Description

Summary

Alliance Capital Holdings LP is a large money management and research firm based in New York. Majority owned by AXA financial (which owns interests in Alliance both directly and indirectly through its Equitable subsidiary), the Company has a number of strengths in its core business. Unfortunately for Alliance, the industry has recently been through something of a perfect storm whereby the combination of a bear market and then regulatory and legal issues have combined to create one of the most difficult periods for many money management firms in some time. While the industry and select firms in it, including Alliance Capital, have mostly themselves to blame for many of these problems, things can’t get much worse and have already started to turn up. Quoting Ben Graham who quoted Horace, Alliance may be one of the many that now are fallen that shall be restored.

Despite all the challenges, when the market began to turn up earlier this year, assets under management (the key driver of revenues and profits) have once again begun to turn upwards. Despite the taint of scandal, assets are up over 20% over the last 12 months to approximately $456 billion in assets as of November 2003.

In the case of AC, investors also get paid to wait because the Company distributes all of its cash flow and so offers current income in excess of 6% per year (distribution will resume again in 2004 as it was suspended just for 4Q 2003 to finance settlement discussed below). Another nice feature of this idea is the market cap and liquidity of the units which have a 3 month average daily volume of over 500,000 units per day.

Alliance Capital has an interesting albeit complicated structure that provides good downside protection and a good value. As the industry moves beyond recent short-term issues, it will emerge stronger than ever and more focused on adding value and providing good service. As earnings grow and short-term issues abate, the company will once again enjoy a value more indicative of the quality of its franchise, other public and private comps and its own business prospects.

Summary of the Business

Alliance Capital is an investment management firm that also sells independent research to other companies. Alliance serves several client segments including a.) institutional clients such as pensions, endowments, and insurance companies b.) individual and other investors through managed funds, group trusts, and other structured products and c.) private clients – mostly high net worth individuals and families through its private client group.

The firm handles a variety of assets and styles including both value and growth products and a break down of the firms assets are included in the table below:

(Assets $ bill) 1998 1999 2000 2001 2002 Sept 03
Institutional $169.4 198.8 237.4 241.5 211.0 245.4
Retail (Funds) 114.1 164.9 176.9 171.5 135.9 145.6
Private Client 1.3 1.8 35.7 39.2 39.7 46.8
Total 284.8 365.6 450.0 452.2 386.6 437.8

Another way to understand the broad diversification of the firm is the look at assets at end of September 2003 by investment management style. By this metric, Alliance managed $119.6 billion (27.3%) in active growth equities, $130.5 billion (29.8%) in active value equities, $162.4 billion (37.1%) in active fixed income, and $25.3 billion (5.8%) in passive index and structured investments.

Due to this broad based diversification, the firm has the ability to serve a wide range of needs and is not has subject to problems that affect only a piece of the business. Only the largest firms like Alliance have the breadth and depth to compete across so many segments and this diversification is a real strength particularly for Institutional and International clients. Another measure of this diversity is the fact that no single institutional client (other than the Equitable Insurance Company which is affiliated with Alliance) represented more than 1% of the company’s revenues for 2002.

Assets under management grew by 18.7% in the period from September 2002 to September 2003. This growth occurred both through new assets growth but also largely helped by better market performance and renewed interest in equities. Importantly, the strongest growth in both absolute and percentage terms came from a 48% increase in the last 12 months of assets managed in the active value style.

This strong performance in the value equity segment of the business highlights one of Alliance’s crown jewels, namely the Sanford Bernstein business which was acquired in October 2, 2000. Sanford Bernstein was acquired for $1.48 billion in cash and 40.8 million units valued at $2.04 billion for total consideration of $3.5 billion. The Sanford acquisition was a strategic move motivated by Sanford’s strength in independent research and focus on the value style of investing. One of the key valuation metrics by which investment management firms can be evaluated is the valuation as a % of assets under management. At the time of the acquisition of Bernstein which had just around $63 billion under management, the valuation of Sanford was approximately 5.5% of assets.

Bernstein has continued to do well post the acquisition and the strength of the value side of the firm has really helped carry Alliance despite its recent problems. Partly as a result of the strength of the Bernstein bench, the CEO was replaced in the summer of 2003 and the new CEO , Lew Sanders comes from the Bernstein side of the business.

Another indication of the quality of Alliance’s business are the high margins that the company enjoys with net income of approximately 25% of revenues as an average over the last 5 to 7 years. Revenues range between 60 and 70 basis points of total assets at year end (somewhat higher on average assets). Even with this model and assuming some compression of margins, Alliance is still a value.

Recent Developments

Despite the broad strengths of the firm, Alliance’s reputation was recently tarnished following revelations of market-timing in its mutual funds. Alliance agreed to settle with the Securities and Exchange Commission and the New York attorney general and provide restitution to mututal fund shareholders hurt by market-timing. The firm will pay a $250 million fine and lower its mutual fund fees 20%. Due to this settlement, the fourth-quarter distribution payment was cancelled though distributions are expected to resume in the first quarter of 2004. The cancellation of the distribution may have or could soon put additional short term selling pressure on Alliance.

As a part of the settlement, Alliance also agreed to fee cut the fees it charges on its funds by an estimated $350 million over five years. However, given the diversity of the business, it only represents about 3% of total revenue per year. Also encouraging is that the scandal has not had a major effect on Alliance's ability to keep assets. Several prominent institutional customers have evaluated their relationships with Alliance and publicly committed to stay on board. On the plus side, getting the settlement out of the way will likely help Alliance move forward and removes uncertainty. Cutting the fees on the funds will also help keep the Alliance offerings more competitive overall.

Structure

Since the structure is complicated, it merits a bit of explanation. In particular, the operating business is owned by another partnership called Alliance Capital Management LP which is not publicly traded. Alliance Capital Management Holding LP is the public traded security and Alliance Holdings owns 30.9% of Alliance Capital, the operating partnership. The rest of the interests in the operating company are owned by AXA and to a lesser extent some Bernstein partners. Although AXA controls Alliance and is Alliance’s largest single source of assets, an investment in Alliance Holdings represents a direct interest in the profits and assets of the operating partnership. Alliance Holdings distributes the cash that it receives on its share of the operating profits to the unit holders. Historically, the current yield on the units has ranged between 6% and 9% providing both current cash and downside protection to unit holders. No matter what else happens, the company will be providing about a 6% current return to holders while they wait for the private market value to be reflected one again in the unit price as outlined below.

Valuation and Comps

Since there are above 77.5 million units outstanding at $33 per unit, Alliance Holdings 30.9% interest is valued at $2.55 billion. This puts the total value of Alliance at nearly $8.3 billion. When compared to the firms $456 billion under management at the end of November, Alliance’s current valuation is only about 1.8% of assets.

Public and private market values for money management firms range between about 2% and 5% of assets under management. The right place within this range is determined by factors such as the mix of assets, the quality of the firm, profitability, and growth prospects. However, a value under 2% for a firm of Alliances breadth and quality is extremely low by industry and private market standards.

A good comparable company for Alliance Capital is Franklin Resources which is somewhat smaller but has a similar widely diversified mix of assets. Franklin (ticker BEN) is valued at about $12.7 billion at current market prices even though it manages about $302 billion in assets. Thus, Franklin is being valued at about 4.2% of assets under management.

The right range for Alliance is somewhere between 3% and 4% of assets under management. The midpoint of this range would mean that the units would be valued around $63 per share. This would represent 90% upside from current levels. With a reasonable low or mid single digits growth in assets, this valuation would be reasonably easy to achieve.

Risks and concerns

Due to the scandals, the firm is the subject to a number of lawsuits. While these will likely be settled, the outcome and cost is not yet certain. However, the SEC and NY state settlement should help move things along and in any case, Alliance has a number of strengths in the firm that had nothing to do with the scandals. Buyers should also look carefully at the structure to study the tax consequences of owning units instead of common shares.

Catalyst

Moving past taint of recent scandals, continued growth of assets especially in international business and value business (Sanford Bernstein), settlement of additional lawsuits, reinstatement of quarterly distribution in early 2004, growth of earnings and distribution in 2004 and 2004.