GAM Holdings (GAM SW) checks a number of boxes for us. It has a solid balance sheet with CHF800mm in adjusted net cash and equivalents (36% of market cap) a good current income stream and the potential to expand future earnings.  The value of the company has declined in the past few months over concerns in Europe, the rally in the Swiss Franc and potential redemptions.  We think each of these are overblown and present a very compelling investment opportunity.  GAM was previously written up by jwilliam903 about a year ago.

Background:

GAM is a holding company comprised of two distinct asset management businesses.  It's was spun out of Julius Baer in 2009 which was reversed merged from UBS a year earlier.  GAM's current management, Chairman de Gier and CEO Solo, were both instigators of the aforementioned corporate actions and are incentivized and aligned with investors.  Revenue is generated from fixed management fees on total assets under management (AUM) and performance fees based on returns.  GAM Holdings is the combination of GAM, an alternative fund management company, and Swiss &Global (S&G), a more traditional asset manager.  It has Chf114bln (H1 2011) in AUM split40/60 between GAM and S&G.  Revenue contribution is the reverse with GAM contributing 60%. The difference between the two platforms is GAM, by offering alternatives, charges a higher management fee and performance while S&G bills out at a lower management free with virtually no performance.  The AUM breakdown has been consistent over the past few years both by client and product.  The diversity of clients and products has lead to a lower than expected rate of redemptions during market duress.

AUM Breakdown

 As of June 2011

The company's main revenue come from USD(40%) and EUR(34%) based funds.  The main group expenses are 45% in CHF and 28% in GBP which makes the results somewhat subject to large moves in the CHF.  Management has indicated there is still room for cost improvements.

Balance Sheet:

GAM has a solid balance sheet with a large cash position and no debt or pension issues.  The company has a 28% stake in Artio Global Investors (ART US) and carries some other market based investments.  The company hasn't indicated any plans for Artio or the other investments and from what we've gathered both are available for sale.  We therefore calculate the enterprise value on the amount of cash that could be raised, discounting for market volatility and liquidity where appropriate.

*based on current market price

Adjusted Enterprise Value CHF(mm):

Market Cap:                            2,208

Debt:                                       +65

Cash:                                       -644

Artio                                         -94

Financial Investment:              -94

Adjusted TEV                        1,441

Current Earnings:

AUM (Bln CHF)

We exclude any earnings from Artio and treat it purely as an asset using a value for liquidation.  Other income is also excluded to determine the earnings solely from the asset management business of GAM and S&G.

Looking back at the previous 18 months suggests we can buy GAM Holdings for CHF 1,441mm and earn an operating yield on just the AUM of close to 13% or 7.9x.. 

Future Earnings:

Recently, the volatility of the CHF and equity markets slowed new mandates and encouraged private banking clients to redeem.  Net AUM growth has stagnated and overall AUM has decreased roughly in line with the appreciation in the CHF.  Most of the AUM moves over the past 4 years have come from the CHF and performance (notably 2008).

Development of AUM (Bln CHF)

Since H1 2011 the CHF is about 5% lower but with somewhat of a floor created by the SNB's declaration to stop the appreciation.  Market volatility has also increased and we have to assume market performance is negative and net inflows are at best flat.

GAM offsets some of the CHF effects on income with hedges and a variable cost structure.  Overall we would expect margins to remain around current levels if AUM continues to decline and exceed H1 2010 when asset growth resumes (GAM had a series of onetime costs effecting margins over the past 18 months).  Management has indicated the same.

Using some conservative assumptions on AUM we see the average AUM for 2012 increasing 3.4% (after further declines in H2 2011) and then a modest 5% in 2013 (assumes market stability).  Margins follow the historic AUM pattern, without considering structural improvements.

Assuming no other income and the value of Artio and other investments are static for the next few years we are paying 6.6x for 2012 and 5.9x for 2013 AUM operating earnings (excluding any income from other or associates). 

Management

Management is important to the investment, especially in their use of excess funds.  We find the management team very well incentivized and straight talking.  They have a good attitude towards shareholders and are aware their performance will ultimately be judged on use of capital.  They have also been consistent and transparent in their reporting.

Employees and management hold 30.4mm options as of Dec. 2010 with an average exercise price of around Chf12.30 (5.6% above current market price).

Other relevant information.

The current share buyback program lasts three years with a total of 41.3mm shares to be repurchased.  As of August 23^rd the company had purchased 5.3mm shares.  Management attitude toward buybacks has softened during the latest round of the crisis and they now feel additional cash may be more prudent.  Previously, without any real acquisition targets, expectations were that most of excess cash be used for buybacks but with the latest round of market volatility, management indicated they are seeing very good "seeding opportunities" in addition to buy backs.

Each seeding opportunity would use about $20mm of capital for about 3 years.

From our conversations with management and the board, they have looked at most of the potential acquisitions and found none suitable, even at current prices.  They have indicated a preference to grow organically at this point.

Conclusions

In our opinion owning GAM at an estimated 5.9x 2013 operating earnings of only the AUM business (7.4x after tax cash) and having the margin of safety of a solid balance sheet represents an excellent value opportunity.  Any further cost improvements or benefits derived from the Artio holding is an added bonus.

GAM's has a better than average brand and a business model based on broad asset gathering through a diverse product platform.  Over the past three years AUM was negatively affected by the currency (FX accounts for 63% of the AUM lost from 2007-2011) and poor performance but not by customer outflows (net outflows in 2008 were 1.5%).  We are not relying on the SNB but feel the risk of another large appreciation in CHF is low at this level with central bank intervention.  This leaves AUM growth going forward dependent on net performance and inflows where we feel the market is already pricing in a substantial decline in assets which hasn't historically occurred without CHF appreciation.

Asset managers like GAM are calls on market stability and we feel asset growth will come once volatility subsides.  Between now and then, GAM is cheaply priced and has the critical mass and balance sheet to ride out the storm.