Description

Note: All currency converted to US Dollars

I am recommending a long in GP Investments, one of Latin America’s largest and oldest private equity firms. The current price provides an opportunity to acquire a portfolio of attractive private equity investments at a ~35% discount to net asset value, own the asset management company for free, and invest in new opportunities in an out-of-favor market alongside one of Latin America’s most experienced investment teams.

Background

GP Investments was founded in 1993 by Jorge Paulo Lemann, Carlos Sicupira and Mercel Telles of ABInBev and 3G Capital fame and has grown to become one of Latin America’s largest private equity firms. In 2003, the current leadership team acquired control of GP from the original Founders, and between 2006 and 2008, conducted an IPO and multiple capital raises that provided GP with permanent capital to invest in its funds alongside its LP investors.

Today, GP manages $5.1bn in assets through 6 private equity funds and one real estate fund, of which $4.2bn is 3^rd party capital and ~$1bn is permanent, proprietary capital. An investment in GP provides ownership in both GP’s underlying portfolio investments and ownership of the management company that receives fees for managing its various funds.

Significant and Widening Discount to Net Asset Value

The current discount to NAV is laid out below. The discount reflects poor performance in its last private equity vintage, which is due to two bad investments (already significantly discounted) and general Brazil underperformance / re-rating, as well as thin research coverage and trading liquidity. While GP’s discount to NAV has persisted for several years now, the discount has widened to its deepest levels in recent quarters (2.5x NAV in mid 2007 down to .65x today) and creates an attractive entry point for longer-term investors.  

GP’s portfolio is generally comprised of high-quality, rapidly growing businesses valued at conservative multiples.

Market-Valued Investments

• Magnesita: Magnesita is the world’s third largest producer of refractory materials. The Company mines, produces and markets over 13,000 different types of refractories that are used in diverse industries such as steel, cement and glass manufacturers. 70% of its raw materials are internally sourced from its own magnesite, dolomite and talcum mines, which are among the largest and purest in the world. Magnesita is expected to grow revenue and EBITDA by 8% and 11% annually through 2015. The Company currently trades at $2.22 per share, which implies 6.0x consensus 2015 EBITDA. Global refractory peers trade at ~7.5x 2015 EBITDA. Research has a consensus price target of $3.31, implying 50% upside to the current price. Convergence to consensus price targets could provide $0.13 of incremental NAV / share.
• Brazil Hospitality Group: BHG is Brazil’s third largest hotel Company, focused on three and four-star business hotels located in Brazil’s main economic centers. The Company currently has 53 hotels in operation, with 17 additional hotels under development through 2016 that will add 35% incremental rooms between 2013 and 2016.

The Company has grown revenues by 36% per annum between 2010 and 2012 and earns 27% consolidated EBITDA margins, near the top of the global hotel peer set. The company maintains a net cash position and is expected to grow EBITDA by 40% per annum between now and 2015. BHG currently trades at 6.5x consensus 2014 EBITDA. Most global hotel companies trade at double-digit EBITDA multiples and Brazil’s largest hotel company, Accor, trades at ~10x EBITDA, so BHG’s current price already embeds a significant discount to relevant comps.

Research has a consensus price target of $9.30, implying 75% upside to the current price. Convergence to consensus would provide $0.13 of incremental NAV/share.

• Tempo: Tempo provides back-office healthcare services in Brazil, such as healthcare administration, dental benefit plans and specialized assistance services. The company currently trades at 10.5x trailing EPS and 9x trailing EBITDA.
• Apen: Apen is a Swiss investment company that owns a mature portfolio of private equity funds and private operating companies. The Company has no research coverage, a $120mm market cap and trades at a 50% discount to its net asset value. Convergence to Apen’s NAV would provide $0.17 of incremental NAV/share to GP.

Privately-Held Investments

GP provides select financial details for its privately held investments.

• Sascar: Sascar provides stolen vehicle monitoring and tracking on an installed base of 216,000 vehicles. Brazil is the 4^th largest automotive market in the world and the market continues to grow at a rapid rate. Vehicle theft remains a widespread issue, as vehicle theft rates per capita are 4x higher than in the U.S. 

Sascar earns 40%+ EBITDA margins on a revenue base that has been growing at 20%+ annually. GP’s current marks for Sascar imply a modest 6.7x trailing EBITDA multiple valuation, a significant discount to Ituran Location and Control, which also provides stolen vehicle tracking services in Brazil and trades at 8.2x LTM EBITDA. Convergence to Ituran’s multiple could provide an incremental $0.09 NAV / share.

• BRZ Investimentos: BRZ Investimentos is the third largest fund manager in Brazil and has grown AUM from $400mm in 2004 to over $4.7bn as of 3Q13, a 35% CAGR over nearly 10 years. BRZ is valued by GP at 1x shareholder’s equity, and while financials for this company are not disclosed, 1x book seems conservative.
• Allis: Allis provides HR and outsourcing services in Brazil. The business has grown revenue by 20%+ in the latest year, earns 9.6% margins, and is currently valued at 5.8x trailing EBITDA
• Real Estate Investments: GP launched its first real estate development fund (GPRE1) in 2013 and is led by a dedicated team from executives at Gafisa, BRMalls and BRProperties with strong investment track records in Brazilian real estate. The fund currently has ~$100mm in total commitments, of which 95% is already committed to 8 residential, 6 office, 2 mixed-use and 1 logistics development projects in the pipeline.

GP ultimately expects a 2x cash-on-cash return on its investment, which could imply an incremental $0.11 NAV/share as the projects are development. 10 projects have so far been launched with 84% of average units sold. 

• EBAM: EBAM is a Brazilian aggregates company that produces 4mm tons of aggregates per year. The Company currently has 4 operational mines, with 3 additional greenfield projects in the pipeline. The business should benefit from multiple growth drivers, including World Cup and Olympics infrastructure investments, oil & gas production and road system and railroad expansions.

In the most recent quarter, GP reported that the Company has doubled its net revenues, operating costs have come down and that the Company sees EBITDA improving significantly, as operations ramp up and G&A gets leveraged. EBAM is valued by GP at $94mm, which includes $34mm is net cash.

• BR Towers: BR Towers owns and operates 4,246 cell phone towers in Brazil, which should benefit from significantly growing mobile usage in Brazil. The Company generates $67mm of revenue and $50mm of EBITDA. GP’s valuation implies a 9.4x trailing EBITDA. U.S. cell phone tower companies such as Crown Castle, SBA Communications and American Tower Corporation all trade in excess of mid-teen EBITDA multiples. At 13x EBITDA, BR Towers could provide $0.20 of incremental NAV / share.
• Centauro: Centauro is the largest sporting goods retailer in Brazil with a total of 231 stores, and was acquired by GP in November 2012. EBITDA grew by 76% in 2012 and is expected to grow by ~15% in 2013. GP’s current marks imply an 11x trailing EV / EBITDA. While the business is showing significant growth, Centauro is still held at cost.  
• Beleza Natural: Beleza Natural operates beauty chains that treat hairs for black Brazilian women. EBITDA has not been disclosed (GP made the investment in July 2013) but GP reports that y/y same store sales has grown by 14% and total revenue is up 38%. The investment is also held at cost

Troubled Investments

• LBR: LBR is a Brazilian dairy company that underwent the Brazilian equivalent of Chapter 11 protection on February 2013, cutting debt from $408mm to R$269mm. The Company has been aggressively cutting costs, reducing its plant footprint, closing distribution centers, reducing points of sales and reducing the number of SKUs. The business is still highly levered at ~5.5x EBITDA but is showing signs of a turnaround. Debt has been reduced from $408mm to $269mm, and in the 9M13, LBR has returned to positive profitability, generating $74mm of EBITDA vs. -$26mm in 2012.  LBR is held at 16% of cost
• San Antonio: San Antonio provides onshore E&P drilling and management services for oil and gas companies in Latin America. The Company has performed well (EBITDA doubled from $64mm in 2009 to $125mm LTM) but suffers from capital structure issues, due to capital restrictions in Argentina that limit the company’s ability to service its offshore debt. GP continues to work on restructuring its balance sheet. San Antonio is held at 21% of cost.

With the exception of LBR and San Antonio, which comprise 9% of NAV, GP’s portfolio is comprised of strong, growing companies at attractive absolute valuations. Valuing the private portfolio is challenging due to the lack of data, but the current stock price is still overly discounted and implies that the private portfolio should be valued at 53% of current estimates and 32% of cost. Furthermore, NAV has various sources of upside potential, as described above.

Management Company for Free: The current price provides the portfolio at a discount and ownership in the management company of one of Latin America’s largest private equity firms for free. While the asset management company is operating at a loss (opex is running slightly higher than base management fees; Company has not been earning performance fees due to performance at GPCP V), the asset manager still has meaningful value as Latin America’s premier private equity franchise. GP has the largest private equity track record in the region, extensive transactional experience, and a strong professional network within the Brazilian business community.  Replicating this institutional credibility and investment infrastructure in an undeveloped market is difficult. Returns in its latest vintage have been subpar but the Company has an attractive long-term track record and a respected reputation. GP continues to incubate new funds and grow third-party assets under management.

Accretive Share Buybacks: GP initiated a share buyback program in 2Q10 and has reduced its share count from 170mm diluted shares outstanding in 2Q10 to 160mm in the latest quarter. While the level of buybacks is not dramatic, GP’s choice to continue repurchasing shares, when management sees opportunities to deploy capital at 25% IRRs, highlights the stock’s attractive valuation.  

Experienced Investment Team with “Skin in the Game”: GP has a deep bench of investment talent that collectively owns 28% of the Company and is well aligned with shareholders. 88% of GP’s Managing Directors and Directors have operating experience as either former CEOs or former CFOs/Directors of operating companies. 69% hold Engineering degrees, many from top US and Brazilian universities. 81% of the senior professionals are between 30-to-44 years old and nearly all have been with the firm for over 4 years, many rising up from within the firm’s Associates ranks.

While returns from the latest vintages have been lackluster, the firm’s extended track record is still strong.

Valuation

In my downside case, I have GP converging to an adjusted NAV that assumes a full write-off of LBR and San-Antonio, and a 40% discount on all other private-held investments. This implies a $1.90 price target, or 5% upside.

In my base case, I assume convergence to current NAV of $2.77 per share, which provides 53% upside.

In my upside case, I assume convergence to an adjusted NAV as follows, which provides 98% upside.

I don’t place a “holdco” discount on this portfolio as I believe the current discount is cyclical rather than structural (GP once traded at 2-3x NAV) and does not include any value for the asset manager. 

Catalyst