Description

NSAM is a remarkably attractive asset manager with annuity-like contracted revenue, 70%+ margins, and multiple levers for growth.  I think it has 75% upside in a good case and minimal downside.  It is trading at a depressed multiple due to recent uncertainty about its fundraising outlook for reasons I will discuss.  However, I believe the fears are overblown and the current valuation is giving almost no credit for the fact that: (i) the quality of the business is exceptional, (ii) there are multiple levers for growth regardless of the current uncertainty, (iii) it has an unlevered balance sheet that management is likely going to lever to use for accretive buybacks and/or acquisitions, and (iv) the management team is very strong and highly incented.

Situation Overview

NSAM is an asset management firm that manages the publicly traded REIT NRF and several public non-traded REITs, with $24bn in total assets. It was spun-out of NRF in June 2014.  NSAM will also manage a European focused REIT, NRE, when it is spun-off from NRF in the fall.

There is significant uncertainty recently about the outlook for NSAM’s AUM growth in light of: (i) the Department of Labor’s (DOL) proposed fiduciary duty rule issued in April which could slow fundraising for non-traded REITs, and (ii) the ~15% decline in NRF’s share price since May which makes it harder for NRF to raise equity.

NRF Contract

NRF is a publicly traded REIT with $17bn of assets.  It is externally managed by NSAM.  It is an opportunistic REIT founded by the former head of the real estate private equity group at Goldman Sachs.  It has a strong long term track record with a ~20% CAGR since its IPO in 2004.  To simplify its model, it attempts to issue equity at an ~8% dividend yield and to invest the proceeds opportunistically in properties and loans, etc. at a 12%+ returns, thereby enabling it to grow the dividend.  It is more like a public real estate private equity firm than a conventional REIT.

NSAM’s management contract with NRF is very attractive.  It has an initial 20 year term (which automatically renews for additional 20 year terms) which includes: 1) a base mgmt fee, 2) a 1.5% fee on incremental equity and preferred issuance, 3) incentive fees of 15% of CAD above $1.56 and 25% of CAD above $1.80, and 4) minimum fees of $10mm for each NRF’s minority interests in two outside real estate investment firms, RXR and Aerium. NSAM will have the same fee arrangement with NRE.

NRF has raised $3bn of equity in the last year which has contributed to fee income growth at NSAM.  But, following its recent decline, NRF is trading a 10% dividend yield, so it is less attractive for it to raise equity and investors are concerned about the growth in fees for managing NRF.  As I discuss below, I think it is reasonable that NRF and the entities it could likely spin-off are capable of raising $1bn+ per year.

Non Traded REITs (NTR’s)

NSAM currently sponsors or co-sponsors seven NTR’s with $2.9bn of AUM.  The first three have essentially completed fundraising.  Two are starting fundraising this year, and two are expected to start fundraising in 2016.  The total offering size of the funds is $10.6bn.  NTR’s are public, i.e. they have SEC filings and they register with a target offering size, but they are not listed on an exchange.  They are sold to retail investors through financial advisors.  

The pitch is that the REITs are sold with the implicit promise of a 7-8% yield.  There is typically a 2-3 year fundraising period and then an expectation to provide liquidity (but no guarantee) after a subsequent 5 years by either listing on an exchange, selling, or liquidating.  The REITs are effectively a perpetual fee stream for NSAM unless their boards decides to sell, or fire NSAM as the manager.

NSAM works with ~150K financial advisers, including the two largest platforms, LPL and Ameriprise.  Barriers include historical track record (NSAM’s recent record is good), and getting shelf space at the financial adviser networks.  NRF has a 50+ person sales team selling its products to financial advisers.

The fees are very attractive for the sponsors and brokers.  There is a ~12% upfront commission which is split as follows: 7% to the financial advisor network (6% to the individual broker and 1% to the firm), 3% for wholesale brokerage commissions (NSAM keeps 50-80 bps of this net of additional rebates to financial advisor networks and compensating employees at its wholesale broker), and 1.5% for offering expenses.  The ongoing fees are typically 1.25% on assets (the equity raised is levered 1x, so assets/equity is 2x), and there are asset origination fees of 1% and disposal fees of 1%.  So, NSAM’s effective fees on the equity raised are ~3.0% if you smooth the acquisition/disposition fees.  NSAM is also entitled to incentive fees equal to 15% of cash flows above a 7-8% return.

DOL Rule Summary and Impact on NTRs

In April the DOL proposed a fiduciary standard for brokers as it relates to retirement accounts (IRAs, 401k’s etc).  Retirement accounts are 40% of NSAM’s NTR sales, so theoretically the other 60% is unaffected.  The rule has two implications.

First, since a fiduciary technically can’t get paid via commissions because it is a conflict of interest (fiduciaries can only be paid fees directly from the client), the DOL created an exemption for most types of investments.  However, NTR’s were left off of the list, so as it stands, NTRs couldn’t be sold for retirement accounts.  NSAM is very confident it can morph new NTRs into BDCs/RICs which are allowed.  In fact, NRF has two new credit funds co-sponsored with Och-Ziff which were structured as BDCs before the DOL proposal came out.

Second, even though BDCs and other high commission products are technically allowed, it is likely that the DOL could effectively put a stop to the sale of all high commission products to retirement accounts because the rule opens brokers to greater liability.

The rule is in a comment period. There will be hearings in August. A final rule is expected in April 2016 and it is expected to go into effect at the end of 2016.  It sounds like the rule has a very good chance of going through.

It is possible that NSAM can sell some products into retirement accounts, but it safer to assume they won’t.  Furthermore, I think the DOL rule will also have a chilling effect on sales to non-retirement accounts, although this is a debatable point.  For a base case, I assume NTR fundraising will continue at a relatively normal pace of ~    $2bn for each 2015 and 2016, but for 2017 I assume fundraising will drop to $1bn, or 75% lower than it otherwise could be as the DOL rule kicks-in.  Note: I think NSAM would have been on track to raise ~$4bn in 2017 because four of its funds would have been at the peak stage in their fundraising lifecycle (i.e. years 2-3).  After 2017, I assume a trickle of fundraising ($500mm per year) because most of the NTR’s will be at the end of their three year fundraising window.  For example, I assume NSAM will develop some new lower fee products that will be appealing to regulators, advisers and retail investors.  

Long Thesis

Stable contractual fee revenue stream which should command a decent multiple

I look at NSAM’s earnings from NRF separately from its earnings from the NTRs, and I use different multiples for each earnings stream.  NSAM’s earnings are roughly 50/50 from NRF vs non-traded REITs.  The management fees from NRF/NRE are essentially a perpetual annuity with significant optionality for growth.  The management fees are not subject to any adjustments (aside from an incentive fee on growing CAD/share).  NSAM can be comp’d against the General Partners of MLPs which trade at 23x P/E, although I assume 20x in a base case (with a range of 15x-25x).

The fees from the non-traded REITs are locked in for at least 5-8 years, and potentially in perpetuity.  However, the fee rate gets renegotiated once investors get liquidity after 5-8 years.  Assuming NSAM retains the management contract (which I think is very likely), the fees probably reset to 1.5%.  I value the NTR business at 12x (with a range of 10x-15x) assuming it will have some moderate ongoing level of fundraising.  Note: this is a healthy discount to publicly traded asset managers which trade at 16x but have significantly higher beta business models.

Optionality for strong AUM growth

I think the NRF “platform” (i.e. NRF plus additional REITs it will spin-off) should be a source of decent fundraising going forward despite the fact that NRF’s valuation is very low now.  NRF can probably find some attractive investments to justify raising equity at a 10% dividend yield, although it will be raising much less than it otherwise would (say $500mm per year instead of $2bn).  

The NRE spin will be an attractive entity for growth because it will have a ~6% dividend and it can put money to work at 9% with low leverage. Base case I assume it can raise $500mm in each of 2016 and 2017.  NRF is also likely to spin off one or more new vehicles, such as healthcare and manufactured housing, which could be sources of new fundraising.  

For the NTR’s, I think NSAM will continue to evolve and will look to introduce new, perhaps lower fee, products that will be attractive for retail investors.

There is also optionality for new platforms.  NSAM will always be looking for new products to raise AUM beyond the current menu.  Management is extremely opportunistic and it will depend on the environment in the future (e.g. the European REIT is a new invention in the last 1.5 years).

Optionality from levering up

NSAM is unlevered and has the ability to lever up to at least 3x, or $700mm (20% of the mkt cap), which could be put to work accretively.  NSAM is looking at acquisitions of other asset managers or management contracts, and is looking at buying back stock.  The board authorized a $400mm buyback in May.  I think the balance sheet optionality is worth $2-3 per share and represents a near term catalyst.

Management

Management is very strong and is highly incented to grow rapidly.  The CEO is the former head of the real estate private equity group at Goldman. The top 3 executives own $76mm of stock and have unvested/contingent equity awards of $95mm.  

Valuation

NSAM trades at 17x 2015 EPS, 14.5x 2016 and 12.5x 2017 based on my numbers which have been reset for a lower fundraising outlook for both NRF and NTRs.  I am at $1.29 for 2016 vs consensus of $1.42 (consensus hasn’t been reset yet, although it is priced into the stock).  These are low multiples for a stable asset manager, even assuming little to no AUM growth.

Given the uncertainty, I value NSAM using a range of fundraising scenarios with a price target range of $17 to $32, implying -7% downside to 73% upside by the end of 2016 including dividends.  I am not factoring in any benefit from accretive acquisitions or buybacks which could add $2-3.

At the low end of $17, I assume fundraising stops entirely and the NTRs trade at 10x ($6.00 per share of value) and the NRF fees trade at 15x ($10 per share).  (Dividends add another $1.)  This is a blended P/E of 12.5x.  As a sanity check for the NTRs, I do a DCF on the fees from the existing NTRs assuming a trickle of ongoing fundraising, and assuming the fee rates reset lower after 7 years of fund life, and I get $6 per share.

On the higher end, I assume a decent, but not unrealistic, level of fundraising and use a blended P/E of 20x (25x for NRF and 15x for the NTRs).  A reasonable middle case is $24 assuming a moderate fundraising pace and a blended P/E of 16x (20x P/E for NRF and 12x for the NTRs).  Again, this gives no credit for accretive acquisitions or buybacks.

As a very rough rule of thumb, $1bn of AUM is worth $1.00 per share for AUM raised at either the NTR’s or NRF.  It is the same because the lower P/E applied to the NTR’s is offset by the higher fee rate.

Other Factors

The biggest issue as discussed is the uncertain outlook for AUM growth in light of NRF’s weak share price and the headwinds for NTRs.  NSAM’s share price has been closely correlated with NRF’s in the last two months as people have reset expectations for how much equity NRF could be raising.

For the NTR’s the biggest issue is the proposed DOL rule as discussed above.  But, I also think there could be an impact from pending changes to non-traded REIT NAV disclosure rules.  Currently, non-traded REITs are sold at a $10.00 NAV and remain marked on customer account statements at $10.00 for 2-3 years during the fundraising period.  In reality, the true NAV at day 1 is $8.80 per share net of commissions.

A FINRA rule is set to go into effect in April 2016 that will require customer account statements to show the NAV net of commissions.  The risk is that investors would have “statement shock” when they see the real NAVs for the first time, but the industry has already adapted. New non traded REITs (including NSAM’s) have different share classes designed to limit the “statement shock” by taking a lower upfront commission (say ~5%) followed by a 50-100 bps trailing commission  for  a number of years.  I think the fundraising pace could slow when the new disclosures kick-in as financial advisers are re-trained and some customers maybe turned off. For 2016, I assume that NRF’s non-traded REIT fundraising will be 20% below what I’d otherwise forecast (so they’ll raise $2.4bn instead of $3.0bn).

The prospect of higher interest rates is also a factor because NSAM’s fundraising pace has benefited from a bull market for REITs in recent years given the search for yield.  Real estate could become a less attractive asset class which could impact fundraising going forward.

This posting is solely for the evaluation of club members and is not a recommendation to buy or sell this stock.  The views expressed are those of the author individually and should not be attributed to any affiliated investment firm, which may or may not hold positions consistent with the views expressed herein and may buy or sell shares at any time.

Catalyst

Putting the unlevered balance sheet to work for buybacks/accretive acquisitions.

Add'l equity offerings at NRE following its spin-off this fall.