Description

Trading at June 2009 prices and 0.8x TBV, OPY is an extremely undervalued and misunderstood, yet growing and recurring revenue nature wealth management business.  Shares worth at least $40, or ~2x current price using conservative 2015 assumptions on a standalone basis.  In a strategic sale, I believe the business commands at least $50-65, for a potential 2.4-3.1x cash-on-cash return.  OPY’s chairman and 22% shareholder, A.G. (Bud) Lowenthal, is 68 years old and the M&A market is active for wealth management companies as banks and brokers compete intensely to grow client assets.  The company has been hampered by regulatory settlements, and all signs point to OPY, its shareholders and employees all being better off as part of a large financial institution.  Regardless, I believe the stock is dramatically undervalued.

Based in New York City, Oppenheimer Holdings Inc. (“OPY”) is a private client wealth management and asset management company, “masquerading” as a middle-market investment bank.  The company has $87bn of client assets under administration, of which $26bn are management fee-based and housed in the Asset Management division.  The money management segments of the company generate >200% of the company’s consolidated pro forma pre-tax income, which I expect to be >$120mm for these two units alone in 2015.  The company presently has a market cap of $300mm and $150mm of long-term debt, which the company has been repurchasing, in the form of 2018 senior notes.  Tangible book value, which should grow quickly, is $357mm, or $26.19, implying the stock trades at a mere 0.8x TBV, an extraordinarily low price for such a business.  The stock’s current dividend yield is 2.1%.

Some brief valuation history:

·         In late 2009, the stock traded for $33 with a P/TBV of 1.7x (TBV = $20.70).

·         In early 2011, the stock traded for $34 with a P/TBV of 1.4x (TBV = $23.67).

·         In early 2014, the stock traded for $29 with a P/TBV of 1.2x (TBV = $26.10).

·         Currently, the stock trades for $20.92 with a P/TBV of 0.8x (TBV = $26.19).

·         From 12/31/08 to 12/31/14, TBV/share has risen from $18.70 to $26.19 and the wealth management divisions’ pre-tax income has risen from $30mm in 2009 to $112mm pro forma for 2014 and client assets are at record levels.

·         Tangible book value should continue to grow rapidly due to strong earnings and low dividend payout ratio.

Keys to the Thesis/Why Does the Opportunity Exist?

There are several reasons, which should become clear after doing the work, why this massive mispricing exists:

·         Virtually No Analyst Coverage/No Conference Calls = Investors Unaware.  There is virtually no sellside analyst coverage, no discussion to speak of on VIC (2 comments on a brief 2013 writeup), never written up on SumZero and negligible hedge fund ownership.  Much of this can likely be attributed to the fact that Oppenheimer is widely considered to be an investment bank, while in reality it is a fairly large asset management firm with a little investment bank on the side. 

·         Confusing 2014 Financials Mask Outstanding Results.  OPY’s recent results and 2015 outlook are both outstanding; however they are obscured by two large factors over the last year. 

1)   First, in 2013 the company realized $33.3mm of incentive fee income from its hedge fund products, while in 2014 it realized only $0.8mm, creating a $32.5mm apparent decline in earnings (split fairly evenly between the PC and AM segments). 

2)  Second, in the first half of 2014, the company booked $19.7mm of expense in the Private Client segment relating to SEC regulatory oversight matter, which was settled completely a few weeks ago, lifting an overhang on the company.  Further, there was likely at least $5mm of non-recurring legal expense in Corporate/Other relating to the regulatory matter in 2014. 

In aggregate, these factors led to at least a $57mm decline in reported pre-tax earnings, despite the company’s outstanding performance and growing AUA.  Compounding this issue, the $19.7mm regulatory charge was not tax deductible, further depressing Reported EPS.  Pro forma excluding these three items, 2014 pre-tax income rose 355% y/y.  Further, pro forma pre-tax income in the two money management divisions grew from $73.9mm to $112.7mm. 

***To put a finer point on this, the company reported 62c of EPS in 2014, while I believe the company will earn ~$2.40/share in 2015 and has “Strategic Buyer EPS” of ~$5.00/share, excluding any potential incentive fees, which I model at $0 and averaged ~$17mm/annum from 2007-2013, and excluding the possibility that the company stops waiving the $31mm of money-market fees annually if short-term rates rise.  If one assumes OPY recaptures half of the money-market fee waiver and a normalized $17mm of incentive fees, pre-tax earnings are an additional $32mm higher, driving an additional $1.30 of EPS, taking pro forma EPS to $3.70 on a standalone basis (a 5.7x standalone P/E at current price).***

·         Press Coverage Relating to Settlements.  It is possible, if not likely, that press coverage relating to OPY’s recent regulatory settlements resulted in investors selling shares in recent years.  The stock traded for $33 in late 2009 and $30 in March 2014, while AUA and AUM are now at record levels.  As the chairman said, “Oppenheimer is pleased to put these matters, which involve activity that occurred years ago, behind it. The ability to finalize matters involving two regulatory agencies in a coordinated manner was helpful in bringing this matter to a conclusion.”  He also said, “The Company's revenues reached $1.0 billion in 2014 for only the third time in its history driven by increased fees earned on traditional management products and from mergers and acquisitions activity as well as increased institutional equities commissions… We look forward to higher levels of profitability through the considerable improvements in our core capital markets businesses as well as the favorable impact that the expected rise in interest rates will have on our business.”

·         High Insider Ownership = Limited Float.  OPY chairman Bud Lowenthal owns 22% of the basic shares outstanding and insiders in total own approximately 28% of the basic shares.  The balance of the stock is held by fairly strong hands, including a number of diversified long-only firms and ETF managers (e.g. Blackrock, Vanguard).  As such, the stock trades only 30-40k shares per day, but this is plenty for most funds to establish a position.

·         Diversified, Growing Private Client and Asset Management Units.

a.       Private Client (AUA now $87bn as of 12/31/14):

b.       Asset Management (AUM now $26bn as of 12/31/14, 77.5% of net asset management fees booked in Private Client unit, 22.5% in Asset Management unit):

·         High Strategic Value for Wealth Management and Asset Management Businesses.  The strategic value of OPY’s Private Client and Asset Management segments has never been higher.  It would make great sense for Lowenthal to sell OPY to a larger bank given both the tremendous valuation disconnect and synergies (both cost savings and revenu/cross-selling synergies are substantial), but also because doing so would eliminate the ball and chain around the company's ankle in terms of the auction rate securities repurchases.  Big banks can borrow against ARS in commercial paper market and at Fed window, but smaller banks like OPY cannot.

None of these is a perfect comp, but examples include:

a.      Stifel acquiring Sterne Agee’s embattled (unprofitable on standalone basis per JMP Securities) private client and fixed income business (Feb 2015).  Purchase price of $150mm (excluding retention and restructuring payments) results in 0.75% Price/AUA for this $20bn AUA unit.  Note that roughly 600 of the 730 Sterne Agee financial advisors are independent (not employees, just using the Sterne Agee platform, therefore client assets are much less sticky), and the CEO was recently fired, causing the purchase price to be lower.  Contrary to Sterne Agee, OPY’s 1,324 financial advisors are all company employees.

b.      Raymond James acquired Morgan Keegan’s private client and capital markets groups (Jan 2012).  Purchase price of $930mm results in 1.3% Price/AUA for this $71bn of client assets.

c.       Wachovia acquired A.G. Edwards (May 2007).  Purchase price of $6.9bn results in 1.8% Price/AUA for this $374bn of client assets (per KBW Research).

d.       UBS acquired Piper Jaffray’s retail business (April 2006).  Purchase price of $575mm results in Price/AUA of 1.1% for this $52bn client assets (per KBW Research).

e.       Asset management firm Cohen & Steers (NYSE: CNS) trades for 5.7x revenue, 15.0x EBIT, 9.2x TBV and 3.2% of its $53bn of AUM.

f.        Asset management firm Legg Mason (NYSE: LM) trades for 2.3x revenue, 13.3x EBIT, and 0.9% of its $709bn of AUM.

g.       Asset management firm T. Rowe Price (Nasdaq: TROW) trades for 5.0x revenue, 10.6x EBIT and 2.9% of AUM.

·         Hidden Asset in Commercial Mortgage Banking Unit.  The Commercial Mortgage Banking unit has $4.1bn worth of mortgage servicing rights that are likely worth as much as $60mm to a strategic buyer (10-K conservatively cites fair value as $42.7mm).  Strategic buyers could include (i) the big commercial banks, (ii) Nationstar Mortgage Holdings (NYSE: NSM), (iii) Walker & Dunlop (NYSE: WD) and other smaller players.  My understanding is that this is a non-core unit for the company, and it clearly is not valued by investors, yet $60mm of value is $4.20/share or 20% of OPY’s market cap for a hidden unit inside an unfollowed company.

·         Large Margin of Safety.  At the current share price, implied upside to 1.0x 2014 TBV is 26%, and implied upside to 1.0x 2015E TBV (again, assuming $0 incentive fee or money market fund fee income) is 37%.

Valuation

I have based my analysis on 2014 TBV and 2015E earnings, which I derive conservatively based on the company’s recent results in two scenarios:  (i) standalone and (ii) in a sale to a strategic acquirer.  Please note the following:

·         A simple 1.5x 2014A TBV valuation gives us $37/share, which is 75%+ higher than the current trading price.

·         A blended pre-tax multiple of only 7.3x (implies 1.0% of all AUA) on the PC, AM and Mortgage Banking units, less the entirety of the $150mm debt and assumed capitalized overhead, alone gives us a value of $43/share, or 2.0x the current share price.  Note that this includes $0 value for capital markets and commercial mortgage banking units.

·         All valuations assume $0 value for the Capital Markets group, though trends are good and this unit delivered $18mm pre-tax income in 2014.

·         The Commercial Mortgage Banking group, which houses the $4.1bn of servicing rights, is valued at $42mm (per 10-K) though independent appraisal indicates these rights are likely worth upwards of $60mm, or $4.20/share (20% of market cap).

·         These estimates assume $0 of incentive fee income, an extremely conservative assumption as such income amounted to $33mm in 2013, $11mm in 2012, $3mm in 2011, $13mm in 2010, $11mm in 2009, $1.5mm in 2008 and $45mm in 2007.  OPY is the general partner of 30+ hedge and private equity funds with $2bn+ of AUM.

·         These estimates assume $0 of money market fees, a conservative assumption if interest rates rise as the company is waiving $31mm of client fees per year to prevent clients’ effective rates from going negative.

·         As can be seen in the table, it does not take heroic assumptions to get to very high valuations for OPY shares, though I have tried to be conservative in triangulating value from both a (i) percentage of assets and (ii) pre-tax earnings basis.

Document Links

·         Q4 earnings release:  https://www.opco.com/investor-relations/easset_upload_file823_5279_e.pdf

·         Latest investor presentation (May 2014 Shareholders Meeting):  http://www.opco.com/investor-relations/easset_upload_file980_5266_e.pdf   

·         2014 10-K:  http://edgar.sec.gov/Archives/edgar/data/791963/000079196315000004/opy-12312014x10k.htm#s0B08BE93A9C0561E79A110A151D2EC43

·         William Blair industry comps:  https://www.williamblair.com/Research-and-Insights/Insights/Investment-Banking-Market-Analysis/2015/~/media/Downloads/Emarketing/2015/IB/Investment_Services_2015_02.pdf

·         2013 Annual Report and Chairman’s Letter:  http://www.opco.com/investor-relations/easset_upload_file373_5266_e.pdf

Key Risks

·         Highly regulated industry, ever-present potential for future regulatory issues.

·         Reversal of rising AUM and customer inflow trend.

·         Intense industry competition for financial advisors (though OPY’s 1,324 financial advisors makes the company highly attractive to strategic buyers).

·         Shareholder unfriendly decision-making (highly unlikely given Lowenthal’s 22% ownership and long history of book value creation).

·         Limited daily volume in shares, which averages ~30-40,000.

Catalysts

·         Investor awareness of the company and its highly valuable Private Client and Asset Management businesses.

·         Reporting of clean earnings will drastically improve company screening metrics.

·         Sale of entire company (or just Private Client and Asset Management businesses) to a larger bank or wealth management firm.

·         Sale of the Commercial Mortgage Banking division, potentially unlocking ~$4.20/share of value from this hidden asset.

·         Increased interest rates result in recapture of $31mm additional income.

Disclaimer:  The author of this idea presently has a long position in securities of this issuer and may trade in and out of these positions without notice.  The data contained herein are prepared by the author from publicly available sources and the author's independent research and estimates.  No representation or warranty is made as to the accuracy of the data or opinions contained herein.  Please do your own research.

Catalyst

Please see above.