Description

Description

Lindsell Train Investment Trust (LTI, or trust) is a GBP 180m market cap closed-end fund listed in London. LTI’s NAV consists of two parts: ~40% from its unlisted 24% stake in Lindsell Train Limited (LTL, or firm), a boutique fund manager, and ~60% from a portfolio of listed high-quality stocks.

Investment thesis

LTI currently trades at a 17% discount to NAV. I believe disclosed NAV materially understates fair value, as I describe below. The biggest component of NAV, LTI’s stake in LTL, is appraised extremely conservatively. If I mark to market the stake at a reasonable multiple, LTI trades at a 43% NAV discount (equivalent to 75% upside).

This is not a value trap. The market has figured out this deliberate undervaluation (of LTL in the LTI NAV) in the past and been willing to correct it. LTI has traded at an average premium to NAV of ~20% over the last 10 years and as high as ~90%. I am not calling for LTI to return to those levels.

For example, consider this quote in a 2018 Financial Times article devoted to explaining the trust’s ~50% NAV premium at that point:

The premium is also due to the fund’s large stake in its unlisted parent investment company, Lindsell Train, which many investors judge to be undervalued by the trust’s stated NAV.

Jason Hollands, managing director at Tilney Group, says: “The fund is really a hybrid between a global equity investment trust and shares in a successful, boutique asset management company.

“The big premium to NAV suggests the market sees the NAV valuation of the unlisted management company as conservative and are possibly speculating that at some point the management company could be split, which might realise value.”

The current discount has emerged after several years of weak relative LTL fund performance and LTL net outflows. I expect better performance or a return to net inflows would enable LTI to again trade at a premium to NAV. In the meantime you get paid a ~6% yield and underlying NAV should continue to compound with stock returns.

I think of LTI as buying a portfolio of quality consumer franchises + a highly-regarded boutique UK investment firm at a substantial discount. This NAV discount could narrow when/if market conditions are more favorable for this time-tested investment team, flows improve, and the market again assigns a premium to NAV valuation of the LTL stake. Monetizing the LTL stake is a low-probability option that adds upside skew to the payoff structure here. I would note LTL founders are approaching retirement age (both in their early 60s), which could perhaps catalyze reappraisal of the business they’ve built.

Background

Michael Lindsell and Nick Train founded Lindsell Train Limited in 2000 to invest in durable consumer franchises. Their firm, LTL, manages GBP ~20b AUM across four long-only equity strategies: global, UK, North America, and Japan. The cult of star managers remains alive and well in the UK; Nick Train is among the UK’s most-followed investment managers with an enviable long-term track record. The firm’s three key products, the UK Equity Fund, Global Equity Fund, and Japanese Equity Fund, have outperformed their benchmarks by 4.5% p.a., 2.4% p.a., and 1.4% p.a. since their 2006, 2011, and 2004 inceptions. (The small North America Equity Fund, launched recently in 2000, has underperformed.)

The two founders each own 36% of their firm. Other employees collectively own 3%. The final 24% stake sits in LTI, a listed investment trust. According to its website, the trust was created at inception to provide investors with the opportunity to share in LTL’s potential growth.

The growth has been phenomenal, turning the trust into a multibagger. LTI’s initial GBP 64,500 investment in LTL is now worth GBP 85m at appraised value (and probably 130-160m at fair value, as discussed below). LTL has become by far LTI’s most important single investment, representing 37% of its stated NAV. The other 63% of the LTI portfolio is invested in public stocks and funds in a manner consistent with LTL’s open-ended funds. The top ten holdings are shown below. Outside of the LTL stake and an investment in the recently launched North America Equity Fund that the firm is incubating, the top public stock positions are London Stock Exchange Group, Nintendo, Diageo, RELX, Unilever, Mondelez, A.G. Barr, and PayPal.

LTI is like a levered bet on LTL. (NB: There is no actual leverage.) You get exposure to a similar portfolio of stocks as the underlying open-ended funds, plus a stake in the firm that grows with AUM growth. When underlying fund performance goes through a rough patch, as it has recently, both these factors work against you. For most of history, they have worked magnificently in your favor. Since its 2001 IPO, LTI has delivered exceptional returns of ~1100% with the biggest contributor being the trust’s unlisted stake in LTL.

Total Returns 1/31/2001 to 8/31/2023 in GBP

                Annualized         Cumulative

LTI LN    12%                        1076%

FTSE       4%                          164%

ACWI     7%                          364%

If you believe as I do that relative performance goes in cycles, and that a defensive quality investing style has periods when it outperforms, then you can expect the cycle to eventually turn again in favor of this time-tested team. The best backdrop for their defensive style would be a risk-off market, particularly one with falling rates that helps long-duration equities. It is not inconceivable that we will have that market backdrop in the near future if major economies enter recession later this year or next.

LTL Valuation

As noted above, the stake in LTL is by far the trust’s most important asset and the source of mispricing in LTI shares that creates the current investment opportunity. For NAV purposes, Lindsell Train Limited is appraised annually by the LTI board. The valuation approach was developed by JP Morgan Cazenove. The formula is simple: P/AUM x AUM. The most recent valuation for the entire firm was GBP 352m based on a 1.9% multiplier of AUM and 18.5b AUM at 3/31/2023. The P/AUM multiplier used in any given year is based on the firm’s profit margin (as a % of AUM). So if the firm is more profitable, it gets a higher P/AUM multiplier, as shown below.

This is a roundabout way to say the firm is valued on P/E. If value = P/AUM and P/AUM is determined by Profits/AUM, eliminate terms to calculate value/profits (a.k.a. P/E), as shown below. The 1.9% P/AUM multiplier used in the most recent appraisal is equivalent to ~10x P/E.

Peer firms currently trade at 8-14x P/E, with the biggest differentiating factor being the outlook for organic net flows. So LTI valuing LTL at 10x is roughly in the middle of the pack. A slightly below median multiple is hardly objectionable for a firm with a good long-term record but challenging recent flows and performance. So why do I say that the marked NAV undervalues LTL? Because the LTI board does not use actual profits in determining the multiplier, they use notional profits. Notional profits are well below actual profits!

The key assumption driving the delta between actual profits and notional profits is the staff cost ratio. The normalized profit formula assumes that staff costs are 45% of revenue, as highlighted below. This is a staff cost ratio that would be relevant for a large, diversified asset manager with numerous investment teams and large distribution and marketing departments. It is not applicable to a scaled GBP 20b AUM boutique fund manager with a single investment process and seven-person investment team. In reality, LTL’s staff costs have consistently been about 30% of revenue.

And if you’re worried about forces that could drive up the staff cost ratio over time, you are protected. LTL’s direct staff remuneration ratio has a hard cap of no more than 25% of revenue (before indirect costs like insurance, which adds roughly 5% to get to the 30% actual) by the LTL shareholder agreement. So even if employees wanted to extract more compensation from the firm, they are prevented from doing so by the shareholder agreement. To recap, LTI is valuing LTL on a notional profits figure that is over 50% below actual profits (and about 40% below actual dividends paid).

 As a result of this obtuse methodology, LTL is deliberately undervalued in NAV. The LTI approach values LTL at close to 6x P/E and a 14% dividend yield on actual trailing profits and dividends. There are very few listed investment firms trading at such low multiples.

LTL financials

I include below summary financials for LTL for the last five years. As you can see, this is a very profitable business with a conservative balance sheet (GBP 91m in net cash). Firm revenues, profits, and NAV valuation have declined for the last two years due to lower AUM and fee compression (due to lower performance fees, which have been zero for the last year).

AUM declines are the result of two years of net outflows as relative fund performance deteriorated after many years of strong results and inflows. Below I show the cumulative and discrete annual performance of the Lindsell Train Global Equity Fund, the firm’s flagship strategy (GBP 5b AUM) as a proxy for overall firm investment performance.

The fund has produced strong results since its 2011 inception even including poor results over the last few years. I don’t believe this strategy is broken. Rather the firm’s defensive style struggled to keep up in the 2019-2021 bull market. As every VIC reader will know, flows and performance are highly correlated. When/if relative performance improves, I would expect flows to stabilize or turn positive. Admittedly this is a key assumption in this investment case.

LTI Valuation

What is LTI worth? I’ll start by valuing the trust’s stake in LTL, and then value the trust itself.

Listed traditional investment managers trade in a range of 8-14x P/E, with the biggest differentiating factor being the outlook for organic net flows. (Dividend yields vary more widely due to varied payout policies, and yield is not the primary valuation metric.) Below I show LTL value at a range of multiples and yields. Even using the lowest 8x multiple, LTL is worth GBP 441m or 25% more than its appraised NAV value. Bullish scenarios are far higher, with the firm worth approximately 700-800m.

I’ll show three scenarios for the value of LTI: the stated NAV and base & bull cases.

• Stated NAV of GBP 1,057/sh is 20% above the current share price. Remember, this is the NAV where LTL is valued at ~10x notional profits, or ~6x actual profits.
• If I value LTL at 10x actual P/E, then LTI is worth 1,298/sh for 47% upside. For reference, at 1,298 LTI would trade at a 22% premium to stated NAV, which is roughly in-line with the historical average NAV premium that LTI has traded at over the last 10 years. This does not seem to require heroic belief.
• If I value LTL at 12x actual P/E and also include LTI’s share in the excess cash sitting on the LTL balance sheet, then LTL is worth 1,542/sh for 75% upside. This scenario reflects the outcome I’d expect if LTL were sold to a strategic buyer.

These targets are a static snapshot in time. The key components of fair value – the stake in LTL and the listed stock portfolio – are dynamic. I think it is reasonable to expect the stock portfolio to compound at a market+ rate over time, say 7-10%. How the fair value of LTL will evolve is an open question. If relative performance and flows improve, firm profits should return to attractive growth. Is there a scenario that firm AUM has peaked and will continue to gradually shrink from here? Yes, certainly. In that scenario, the appraised NAV valuation is more appropriate for a genuinely ex-growth investment manager. With a 14% dividend yield on LTL, the rapid capital return should de-risk your valuation and investment case.

Risks

•             Persistent fund underperformance

•             Manager turnover. If Lindsell and/or Train retire without seeking to monetize their LTL stake, flows could accelerate, LTL profits and thus LTI NAV would decline

•             Other factors to consider in NAV: fees (0.60%) and taxes (the LTL stake is virtually all capital gains)

Catalyst

•             Improved relative fund performance (perhaps by way of a recession with falling interest rates)

•             Flows stabilize or turn positive

•             Transaction to monetize stake in LTL

•             Actions to unlock value at the LTI level, such as share buybacks or an updated LTL valuation approach