Overview:

GAM Holding AG is an attractive long with a compelling valuation, an overcapitalized balance sheet that is starting to be utilized, significant earnings potential, a solid and incentivized management team and several potential catalysts.  Our base case target for GAM is 19 CHF, or almost 40% upside.  In our more aggressive scenarios, including a possible takeout, we arrive at higher targets, implying 50-100% upside potential.

GAM was spun off from Julius Baer in October of 2009 and is an asset manager based in Zurich with AUM (net of eliminations) of 116.6B CHF.  GAM is comprised of two divisions - GAM and Swiss & Global.  Additionally, GAM holds a 27.9% interest in Artio ("ART"), a publicly traded U.S. based asset manager.  AUM is broken down as follows - Private clients (16%), Institutional clients (19%) and Clients of 3^rd party distribution (65%).  UBS is now less than 10% of total AUM (down significantly from prior years but now steady).  AUM by asset type is comprised of 16% Equity, 21% Fixed Income, 7% Managed Portfolios, 12% Hedge Funds, 9% Multi-Manager Hedge Funds and 34% Private Label Funds (slight rounding impact).

Investment Thesis:

Attractive Valuation

By the end of 2010, GAM will have 5.55 CHF per share of net cash/ART value (4.34 CHF of net cash per share and 1.21 CHF per share from the current market value of GAM's ART stake).   When considering the significant cash balance/ART value, GAM trades at extremely compelling valuation across all metrics on a relative and absolute basis.  Looking at multiples net of the cash/ART stake, GAM is trading at a TEV/AUM of 1.3% on 2010 and 1.1% on 2011 with PEs of 10.5x 2010, 9.9x 2011 and 7.4x 2012.  Without the cash/ART stake (and still excluding the ART ownership positive impact on earnings), GAM is trading at a TEV/AUM of 1.9% on 2011 and a PE of 16.5x 2011 and 13.0x 2012.  In our view, you're getting the cash rich balance sheet and ART stake almost for free. Additionally, GAM is worth significantly more in a take-out scenario. 

Compelling Cash Deployment Opportunities

There are three obvious baskets - dividends, buybacks and acquisitions.  Shareholders will see all three of them with GAM.  Management has announced a 50% dividend payout.  Given the share price and lack of acceptable acquisitions, the company has recently announced a 10% buyback with a max duration of 2 years.  They've already bought back 5% (separate to this announcement) which will be used to offset option dilution.  We believe its reasonable to assume the buyback gets utilized more quickly than anticipated and that further buybacks will materialize in the coming quarters.  On the acquisition front, management has been thoughtfully reviewing numerous opportunities.  Thus far, the price and/or the strategic fit hasn't been quite right.  They are disciplined buyers and if nothing fits their profile, it won't get done.  Of course a bad acquisition can never be fully ruled out, but we think management's appropriately cautious track record thus far demonstrates their prudence, and it wasn't for lack of opportunities.  The one deal that they've executed (the Augustus deal) has been a home run.  Given today's exceptionally low interest environment, any reasonable use of GAM's cash should be wildly accretive to EPS.

Potential Takeout

We believe GAM has a decent chance of being acquired in the next two years at much higher prices.  The industry is consolidating and scale is becoming more important for profitably dealing with the higher regulatory burdens and critical for asset gathering.  The management team is comprised of known deal makers/money-makers and is very open to the idea of selling the company at the right price.  Based on our diligence, a common theme was that GAM will either be significantly larger in a couple years or it will be taken out after they return a bunch of cash to shareholders.  In our conversations, management has noted several times the importance of scale when discussing the future as it relates to the sell vs. buy decision. 

Solid and Incentivized Management Team

Based on our diligence, management is highly respected and our interactions and visits with the company have given us comfort that they can execute.  Management has a significant amount of options just below current prices and very much cares where this stock is a couple years from now. 

Confusion

Post GAM's stand-alone listing, there was a lack of information/pro forma detail and management wasn't widely accessible.  This has changed recently but there is still some confusion out there regarding the share count and the true cash balance.  Additionally, key management has had a limited number of meetings with investors and GAM is still a relatively unknown name/unproven stand-alone story.  A true conspiracy theorist would argue that management was less than available/forthcoming on its true cash balances, temporarily elevated non-cash compensation costs and earnings power ahead of new and significant options being granted.

Non-Cash Costs Decreasing

Due to the equity-incentive compensation treatment, there is an elevated level of non-cash compensation cost running through the P&L for 2010 that will basically go away by 2012 (30MM CHF in 2010 going to less than 5MM CHF in 2012). 

Significant Earnings Power

GAM has significant earnings potential.  EPS upside could come from more elevated levels of buybacks, accretive acquisitions, an uptick in investor appetites for riskier assets (equity/hedge fund products), greater performance fees, better fund or market performance or stronger than expected flows.  Also, ART could be worth more as its trading well below its IPO (done at the time of the spin) price.  You don't need any/all of these scenarios to win from current levels, but we think it is reasonable to assume some of these earnings/value drivers materialize.

Rising Tide

GAM should benefit from an expected increase in alternative asset flows from pension funds/institutions as well as Middle East and Asian investors.  GAM is increasing distribution in these verticals, has sufficient scale, a solid track record and has largely avoided several pitfalls (Madoff, Galleon, gating).

Targets Elevated

Given the success of the Augustus acquisition, Swiss & Global's mid-term targets are going to need to be adjusted higher.  We think its reasonable to assume this occurs with full year results.

Risks/Issues:

Weak demand from higher margin retail clients will derail the earnings.

This is a well known issue and why the fixed income market is yielding what its yielding.  This issue could create some 2012 margin goal risk for the GAM segment but Swiss & Global's targets need to come up substantially if this trend continues (and they already need to be raised based on current performance).  Current expectations are that this dynamic won't change until late 2011.  Even if it doesn't happen in 2012, we still see earnings being driven higher and the company's goals are more than attainable.

Management does something stupid with the cash/ART stake.

As touched on above, we think the combination of our diligence, meetings and mgmt's track record (especially with recent success of the Augustus acquisition) gives us comfort here.  We see a very small chance they destroy the value of this cash/ART stake.  ART's stock could continue to perform poorly but the valuation seems compelling for what it is and we believe they had offers to sell ART above its IPO price at one point.  That said, performance needs to improve there.  We aren't shorting out ART and there are reasonable cases where its worth significantly more. 

Poor performance of funds.

Always a worry with an asset manager.  June wasn't a good month for GAM's fund of funds product so this is something we try to watch closely.  The long term track record is pretty solid/decent and institutionally they are very well respected. 

Weak demand for fund of funds. Is it viable?

For personal reasons, I sure hope so.  There are signs that activity is starting to pick up - its more qualitative in nature though.  I personally think it's a viable business and since GAM has avoided many of the high profile disasters, I think they should be a share winner (assuming no material difference in performance).  Our concern centers on fees - we believe its fair to expect lower fees down the road though that has seemingly yet to really happen. 

Tax amnesty worries.

There are headlines that occasionally swirl around swiss banking losing assets as tax shelters get exposed/revoked and in turn cause outflows for GAM.  We've done a lot of diligence on this topic and though mostly qualitative in nature, we think the issue is really going to have a limited impact if any.  It hasn't had any impact to date.

Distribution channel worries.

UBS has been experiencing outflows and Julius Baer (post the spin-out) has shifted to an open architecture platform (in theory - no longer favoring GAM products).  UBS and Julius Baer are much smaller parts of the AUM than they used to be.  In our view, the damage has been done.  UBS recently pointed to some improved performance and GAM management hasn't lost one client as a result of the Julius Baer open platform decision. 

The market will tank

You probably don't want to own an asset manager if you have this view.  We view our collective group of shorts as a good offset to the risk here.  GAM's stock won't perform well if this were to materialize but given its cash deployment opportunities relative to its earnings potential and valuation, I think management will be able to take advantage of that situation in a favorable way for shareholders over the long term.

Summary: