Description

JMP group is a high-conviction idea easily worth 60% to over 100% higher than this price and the company is paying you 6.5% dividend yield and buying back shares while you wait alongside the well-aligned senior management and board of directors who own 49% of outstanding shares, compared to 27% at the time of the May 2007 IPO. In addition to buybacks and dividends, there is a pending IPO of a REIT that JMP owns, that can unlock more value. (NOTE: Since this is a financial, the EV values are N/A because it does not make sense to compute EV for financials and banks)

Treat this short write-up like a Wagyu Beef tartar appetizer to whet one’s appetite. Then, please look at the presentation on the website, and the Q3 Press Release to understand the reconciliations.  Of course, read the Q’s , K’s, proxy statements, blah blah blah. I am pasting tidbits of quotes from CEO in past conference calls to support my points. (Makes it harder to read, but hopefully easier to understand)

JMP group is the sum of three parts: 1) an 18 year old countercyclical investment banking (advisory & equity capital raising) with brokerage business that has withstood the crash and burn cycles of the investment banking business over the last twenty years, worth 10 to 20 times P/E;  2)  an asset management business worth another $0.50 to $1; and 3)  a very liquid balance sheet whose book value is around $5.40

At this $5.5 a share price, one can buy at book value a very liquid balance sheet that invests smartly in real estate, lending, convertible securities and equities, and get an asset-light operating business (its investment income  on the balance sheet has a good track record) for free that can be worth another $3 to $7 based on a simple annualized $0.30 per share after tax net income with 35% ROE. This $0.30 a share in net income may increase in 2018. In 2016, industry fee income dropped 60%. 2017 fee income was up 20-25%, but still 50% below peak.  Year-to-date, JMP’s market share in the industry is up 40%. Of the ten investment banks left, JMP is the most profitable.

Why is JMP cheap?  People do not correctly reconcile the operating business’ EPS from the earnings drag resulting from not-yet-deployed excess cash on the balance sheet as of Q32017 funded with 8% debt. JMP is cashing out of its investments to newer investments and during the transition, its earnings is getting negatively dragged by the 8% rate on its debt.  The good news is this is an easier problem to solve because sooner or later, the management should be able to redeploy the cash.

Let’s take a closer look at three parts of the business:

1. Investment bank with brokerage business worth 10 to 20 times P/E or about $3 to $7 a share based on my estimate of 2017 EPS.

Capital markets firm with diversified revenue mix and scalable platforms

Boutique investment bank with franchise value in consolidating industry

24 publishing research analysts covering 451 stocks with a median market capitalization of $1.8 billion  

Emphasis on increasing research coverage enhances JMP Securities’ relevance to institutional brokerage customers and grows the number of relationships with potential investment banking clients  

Brokerage platform is a highly effective distribution network for underwritten securities offerings

Headquartered in San Francisco and focused on four growth industries: technology, healthcare, financial services and real estate  

Capital-light business model centered on providing attractive ROE  

Publicly traded partnership provides tax-efficient structure for cash distributions to shareholders  

On track to earn $0.30 a share in Calendar 2017 with a return on equity of 35% unlevered

By contrast, this segment earned $0.05 a share in Calendar 2016 with an ROE of 7.6%.

In 2016, industry fee income dropped 60% while 2017 fee income was up 20-25%, but still 50% below peak

Growing market share: Year-to-date, JMP’s market share in the industry is up 40%

Of the ten investment banks left, JMP is the most profitable.

Following a decade of consolidation amongst institutional broker-dealers and advisory firms, JMP Securities is one of the few remaining independent, West Coast-based investment banks  

To appreciate how well a job the management team has done, below is a list of selected peer firms acquired or closed since JMP Group’s 2007 IPO. It reads like a casualty list.

At the right price, JMP may be bought out. In 2017, Wanderlich and FBR were bought out. If it does not get bought out, this business has been around 18 years and it has grown in market share, and it has the market share to stay as an independent investment banker even 10 years from now.  The management team has been together for 20+ years, and is aligned with shareholders and owns 49% of the company.  

JMP group is countercyclical because the company hires staff opportunistically.  It is defensive when other investment banks are aggressive.  JMP group’s investment banking business is in the business of equity capital raising in real estate, finance, tech and healthcare.

NOTE: the Q3 2017 Press Release will show that Operating diluted EPS is 0.03 while the Operating Business (Investment Banking, Brokerage) EPS is 0.19,  but that is because of the 14c loss in net investment income (see Balance Sheet below). This was due to the drop in net interest income that its capital earning 15%+ turned to cash earning +/-1% early in 2017 funded with 8% fixed rate debt and similar corporate expenses. When the company redeploys @$2.50 in excess investable cash, this should help reduce/eliminate the drag on its earnings. (If you see page 17 of the presentation at http://files.shareholder.com/downloads/JMPG/5719442159x0x898396/D391EDFF-7F83-4F9B-9F13-30B0175496AC/JMP_Group_LLC_11-15-17_.pdf , you need to use this fact to reconcile the numbers to get to the EPS of the operating business.)

This business segment is worth 10 to 20 times EPS or about $3 to $7 a share. For example, at the time of its IPO in 2007, the P/E valuation was 20.  This business should be worth more now because of the few survivors, the enhanced franchise since 2007, and the added M&A and strategic advisory fee business as shown in page 9 of the presentation. http://files.shareholder.com/downloads/JMPG/5719442159x0x898396/D391EDFF-7F83-4F9B-9F13-30B0175496AC/JMP_Group_LLC_11-15-17_.pdf

Cyclicality of the Equity Capital Markets Business

JMP’s business is mostly in the Equity Capital Markets business so one needs to understand the general ECM cycle which tends to lag behind the stock market.  2014 and 2015 were considered difficult years.   Hence, 2016 ECM revenues dropped a lot from 2014.  ECM revenues rebounded in 2017 and following the positive 25% market returns, 2018 is looking pretty good for the ECM business.  

I quote the CEO in 3Q Conference Call :

“Thanks, Andrew. Our results were better than expected driven by record third quarter investment banking revenues at JMP Securities and continued progress in redeploying our excess cash. JMP Securities share of the U.S. equity capital markets business has increased as evidenced by year-over-year jump in equity underwriting revenues of 41% for the third quarter and 77% year-to-date. In contrast the broader industry has recovered more slowly from a two year slump with U.S. ECM fees down 11% year-over-year for the third quarter though up 26% for the first nine months of the year according to deal logic. At period end we had a $1.49 a share in investable cash compared to $2.18 a share in June. In July we announced a $200 million warehouse facility that enables us to accumulate loans for our fit CLO over the next 6 to 12 months. If we successfully execute CLO V we may once again be able to cover our fixed corporate costs on a consolidated basis and also fund our current cash distributions completely with net investment income from our publicly traded partnership.

We are off to a good start in the fourth quarter as our investment banking momentum has continued with the closing of a large M&A transaction for Forestar. Thanks to a more normalized capital markets environment we're also executing an increasing number of IPO's and follow on offerings, in addition workspace property trust recently filed a registration statement in connection with an IPO and as a founding investor we are hopeful for a successful transaction. JMP Securities contributed $0.13 per share to operating earnings for the third quarter up from $0.05 last quarter and $0.02 in the third quarter of last year. Our asset management platforms lost less than a penny a share on an operating basis while our net corporate expense cost us $0.02 a share. All told we produced operating EPS at $0.10 a share for the quarter up from $0.03 for the second quarter but down from $0.13 a year ago. For the first nine months of this year operating earnings were $0.03 well below the $0.35 we earned for the first nine months of last year but improving rapidly”

2)  Asset management business is worth $0.50 to $1 a share.

Alternative asset manager with nine strategies across five different asset classes  

Attractive economics of the alternative asset model provide management fees and profit participation  

Long-term strategy to develop a portfolio of distinct strategies in non-correlated asset classes

Economic interests in strategies in five different asset classes

Focus on adding new fund strategies and distribution channels to drive growth in AUM

In 2016, the Asset Management business earned $0.07 a share

The 2016 and 2017 performance records of the funds they managed can be seen on 3) Balance Sheet section below.  

(2) AUM represents par value of loans and cash in CLOs. Net return calculated as change in book value from end of prior period.

(3)  Very liquid balance sheet with adjusted tangible book value of $5.40 a share

JMP’s conservative investment outlook meant that in 2017 it was paying 8% interest rate on debt but its excess cash was not earning much.  Based on Q3 PR, management will redeploy this cash and remove the drag on earnings, which shows up as operating EPS on the PR and 10-Q.  Here is a quote by the CEO: “Our results were better than expected, driven by record third-quarter investment banking revenues at JMP Securities and continued progress in redeploying our excess cash," said Chairman and Chief Executive Officer Joe Jolson.

Here is how balance sheet’s capital was deployed  in alternative assets:

Book Value per Share
On September 30, 2017, JMP Group's book value per share was $4.69. Adding back the accumulated depreciation and amortization expense related to commercial real estate investments recognized by JMP Group as a result of equity method accounting reflects the reversal of that expense in the calculation of adjusted net revenues, adjusted principal transaction revenues and operating net income. Likewise, adding back the accumulated general loan loss provision related to collateralized loan obligations reflects the reversal of that provision in the calculation of adjusted net revenues and operating net income. Such reversals result in an adjusted book value per share of $5.42

Pending IPO of Workspace Property Trust REIT

JMP Group invested an initial $10 million into a private REIT named Workspace Property Trust that is going public soon.  This makes them a greater than 5% beneficial owner.

Yesterday, the company withdrew the registration, but did not rule out future ipo or future private investment. I take it that perhaps the market conditions of the volatility of the last week have caused them to withdraw and opt for a private investment instead.

I was not able to get the exact percentage that JMP owns but I read from previous conference calls that it is between 5 to 10 pct. My estimate that is at least another $0.50 to $1 a share of value can be added to book value if this value is unlocked.

“On December 2, 2015, the Company made a $12.8 million investment in Workspace Property Trust, LP (“Workspace”), which acquires buildings and land for the purpose of holding, selling and managing the properties. The Company recognizes its investment in Workspace using the equity method. The risks associated with this investment are limited to the amounts of invested capital. In the year ended December 31, 2015, the Company recognized gains of $0.2 million. There were no distributions in the year ended December 31, 2015.”

Q32016 Conference Call

“As a founding investor in Workspace, we expect to benefit from an estimated 30% increase in its adjusted book value per share, as well as higher returns on our $10 million of invested capital and our ownership interest in the manager going forward. At this juncture, without pro forma financial statements, our best estimate is that the transaction could add upwards of $0.05 a share to our fourth quarter operating EPS on a one-time basis.”

“Well we owned a bigger percentage of RiverBanc than we own of this, so RiverBanc we own 20% of just to put in perspective, and Workspace it’s a little under 8%.”

Pro forma weighted average shares-basic and diluted of 45,996,000 shares outstanding based on https://www.sec.gov/Archives/edgar/data/1710394/000104746917006770/a2233700zs-11a.htm#F2

And applying 6.5% I estimate it to be 3 million shares of Workspace Property Trust that JMP owns.   The first pricing was meant to be $13.5 per share but then it was cancelled.  

The adjusted book value does not break down how much of the adjustments came from its stake in WPT but it is safe to say it does not fully account for the step-up in valuation that JMP’s ownership will own after Workspace Property goes public.  I estimate this could be another $0.50 to $1.00 a share enhancement to book value.

Distribution to Shareholders

Since the company’s IPO in May 2007, JMP Group has returned 113% of its adjusted operating net income to stockholders in the form of cash distributions, share repurchases and net settlements of vested RSUs.  As a publicly traded partnership, JMP Group intends to pay out more than 50% of operating earnings annually and to grow its book value per share by 5% to 10% per year in a normalized capital markets environment.

In Q3 2017, the company bought back 235,000 @ $5.35 a share.

The company just replaced its old buyback authorization of 700,000+ shares with an authorization to buy back up to 1 million shares, which is a little less than 5% of the company. Since its initial public offering in May 2007, the company, together with its predecessor, JMP Group Inc., has repurchased a total of approximately 6.9 million common shares at an aggregate cost of approximately $44.4 million (approximately $6.43 per share). JMP Group Inc. became a wholly owned subsidiary of JMP Group LLC as a result of a corporate reorganization in January 2015.

Management ownership of shares have grown from 27% to 49% through share repurchases and open market purchases. The table below shows dividend and buyback yield of JMP since 2010

Management Team

The team, led by CEO Joe Jolson, has worked together as a team since the 1990s.  They came from Montgomery Securities and started JMP Group.   I believe that with investment banks and almost all businesses, the competitive edge is the management team’s ability to work as a team versus its competitors.  I think JMP Group has shown that it has a strong working team.

I have pasted snippets from the past 2 conference calls (2Q 2017 and 3Q 2017) so you get the flavor of management’s conservatism and corroborating statements.

On buyback versus dividend:

“Well you know I think that the buyback is a function of where our stock sells. We bought some yesterday for instance not a lot, it doesn't trade that much so we're limited by the buyback rules but you know it's in a 10b5 plan that we don't change a lot and there's a limit kind of based on a guess [ph] of what you know book value might be and then if it trades it some discount to that then we might be active in the in the market subject to the rules right, so I mean we bought back over 1% of the stock in the third quarter given all those constraints. So if you annualize what we bought back in the third quarter if the stock continues to sell down here for whatever reason probably retire 5% of the shares if that gives you any guidance there but that's not our goal to go private one share at a time here. Our goal is to get the stock more fairly valued but if people are somehow interested in selling us shares down here we will keep buying it back. In terms of the cash dividends you know that's driven more through operating earnings in particular net investment income at the publicly traded partnership level and year to date we haven't earned the dividend on either measure. Now the third quarter we did earn the dividend for the first time this year on operating earnings but not on earnings that publicly traded partnership -- it's a thing with $0.06 so we're still little below that $0.09 at the publicly traded partnership level. And of course we think that will continue to improve sequentially as we add more loans you know obviously the quarter that you add the loans doesn't help that quarter really, it helps the next quarter, so there is a lag in the impact on that but you know we're hoping that by the middle of next year that we will have enough loans on that warehouse or would have completed another CLO that will be able to cover that dividend you know that's essentially why we've maintained it at the level we have even though we haven't earned it at the publicly traded partnership level year to date.

So hopefully over the next few years we will be in a position to raise the dividend which we haven't been in quite a while. Now in terms of the buybacks we're just looking at if its accretive to net asset value per share we have a lot of cash. So they're not mutually exclusive. So the buybacks are coming out of investable cash not operating earnings.”

On the sustainability of the dividend and redeployment of cash:

“In terms of the cash dividends you know that's driven more through operating earnings in particular net investment income at the publicly traded partnership level and year to date we haven't earned the dividend on either measure. Now the third quarter we did earn the dividend for the first time this year on operating earnings but not on earnings that publicly traded partnership -- it's a thing with $0.06 so we're still little below that $0.09 at the publicly traded partnership level. And of course we think that will continue to improve sequentially as we add more loans you know obviously the quarter that you add the loans doesn't help that quarter really, it helps the next quarter, so there is a lag in the impact on that but you know we're hoping that by the middle of next year that we will have enough loans on that warehouse or would have completed another CLO that will be able to cover that dividend you know that's essentially why we've maintained it at the level we have even though we haven't earned it at the publicly traded partnership level year to date.

So hopefully over the next few years we will be in a position to raise the dividend which we haven't been in quite a while. Now in terms of the buybacks we're just looking at if its accretive to net asset value per share we have a lot of cash. So they're not mutually exclusive. So the buybacks are coming out of investable cash not operating earnings.”

On discipline of not overpaying for acquisitions:

“Yeah, I mean, that just to be clear, we haven’t really made any acquisitions since we went public. I mean, we kind of assumed we did a management buyout of our CLO business, we didn't pay anything for that platform, but, I guess, you could call that an acquisition with management technically, but it was really more of an investment in the financial assets that came with that first CLO. But we have looked at a lot of things. I would just say in 10 years, we probably bid on five or six things and so we, there's not that many things that we've seen that we think are good cultural fit that actually we think are within our ability to afford that hits our return criteria.

It's not to say other people haven't done those things. We've looked at, in many cases they did, but just didn't fit our criteria. And we haven't – we've, obviously, been outbid on all those possible things in the past. So we continue to look and we spent a bit of time on meetings and that type of thing for that, Alex, but we have to assume or I have to assume that, that doesn't happen, obviously, in managing our business.

But one day maybe, we'll do a series of acquisitions, it just hasn't happened yet and it doesn't mean we're going to stop looking. The main reason why we haven't acquired anything is – I think, is the very optimistic viewpoint of the acquirers out there on looking at the same businesses that we're looking at in the way of what they think that those companies are going to earn from them.

Plus at least historically, most of the other buyers have a bogey to do an acquisition that's way below what we would have, okay? And I think that's dictated by just, like, it's accretive to earnings per share, which is an important bogey, no doubt, but with interest rates so low and cash on the balance sheet or the ability to borrow some money it's not really high bogey in terms of your return on equity longer term. And so I think that's the other factor. Not to criticize any of our competitors out there that are doing these deals, but I think those are probably the factors.”

On management’s view of intrinsic value of stock:

“The second part is, do I think the stock is fairly valued here. I mean, we continue to repurchase shares. In the quarter, we bought some back. And then in that sell-off that you are talking about that was in the third quarter, we bought some more shares back.

And it was limited by 144 rules that we can only go in after the first half hour and we can't be in the market in the last half hour, which is, you probably know, that's where high percentage of the trading volume everyday happens in the first half hour and the last half hour. And then we're limited in terms of average volume and given our stock trading that's a relatively low daily amount but we have tried to execute at a certain price levels as much as we can buy back under those constraints.

So in the last couple of years, management's, including myself, have bought back over 10 percentage points in the open market of the company's stock. So yes, we think that value was significantly higher than it's trading right now and we're hopeful as our earnings recover, which should be driven by successfully redeploying our cash balances as well as this normalization that seems to be occurring in the equity capital market side. We're hopeful as our earnings recover, that it'll drive our stock price significantly higher.”

On being bought out by acquirer or not:

“Well, no. I think that we're publicly traded company, so we're not, there's no special deal for any management people, there is no golden parachutes, they is no larger salaries for any of us or guaranteed bonuses or anything else. So we own close to half of the stock, just the senior management and if you include the employee basis, closer to 60%. So we're pretty well aligned with you guys.

I think that as well as aligned as I could fathom in terms of a public company so I think if an opportunity came up to buy someone to get bigger in a accretive way for shareholders, we'd certainly look at it and try to do it. And as I mentioned to an earlier question, we keep looking for those kind of things. But by definition, if we haven't done one of those things and in part because buyers have a different set of calculus to look at these things then it's possible that, that will get scale by merging with someone else down the road.

But our eyes and ears are always open to doing what makes the most sense for the shareholders. So I don't think there's, there’s certainly no disconnect between us and you guys in terms of that kind of stuff.”

On how to view the sum of the parts:

“I think that when you look at our stock as a former portfolio manager for 15 years and an analyst in this space before that, you look at our balance sheet and recently, we've had a lot of cash but if you go back on an annual basis without these quarters of trying to redeploy the cash, we've had excellent returns on our capital invested in our fund strategies over the last 10 years as a public company but even before that, well before that.

So way above kind of what should clear the marketed book value. And then you look at our operating businesses, the asset management businesses and JMP Securities and while there is some cyclical components to that, over any period of time they've, even though they don't have scale, been able to generate a mid-to-high double-digit ROE, okay?

And so another alternative to look at, for us is management but also you as a potential or an actual investor is what are those two parts' worth, right? One doesn't have scale but probably is averaged at 20% plus after tax ROE over a long period of time, at times it's been 40% or 50% a couple of years ago. And the other has generated really good returns recognizing right now we're sitting on a lot of cash that we need to redeploy but once that gets done, it should be back in the low double-digit kind of returns on our average investments. So I think we are significantly undervalued even without some kind of event that you are suggesting but time will tell.”

On adjustment to earnings and book value:

“The other thing that's also material about that deal is that our operating earnings have diverged pretty materially as well as our adjusted book value from GAAP since we made that investment and that distortion will go away. So there's two adjustments to book value that we make, a GAAP book value one is general loan loss reserves which is a number that will go up and down with assets under the CLOs and it's an non-cash reserve. The other thing that we adjust for is the property depreciation to amortization on workspace that's a much bigger number at the end of September that was around $0.50 a share that number as well as in the quarter it was almost $0.12 a share. So when you look at our GAAP loss of $0.06 that getting rid of that $0.12 depreciation we would have had a GAAP profit of $0.06 so it's pretty distorted. So you know to the extent that it potential investors screen for ideas based on GAAP not what we adjust for operating, I think that might have benefit for our stock. The other distortion just so I close the loop there between what we call operating and GAAP that is meaningful is just we expense when we pay people in a given year we expense all the deferred comp on day one in our operating earnings and of course GAAP may she defer that overtime. So there are some times doing that where our GAAP earnings are actually a lot higher than our operating earnings, if we're having really good year and there's a lot of deferred comp and you know we've always done that and we're going to continue to do that because we think the GAAP accounting is actually overstates what you earn when business is good and understates on the other side of a cycle. So we're still going to do that but that would be the only material difference between GAAP and operating going forward.”

On Workspace Property Trust

“One is our last filed 10Q that shows what the dollar amount we invested for JMP Group is in workspace not our cost basis which has been depreciated through just our normally the company running through a high degree of property depreciation and amortization. So you can look at that and find that number and since its closed it's essentially $10 million. The other place you can look is in the red herring since workspaces on its road show right now that you know you can look and it shows you got to go into the middle of long document but there is a table in there, sorry I don't remember the page number that shows all the original investors what the value will be of their investment. Now I want to caution you that our investment includes some affiliated funds that we managed, that invested in as well so it shows it's not apples and apples but the percentage increase is relevant to our cost basis. So that would be helpful. Obviously it depends on where the deal prices is and we will be locked up for six months so we intend to whatever the gain is we will conservatively book at some lock up discount like we have when we've had similar things like that in the past. So we won't book the entire gain on day one and some of it will be deferred into the future months as the lock up runs off.”

Management’s Strategic Initiatives:

Grow JMP Securities’ strategic advisory business

― Increase annual M&A fee revenue to more than $50 million by 2021

― Add experienced, advisory-focused investment bankers

― Gain additional visibility among corporate clients with respect to the firm’s advisory capabilities

Continue to invest in JMP Securities’ capital markets platform

― Protect franchise value derived from position as one of the few remaining independent
research boutiques in a consolidating industry

Expand asset management platforms

― Attract new capital to existing funds with additional capacity

― Develop new private capital strategies that can leverage relationships across the company to source unique investment opportunities

Deploy large, investable cash balance

― $1.66 per share in unrestricted cash

― Formation of new CLOs, future fund commitments, strategic acquisitions or retirement of
outstanding debt

In summary, the investment highlights

Publicly traded partnership structure is unique among peers, allowing for an attractive dividend
while funding a growth strategy
Beneficiary of industry consolidation ― Increasing franchise value of independent, full-service investment banking platform
Capital-light business model
― High return on equity at operating platforms in a normalized capital markets environment

― Attractive, risk-adjusted returns on capital invested in differentiated asset management strategies

― Efficient return of capital to shareholders

Regular annual cash distribution of $0.36 per share

Approximately 700,000 shares eligible to be repurchase

Catalysts

Continued buyback

High-dividend yield

Redeployment of excess cash

Quarterly reviews during this cycle for investment banks that do equity capital raises

Pending IPO of Workspace of which JMP  owns significant amount.

Catalyst

Catalysts

Continued buyback

High-dividend yield

Redeployment of excess cash

Quarterly reviews during this cycle for investment banks that do equity capital raises

Pending IPO of Workspace of which JMP  owns significant amount.