Description

GBL was the first stock (I) profiled on VIC and it eventually went from the mid teens to the mid 40s.  While the opportunity is not as attractive today, I think GBL offers a unique opportunity to buy a cash rich asset manager at the lowest multiple of earnings in the group by far. 

Business.  GBL is an asset manager.  As of Q3-06, the company managed $26.6b with most assets in stocks with a roughly ½ split between institutional and retail assets.  GBL also had more than 5.3b in closed end funds, money that can’t be redeemed. 

Here is why I like the stock:

*exceptionally strong balance sheet.  GBL has $16.54 in cash and investments, net of debt and minority interest.  The balance sheet is significantly overcapitalized (see disadvantages below).

*huge free cash flow.  The company doesn’t list capital expenditures on its cash flow statement.  Most of the income the company generates ends up as cash on the balance.  Trailing net income is ~62m.

*solid recent performance in the fund area.  You can see the 12 month returns (and more) on the Gabelli website (prices and performance).  For example, Gabelli Asset, Small Cap Growth, Equity Income, and Value returned 21.8%, 19.2%, 19.2%, and 15% respectively.  Performance was even better in the closed end fund area (partially due to leverage from preferred shares).  So far in 2007, performance has been solid. 

*a recent $375m closed end fund offering (before allotment).  GBL recently announced the recent IPO of the Global Deal fund.  Usually these funds carry a significant upfront cost but then generate annuity-like income thereafter. 

*very low valuation.  GBL trades for a very low pe multiple of just 18x which is far lower on an enterprise value basis.  Because some of the net income is composed of merger arbitrage gains the exact EV (at least on a go-forward basis) is very hard to estimate.

*a low valuation compared to peers.  To put GBL’s valuation into perspective, consider that emerging asset managers GROW, DHIL, and EPHC collectively have a market cap exceeding GBL’s enterprise value and yet the net income between those three companies equals about 13m vs. more than 60m for GBL. 

So what’s the problem?  Why does GBL trade where it does:

*outflows, outflows, and more outflows.  GBL has been suffering from horrific outflows (see below).  While a healthy market and performance have kept AUM somewhat stable, this is a very difficult issue that will always punish the valuation of any asset manager.  However, consider that recent CEF IPO which will greatly mitigation any outflows in Q1.  Also consider that these outflows, at least based on very strong recent performance, are unwarranted and ought to slow (my opinion).  Even a breakeven outflow situation with GBL ought to lead to a much higher valuation

*the cash.  In one of the most bizarre ironies in management today, Mario Gabelli has been holding a significantly overcapitalized balance sheet for years and despite repeated statements that they will do something about it (“if opportunities are not present with what we consider a margin of safety, we will continue to return value to shareholders through stock repurchase and dividends and will consider other options as well”) nothing major has happened.  The company has repurchased shares but not enough to really matter.  Dividends are minuscule, and one-time dividends have not been persistent.  Eventually, you might hope that Mr. Gabelli will be true to his word, though long-time shareholders have to wonder when something will really happen.

*pressure on domestic flows.  International flows have been the hot area in the mutual fund world and GBL’s mostly domestic focus is not in the crosshairs of this development.

*bad publicity.  There has been array of bad publicity associated with Mario Gabelli that I won’t detail here but suffice it to say that most of these seem to be resolved. 

*succession issues.  Lastly, any discussion of GBL can’t help but focus on the fact that there are really no high profile managers at GBL other than Mario Gabelli.  His untimely death or disability could be a serious issue for the company, though my understanding is that the management fee paid to Mr. Gabelli would end too.

So what has to happen for GBL to succeed as an investment from here?

*they have to use the balance sheet for some useful purpose.  I formally took this as a given with Mr. Gabelli’s reputation but obviously doubts have creep in with anyone who has followed this business but maybe eventually – maybe sooner than later – they will do something.

*outflows have to moderate or equalize.  Short-term, the prognosis here looks good.

*the market can’t collapse.  GBL is an equity shop.   Assets would fall which combined with outflows would be a very bad thing, particularly since the balance sheet also has investments in the company’s funds.

*business as usual.  Even if three years passes and nothing happens here to make earnings go up again what would the company look like?  Well, with a stock at $39 a share they would then have another $6+ a share in cash.  So in 2009 the company would have $22.54 in net cash, meaning you buy the rest of GBL for $482m.  Pay $482m for a company that (hopefully) generates $60m in cash?  Sounds like a potential bargain to me even with these issues.  Now just imagine that Mr. Gabelli actually does something with that cash and that outflows moderate or go positive. 

Flows

06-Q4   -733

06-Q3   -517

06-Q2   -904

06-Q1   -755

05-Q4   -298m

05-Q3   -830m

05-Q2   -956m 

05-Q1   -208m 

04-Q4   -1.162b

04-Q3   -512m

04-Q2   -201

04-Q1   +180

Catalyst