Description

Intermediate Capital Group (ticker ICP.L, but henceforth referred to in this write-up as ICG) is a European alternative asset manager.  I’m recommending it as a long.

TL;DR version:

ICG is an especially well-positioned alternative asset manager.  Their niche is European middle-market private debt and mezzanine, where reputation and relationships are especially important for sourcing deals (thereby allowing them to sustainably generate attractive returns for LPs).  They are favorably positioned geographically (compared to the US, Europe is a less mature, faster-growing market for alternative asset managers) and by product type (debt investments comprise ~2/3 of ICG AUM; low interest rate environment, especially in Europe = search for yield = increased demand for alternatives, especially fixed income).  And they are “Goldilocks” sized – big enough to have a reputation as an established, safe choice for LPs, but still small enough to have many years left of double-digit AUM growth without the Law of Large Numbers coming into play.

Despite attractive positioning and stellar AUM growth, ICG is one of the cheapest publicly-traded alternative asset managers.  ICG’s discount valuation is due to the fact that, historically, most of the ICG’s value came from its own investment portfolio and not from predictable, recurring fees on third party AUM.  As that changes (revenue from management of third party AUM is now ~55-60% of the total for ICG and going higher over time), ICG’s valuation discount to peers should narrow.  And even if it doesn’t, compounding of ICG’s earnings should alone generate an attractive return to shareholders.

Full version:

There have been a number of alternative asset managers written up on VIC (Blackstone, KKR, Apollo, Ares, Carlyle, Brookfield), so many of you are familiar with the appeal of this subset of the asset management industry.  The alternative assets value proposition (perceived higher and less volatile returns in exchange for lower liquidity) is compelling to investors with long time horizons.  As a result, LPs have been steadily upping their allocations to alternatives over time, and surveys of LPs suggest this trend will continue.  By my calculations, publicly-traded North American alternative asset managers (Blackstone, KKR, Apollo, Carlyle, Ares, Hamilton Lane and Brookfield) have, in aggregate, grown AUM organically at a 12% CAGR over the last 5 years.  In Europe, where the industry is less mature than in the US, growth has been even faster, as publicly-traded European alts (Partners Group, EQT, ICG, and Tikehau) have, in aggregate, grown AUM organically at an 18% CAGR over the last 5 years.

AUM for alternative asset managers tends to be sticky, due to fund structures which lock up AUM for years at a time as well as the fact that “brand name” matters a lot more for alternative asset managers than it does for most other asset managers.  LPs are most comfortable investing with established alternative asset managers – this is evidenced by minimal fee rate pressure over time (a stark contrast to the rest of the asset management industry).

Within this attractive industry, ICG is an especially well-positioned player.

ICG was founded in 1989, IPO’d in 1994, and is headquartered in London.  When the company started out, the business model was to invest primarily the firm’s own capital in direct debt and mezzanine investments in mid-market European companies.  Over time, as they had success investing their own capital, they also started managing third-party AUM, although this was a minority of the business.  During the Financial Crisis, ICG saw its stock price whipsawed (who wants to own a small cap stock whose value comes principally from an illiquid portfolio of private debt investments in a global financial crisis?), with the stock trading as low as 0.2x price to book.

In response, ICG decided after the Financial Crisis to try to become primarily a capital-light manager of third-party AUM.  They’ve kept the size of their own balance sheet investment portfolio flattish at ~£2 billion, and they’ve been successful in growing third-party AUM from ~£7B a decade ago to ~£40B currently.

They continue to run their core “Corporate” strategy of direct debt and mezzanine investments in mid-market companies (~45% of AUM).  In addition, they manage “Capital Markets” funds (CLOs and the like, ~35% of AUM), “Real Asset” funds (real estate focused, ~10% of AUM), and “Secondary” funds (investing in secondary LP stakes in private equity funds at a discount, ~10% of AUM).

As you might have guessed, what’s allowed them to grow their third-party AUM has been a good performance track record.  A good proxy for ICG’s performance for LPs is how ICG’s own investments in its funds perform.  By that measure, ICG has done well:

Looking at it another way, in their core “Corporate” strategy (direct debt/mezzanine/equity investments), ICG targets a 1.6x Money Multiple, and they have a track record of consistently achieving that target over the last 30 years:

They report in two segments – “Fund Management Company” (FMC) and “Investment Company” (IC).  In the Fund Management segment, they generate revenue primarily from base fees charged on third-party AUM (blended average of ~85 bps across their products), with additional revenue coming from performance fees (which typically average ~10-15 bps on AUM) and dividends received from the equity slices of the CLOs they manage.

In the Investment segment, they generate revenue from interest income, dividends, and gains and losses on their ~£2 billion balance sheet portfolio (which is invested in their own funds).

A decade ago, ~75% of ICG’s revenue came from the Investment segment, with only ~25% coming from Fund Management.  Today, more like 55-60% of revenue comes from Fund Management, and this figure should increase further over time.

Management’s decision to keep the Investment portfolio flattish while growing the third-party Fund Management segment has been a good one, but a side effect of this is that low growth in the Investment segment earnings stream has somewhat masked the terrific underlying growth of the Fund Management segment.  ICG’s overall growth still looks good – they’ve been compounding EPS at a 12% clip the last several years while paying out sizable dividends:

But the growth in ICG’s Fund Management profits has been even more impressive:

Given ICG’s attractive positioning (both geographically and in terms of product focus), I expect ICG to continue to generate high growth in its Fund Management segment.  For some of the larger US alternative asset managers, a (perhaps unfounded) concern that I have is that the Law of Large Numbers will come into play, and AUM and profit growth will decelerate going forward.  In ICG’s case, they are “Goldilocks” sized – large enough to be viewed as an established, safe choice by LPs, but still small enough where it is easy to envision a long growth runway.  I’ve looked at other publicly-traded alternative asset managers and how they grew after reaching ICG’s current size (equivalent to ~$40B USD in AUM).  ICG’s peers have all been able to generate years of attractive AUM growth after reaching ~$40B in AUM:

In the near term, the outlook remains bright.  As is the case for most alternative asset managers, AUM growth for ICG can be lumpy from year to year based on the timing of large flagship fund launches.  The current fiscal year (ending March 2021) was expected to be a trough year for fundraising, but AUM growth should re-accelerate this coming fiscal year as new vintages of some of ICG’s flagship strategies come to market.

Excerpts from recent ICG earnings calls:

-“We’re not going to benefit this year (FY 2021) from having a flagship fund to market….this year was always going to be a low point in our fundraising cycle.”

-“Next year (FY 2022) is looking like a very strong fundraising year.  This prospect, combined with the anticipated performance this year, which was supposed to be trough year, begs the question of the continue relevance of our three year rolling average fundraising target (of €6B annually).  We may have outgrown it faster than expected.  We will look into it and amend it as appropriate for the full year results.”

Despite being one of the fast growing alternative asset managers, ICG trades at a discount to most of its peers:

And if anything, I think the above chart might understate ICG’s discount.  ICG’s EPS estimates don’t include any funky add-backs – they don’t add back stock-comp, expenses related to new funds, etc.  So the ~17x forward P/E multiple for ICG in the chart above is a conservatively calculated figure.  In contrast, many US alternative asset managers calculate adjusted EPS much more aggressively.  Take Ares, for instance.  Ares’ adjusted EPS figures exclude depreciation (!), stock-comp, deferred placement fees, and acquisition and merger-related expenses (all of which are items that recur every year).  If you don’t give Ares credit for these addbacks, their EPS would, by my reckoning, be about 40% lower (and their forward P/E multiple would be above 30x).

So summing it all up, ICG is one of the fastest growing players in an attractive, high-growth industry.  That factor alone should allow them to compound earnings at a rate sufficient to drive good shareholder returns.  Moreover, there could be a kicker from multiple expansion, as ICG’s transition to generating a higher proportion of its revenues from predictable and recurring fees on third party AUM is likely to lead to ICG’s valuation discount to narrow.

Risks

The obvious key risk to the story is if ICG’s funds underperform, thereby tarnishing ICG’s track record and dampening its fundraising outlook.  FWIW however, ICG has diversified by launching new funds in recent years and now operates funds across 22 “strategies”, thereby mitigating the risk of any on fund underperforming.  And the sense I’ve gotten from following this industry is that LPs tend to give established managers a pass for at least one bad flagship fund.  As an example, Apollo’s most recent flagship PE fund has been perceived to be a relatively weak performer, but that hasn’t impacted fundraising for their record-sized next PE fund.

Catalyst

Continued growth of ICG’s third-party AUM