $6.00 per contract.

Wells Fargo January 2009 30 Puts (WFC MF): The SEC extended the short selling ban, which delays the next round of selling pressure on WFC. This week, WFC tried to steal Wachovia bank away from Citigroup, but rumors are swirling that this maneuver could get legally rejected. Therefore, let’s maintain these puts for more selling pressure. Hold.

Southern Peru Copper January 2010 25 Calls (YPV AE), Barrick Gold January 2010 40 Calls (WRX AH), & United States Natural Gas Fund January 40 Calls (UNG AN): The so-called “global commodity un-wind” continues to apply pressure to these three assets, but I’m not going to get scared away. Gold, copper, and natural gas are three powerful commodities that we must maintain exposure to. From a political standpoint, whoever takes office in November will support the biggest push towards natural gas in our lifetime. This makes a strong case for UNG. Therefore, hold all three positions. Hold.

Valero Energy January 35 Calls (VLO AG): As soon as the markets stabilize (which could happen with the passage of the bailout bill), investors will finally realize the powerful potential in oil refiners. Hold.

America Movil January 2009 70 Calls (AMX AN), Petroleo Brasileiro January 90 Calls (PMJ AR), & Entergy January 140 Calls (ODF AH): Could the passage of the bailout bill finally snap these three positions back to life? I sure hope so! Hold.

Sincerely,