Description
Absolute Capital Management (ACMH) is a UK-listed Hedge Fund management company, which is in the process of turning itself into a fully fledged institutional asset management company. The company has just reported excellent results for the first half of the year, has also reported positive results in almost all of its funds for July, and yet is trading for less than 8x analyst 2007 estimates and under 7x 2008 numbers. It currently yields about 4% based on first half dividend. Forward estimates are not predicated on outstanding performance at the underlying funds. Comparable hedge fund management companies like RAB trade for over 10x earnings, and 13x prior to the selloff, implying room for a double from here.
The stock is down 20% from its peak post-earnings (when it was under 10x 2007E anyway). Part of that is due to the general market selloff, part due to confusion with an unconnected Australian fund (see below). In addition, the stock is off the general investor radar screen. That combination of neglect and confusion may be a source of opportunity for those willing to dig deeper.
There are a couple of “key man” issues that you have to get comfort with (see below) and I don’t want to gloss over these but I believe that managing hedge funds is fundamentally a good business to be in. ACMH is an interesting risk/reward given its growth, dividend payments, and low valuations. So on to the details.
What does ACMH do:
ACMH is a fund management company managing 12 different hedge funds focused on absolute return strategies. AUM as of 6/30/2007 were $3.25B. 8 of the funds are long/short equity (one focused on India, the balance primarily on Europe), 2 are fixed income, one is private equity and one real estate related. The oldest funds have been in existence for over 5 years. The funds are managed conservatively, using catalyst-driven long/short strategies with an emphasis on risk management and stop losses, and have very few down months. The Sharpe ratios are impressive, and the funds have won several awards.
The company seeks to develop into a fully-fledged asset management platform. It has created new fund products, expanding beyond equities into fixed income and real estate, bringing fund marketing in house, and filling out the management team.
Company history.
Florian Homm set up the Absolute Return Europe fund (ARE) in 2002. Sean Ewing founded ACMH along with Florian in 2004, folding in ARE and two other funds. After launching another 3 funds, ACMH went public on the AIM in London in March 2006 via an “introduction”. That is to say, they registered shares and started trading, without a large fund raising. This lack of an IPO roadshow, and the resulting lack of coverage and liquidity probably didn’t help to raise their profile, and the stock languished for most of 2006. The underlying funds did well, two more were launched and returns came in ahead of expectations. ACMH began to use its new currency to grow from a narrow family of funds to a fully fledged asset management platform.
ACMH didn’t raise capital since they didn’t really need it. They did want a currency to make acquisitions and build out their asset management platform, and have made three major acquisitions so far:
- TCA Group Limited, a third party marketer in January 2006. This appears to have been primarily an earnings-enhancing move to eliminate a stream of fees that would have been payable to TCA
- Acquired emerging market debt fund manager Argo Capital management in January 2007 (brought fixed income and real estate capabilities)
- Acquired North Asset Management’s Real Estate Fund (brought real estate funds, and ACMH added “in addition it is our intention to launch a long/short global property fund the timing of which we believe to be opportune.")
We believe that management still has an eye out for opportunistic acquisitions, has passed on several recently, but has indicated that a few more under review.
The future:
ACMH’s earnings growth will obviously depend on returns and success in growing AUM. Risk adjusted returns (as measured by the Sharpe ratio) have been excellent, the company has institutionalized risk management and invested in its back office and operations. The focus is now on:
- Improving the sales/marketing effort – both reducing cost and improving asset gathering efforts. On the marketing side, management believes that there is a lot of room for improvement (despite decent results to date). To date they have raised funds primarily in the eastern US, London and Switzerland. They have been building out their direct sales teams in Europe and the US, plan to hire a global head of sales and staff up in Asia and potentially the Middle East with the goal of driving down marketing costs and increasing growth.
- Expanding into new strategies/funds. ACMH has capacity in most of its strategies, several of which have yet to be actively marketed (especially those with less than one year track record). The firm has deliberately targeted new strategies like fixed income, private equity and real estate to be able to better lever its investor relationships, back office and brand. It has indicated that it may launch another long/short real estate fund in the near future, and will look at attractive acquisition opportunities where the right fit can be found at an accretive price, and where the principals are willing to lock-in.
- Reducing / eliminating “Key-man” risk. The firm has staffed each fund with two PMs
- Operations – the hiring of an experienced COO from ABN Amro asset management signals the strong commitment to operations and process.
- Increasing investor awareness. This is a key task of the new CEO, and will be a priority in choosing a new Chairman.
The right strategy for the current market?
With all hedge funds, two big concerns are:
How stable are the assets?
How stable are the returns?
ACMH has deliberately been constructed as an institutional asset management platform first and foremost. Risk management is a priority, and they are not swinging for the fences. ACMH’s funds were designed as a low-volatility long-short product and have few down months (see table below, almost all up in July, only one down month last year). Returns have been good (exposure to central European markets hasn’t hurt). The style is what might be called “catalyst-driven value” – which is to say that they haven’t made their money making directional bets on energy or minerals etc. The funds hedge with shorts, do a lot of pair trading and employ stop-losses. If August returns are even flat-to-down-small, following on a solid July, it will be another feather in their cap.
Per the 2006 Annual Report, all funds had Sharpe Ratios over 1.9, and the AUM weighted Sharpe Ratio was 2.70 for the equity funds and 3.10 for the debt funds over the prior two years. In short, the funds appear to be conservatively managed with a view to minimizing risk. A consistent record as a low-risk medium return vehicle with a focus on pair trading, shorting, catalysts and stop losses should offer protection. In fact, after the losses that some funds have experienced recently, ACMH could conceivably find greater demand for its absolute return products.
Asset growth has been spectacular:
|
Year |
2002 |
2003 |
2004 |
2005 |
2006 |
H12007 |
|
AUM $ |
16 |
134 |
393 |
841 |
1608 |
3116 |
Bear in mind that the Argo Funds were acquired in January (around $900mm)
The funds generally do not have long lockups (not too popular with European investors). There is some permanent capital (around €100MM) via traded units on the German exchange. The recently acquired North Real Estate Fund has a publicly traded €100MM fund (NREOF), and we believe that additional permanent funds of €100MM-200MM in the near future.
They have won several awards:
- No. 1 Best Hedge Fund Group, 2006 Hedge Fund Review
- No. 1 European Event Driven Fund, 2005 Eurohedge
- No. 1 Risk Adjusted Long/Short Fund 2005 Barclay Group
- No. 1 Germany Fund over 1, 2 and 3 years, 2004 Micropal
- No. 1 European Long Short Fund, 2002 HFI
Recent nominations
- No, 1 Hedge Fund Group 2007 Hedge fund Review
- No 1-4 Global leaders of 2007 Alternative Investment News
Management team:
Florian Homm (co-CIO). Florian is co-founder and the largest shareholder as well as being co-CIO. He’s also a colorful character to say the least. He worked at Merrill Lynch, Fidelity, Julius Baer and Tweedy Browne, and has run a couple of his own firms since. Known as a money-maker and a smart catalyst-driven investor, but has dirtied his bib on a couple of occasions. As disclosed in the Admission Document, he published bearish research on a couple of names which he was short (see details at the end). Florian is not the only Hedge Fund manager to have published research favoring his holdings during this period. The bull case is that he has learned his lesson, does have a very good track record as an investor, and he now directly manages a decreasing proportion of the AUM, so his importance to the story has declined. That said, you either get comfort with him or you don’t, and I want to put the issue front and center.
Jonathan Treacher (CEO) Was previously a non-executive director. Has over 20 years of asset management and corporate finance experience and has been actively involved in the development of a number of growth companies in the sector. He was a non-executive director of Farlake Group plc, and a founder and director of Romanian Reconstruction Capital, a country specific fund. He has experience of public offerings and in particular the AIM market. Previous career included corporate finance roles at Hill Samuel and Drexel Burnham Lambert.
Rob van Oostveen is Chief Operating Officer, a newly created position. He was previously Global COO for Equity portfolio management at ABN AMRO Asset Management, after stints as Head of Fund Accounting and Head of Portfolio Management.
Sean Ewing. (former Chairman and CEO).Formerly Chairman and CEO of Farlake Group plc, an AIM quoted asset management firm, built AUM from £120 million to £600 million in four years, sold to Seymour Pierce in April 2000. Founded and launched the UK and European fund supermarket Fundsdirect, which he sold to Egg and Prudential in 2002.
Sean has stepped aside from the business, to take a break after several years of working flat out. The search for a new non-Executive chairman is underway. This was announced with second quarter earnings, but was something that Sean has been talking about as a natural progression for a while (indeed, since I first spoke with him). He is an entrepreneur, and believes that the time has come to hand over the reins, though he will remain available as a consultant. Per my conversation with him, he will be staying invested, though he may choose to move some part of his investment to one of the funds in the future.
Valuation.
ACMH is a non-capital intensive business with good cash flows. Revenues are generated from the usual 2-and-20 fee model, plus fees for redemptions etc. The major costs are compensation and marketing. Historically, over 50% of revenues drop to the bottom line. This may wander around a bit over time as the marketing fees reduce, but I expect comp costs to increase and offset. The company has a low tax rate, partly as a result of its tax treaty with the Swiss canton. It uses the cash to pay a dividend – expected to be around 40% of earnings, to seed new funds and to fund growth by acquisition.
Returns: I use 12% per annum going forward. This is significantly below historical returns (see below), but given the current valuation, even with lower returns the valuation is attractive.
Fund raising: I assume they raise a net $300MM in the second half of 2007 (same as H107, but with a much stronger sales/marketing effort). Obviously, AUM also increases due to appreciation. Looking out over the longer term, it seems reasonable to assume a similar level of growth, especially with the expanded marketing team, new geographies that they are targeting, longer track record and additional strategies. Nonetheless, I use $375MM in net inflows for all of 2008.
That gets me to the following model:
|
Data in millions of Euros, except bottom line EPS in pounds sterling |
|
|
|
|
|
|
|
FY2004 |
FY05 |
FY06 |
H107 |
H207 |
FY07 |
FY08 |
FY09 |
|
Revenues |
|
|
|
|
|
|
|
|
|
Management Fees |
3.75 |
8.72 |
19.73 |
20.63 |
25.08 |
45.71 |
60.38 |
73.59 |
|
Incentive Fee |
5.76 |
20.54 |
29.72 |
38.49 |
30.09 |
68.59 |
72.46 |
88.31 |
|
Other Revenue |
0.41 |
1.26 |
3.04 |
2.55 |
2.55 |
5.11 |
4.55 |
4.55 |
|
Total Revenues |
9.92 |
30.51 |
52.48 |
61.68 |
57.72 |
119.40 |
137.39 |
166.45 |
|
|
|
|
|
|
|
|
|
|
|
Employee Costs |
- |
(4.69) |
(9.55) |
(15.73) |
(15.41) |
(31.15) |
(36.65) |
(44.50) |
|
Management/Incentive Fees Payable |
(2.92) |
(8.66) |
(9.96) |
(8.12) |
(7.60) |
(15.72) |
(18.09) |
(21.91) |
|
Operational Expenses |
(1.21) |
(0.70) |
(0.55) |
(1.25) |
(0.97) |
(1.93) |
(2.89) |
(2.19) |
|
Expenses |
(4.13) |
(14.60) |
(22.41) |
(26.04) |
(24.97) |
(51.01) |
(59.51) |
(71.89) |
|
|
|
|
|
|
|
|
|
|
|
Operating Profit |
5.78 |
15.92 |
30.08 |
35.64 |
32.76 |
68.39 |
77.88 |
94.56 |
|
|
|
|
|
|
|
|
|
|
|
Share-based Payments |
- |
(0.38) |
(2.70) |
(0.34) |
(0.34) |
(0.68) |
(0.68) |
(0.68) |
|
Other non-op. expense |
0.04 |
0.06 |
0.09 |
0.15 |
(0.46) |
0.65 |
0.19 |
0.70 |
|
Earnings before Taxes |
5.83 |
15.69 |
27.56 |
36.00 |
32.92 |
68.92 |
78.42 |
95.14 |
|
Tax provision |
- |
(0.04) |
(0.50) |
(3.64) |
(3.33) |
(6.97) |
(7.94) |
(9.63) |
|
Net Income (Loss) |
5.83 |
15.65 |
27.06 |
32.36 |
29.59 |
61.95 |
70.48 |
85.51 |
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|
Diluted EPS |
|
|
|
|
|
|
|
|
|
In Euros |
- |
- |
0.45 |
0.47 |
0.40 |
0.87 |
0.92 |
1.08 |
|
In Pounds Sterling: |
- |
- |
0.30 |
0.32 |
0.27 |
0.59 |
0.63 |
0.74 |
|
|
|
|
|
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|
FD Wt Avg. Shares |
51.44 |
51.67 |
60.68 |
69.06 |
73.83 |
73.83 |
76.33 |
78.83 |
|
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|
|
|
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|
|
AUM, EOP, EUR Millions |
323 |
693 |
1,193 |
2,308 |
2,707 |
2,707 |
3,331 |
4,028 |
Note: The AUM number at the bottom is my rough conversion from dollars to Euros, the previous AUM table was in dollars (as the company reports it). The stock is priced in sterling, so I convert EPS to sterling. One of the pains in dealing with the company is the need to work in dollars, euros and sterling…
Also, I have not modeled in the new real estate fund into the above.
Note that my estimates are below those of analysts. ( Panmure are at: 2007: 62p 2008: 72p). I assume lower investment returns going forward (12% p.a) and lower asset gathering, and I use a higher FD sharecount (vesting of shares and higher option grants).
So what to pay for EPS of 0.59 in 07 and 0.63 in 08, and 0.74 in 2009 with a dividend yield of about 5.8%, and growth of ~15% going forward, with minimal capex requirements?
Mutual fund managers trade for high teens multiples, but arguably have stickier assets, so I’ll set them aside.
I pulled together a comp table below. I included my calculation of EV/AUM as best I could figure it, but I don’t think it’s a good comparison – some managers have mutual funds, different fees structures, different emphasis (credit, fixed income etc) and ACMH has a very low tax rate by virtue of jurisdiction.
|
|
|
Price |
EV/AUM |
Yearend |
P/E 07 |
P/E 08 |
P/E 09 |
|
Polar Capital |
AIM:POLR |
2.09 |
0.06 |
March |
14.06 |
11.13 |
- |
|
RAB |
AIM:RAB |
0.96 |
0.13 |
December |
10.79 |
8.46 |
6.86 |
|
BlueBay |
LSE:BBAY |
4.36 |
0.13 |
June |
15.95 |
11.28 |
8.92 |
|
Charlemagne |
AIM:CCAP |
0.56 |
0.06 |
December |
8.62 |
7.43 |
6.25 |
|
Ashmore |
LSE:ASHM |
2.22 |
0.08 |
June |
13.15 |
10.51 |
9.06 |
|
Average |
|
|
|
|
12.51 |
9.76 |
7.77 |
|
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|
|
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|
|
Absolute (Cons) |
AIM:ACMH |
4.58 |
0.18 |
December |
7.39 |
6.21 |
4.95 |
|
Absolute (Mine) |
AIM:ACMH |
4.58 |
0.19 |
January |
7.78 |
7.29 |
6.21 |
RAB, ostensibly the closest comp, trades for just over 10x 2007 EPS after the recent selloff. ACMH is less associated with mineral plays, less dependent on performance fees than RAB, and its hedged, risk-averse style should give some comfort. Polar Capital (POLR LN) is another potential comp, but the business mix is different (not all hedge funds), and in my mind inferior, but appears to trade at 14x 2007E.
At 10x my 2007 EPS ACMH should trade at about £6.00 for a 33% upside. I would argue that over time the business might reach the heady levels of 12-13x EPS (a discount to where RAB has traded). At 13x my 2009 estimates, the stock would be at £9.60, over a double from here. Note that if you use analyst estimates for ACMH (as for the comps) the upside is greater - at 12x consensus 2008, you get £8.90, almost a double.
Analyst coverage:
The company is followed by 2 small UK firms – Panmure Gordon and Equity Development. Altium had coverage but the analyst left. Sandy Chen at Panmure is probably closest to the company. Morgan Stanley have met with the company, and include ACMH on their European asset management value chart (as you might expect, they are a huge outlier) but do not yet cover them. I believe this may be due to the limited float, but if MS were to pick up coverage it would obviously act as a catalyst for the stock.
Confusion on the name:
Absolute Capital can refer to one of two firms: It can be Absolute Capital Management Holdings Ltd (ACMH), our AIM – listed hedge fund management company. Or it can be Absolute Capital Limited, “a specialist structured credit fund manager based in Australia”.
The latter has suspended withdrawals due to losses incurred in the subprime debacle, and would seem to have a few issues to say the least. Importantly, the two are NOT in any way linked. There appears to be some confusion (per the analysts and the company, both of whom have been fielding calls). ACMH has clarified in two press releases – the latest on Aug 20th:
Absolute Capital Management Holdings Limited ("ACMH")
Clarification
In response to some reports, ACMH wishes to clarify that there is no connection whatsoever between ACMH or any of its funds and a business called Absolute Capital Limited, a specialist structured credit fund manager based in Australia.
Risks:
- Asset flight. Investors could abandon hedge funds wholesale due to losses in unconnected strategies. I believe the recent shakeout puts a premium on quality and risk management. ACMH could prosper.
- Blowup risk: If they screw up swinging for the fences (which as detailed above, is NOT what their history would indicate) then its all over.
- Sustained underperformance: If ACMH’s funds continually post low returns, funds will flow out. Returns have been excellent to date, and by diversifying into new strategies, new geographies (India), new asset types (debt, private equity and real estate) the firm mitigates this risk
- Key Man Risk: One of the founders (Sean Ewing) has left, though he was not on the investment side and remains invested in ACMH. He has a knowledgeable successor, has expanded the management team to add a COO and is available on a consultative basis.
- Florian Homm is the other key man and while he now directly manages far less of the AUM than he did previously, it would be a blow if he left. The firm has been hiring and training additional PMs (2 per fund) and building out new funds to reduce key man risk in all funds. All of the principals (Florian, Argo guys) own stock which aligns incentives with shareholders.
Information on the funds and their returns.
Information is available on the fund website www.abcapman.com, in detailed form. Summary from the latest earning release is:
|
ACM Funds |
AUM US$ million |
Annualised* Performance |
2007 YTD* Performance |
Positive Months |
Launch date |
|
Absolute Return Europe Fund |
490 |
15.81% |
5.33 |
97% |
Mar-02 |
|
Absolute European Catalyst Fund |
273 |
20.53% |
9.29 |
91% |
Oct-03 |
|
Absolute Germany Fund |
381 |
21.71% |
13.79 |
95% |
Jan-04 |
|
Absolute East West Fund |
222 |
23.93% |
10.38 |
96% |
Jul-05 |
|
Absolute Octane Fund |
342 |
38.55% |
7.26 |
96% |
Jul-05 |
|
Absolute Large Cap Fund |
137 |
19.29% |
6.35 |
88% |
Feb-06 |
|
Absolute India Fund |
18 |
16.46% |
7.90 |
100% |
Jul-06 |
|
Absolute Activist Value Fund |
241 |
29.37% |
8.94 |
100% |
Jul-06 |
|
Argo Fund |
484 |
17.77% |
6.74 |
96% |
Oct-00 |
|
Argo Global Special Situations Fund |
455 |
15.64% |
8.15 |
91% |
Aug-04 |
|
Argo Capital Partners Fund |
73 |
|
|
|
Aug-06 |
|
North Real Estate Opportunities fund |
140 |
|
|
|
Jul-07 |
* Note: All Performance to 30 June 2007 and AUM as at 1 July 2007
Catalysts:
- Improved marketing efforts – the new hires should continue to get traction
- Building track records at new funds. As their newer funds pass their 1,2 and 5 year anniversaries they land on the radar screens of new institutional investors.
- Acquisitions. The firm is disciplined on price (must be accretive, which is a high hurdle at their low multiple)
- Clarity on the name – investors realize that ACMH has no subprime issues.
- Possible coverage from Morgan Stanley or other firms as new CEO/Chairman reach out
Catalyst
Improved marketing efforts – the new hires should continue to get traction
Building track records at new funds. As their newer funds pass their 1,2 and 5 year anniversaries they land on the radar screens of new institutional investors.
Acquisitions. The firm is disciplined on price (must be accretive, which is a high hurdle at their low multiple)
Clarity on the name – investors realize that ACMH has no subprime issues.
Possible coverage from Morgan Stanley or other firms as new CEO/Chairman reach out