Description

Pzena Investment Management Inc. (PZN) went public on October 30, 2007 by selling 6.1mm shares at $18 per share.  Today the stock is $12.55.  As a result of a skittish market, poor recent fund performance at Pzena, and a poorly placed IPO, today you can buy this good business with exceptional management at 15x 2007 earnings.  The company currently faces some headwinds but I think over the long term these will be overcome and current investors will be fairly rewarded for their patience. Timing is everything with this investment.  However, I think this would fall into Buffett’s category of a good business with management you can like, admire and trust, at a reasonable price.

The funds run by Pzena – all of which are value oriented – have declined in NAV, though not nearly as much as the 30% stock price decline implies.  As a proxy for the funds managed by Pzena, I personally look at John Hancock’s Classic Value Fund which is sub advised by Pzena.  This fund has roughly $8bn in AUM (at 9/30/07 the firm's total AUM were $29bn).  This fund is down 9.1% YTD and 8.4% QTD.  The top ten positions are Freddie Mac, Citigroup, Alcatel Lucent, XL Capital, Fannie Mae, Wal Mart, Allstate, Pfizer, J&J and TJ Maxx so you can understand why it is underperforming.  Investors are justly concerned about redemptions, which will in turn affect the fee income and the EPS of the company.

Over the long term, however, it is my view that PZN is one of the best value oriented asset managers around.  The company will appeal to members of VIC because Pzena is a dyed in the wool value investor.  The firm only buys stocks when they trade in the lowest quartile of price to normalized earnings power.  Once they trade out in the 1st or 2nd quartile, they are sold.  This approach is simple enough that clients can understand why it will succeed over the long-term.  It is scaleable and sound. Most of the firm’s positions are in very large capitalization companies. Non-US strategies are only 12% of assets. 

Management strikes me as talented and motivated.  Unlike some of the other financial services IPOs this year, management did not sell a single share of stock in the IPO.  The sellers were two financial partners and one operating partner who were with Pzena when he founded the firm in 1995.  At least two of the sellers still hold significant stakes in the firm.  The buyers of the stock include Morgan Stanley which surprisingly bought 24% of the float, and hedge funds Brahman and Americus each have 5% of the float.  I imagine other savvy investors who know Pzena have invested as well.

Over the long-term, it would not be unreasonable to assume to see PZN managing double the assets.  Without overcomplicating the analysis with margins, options, etc., let’s assume double the assets will result in double the EPS.  Street estimates are for $0.80 in EPS in 2008.  The stock pays an $0.11 quarterly dividend.  Using a target price of 16x earnings of $1.60 in seven years, plus $0.44 in dividends per year, we have a 13% annualized return.  The asset growth in this model is about 10% per year which is not unreasonable provided the firm does a little better than the overall market average (lets say 6-7% per year) and attracts a modest amount of assets.

There are certainly risks.  My greatest concern is that the business is centered around Rich Pzena.  He's distributed equity to a large number of his partners, so I think this risk is not as bad as it would be at your run of the mill hedge fund.  Also, if value investing remains out of favor for a while, AUM will decline. 

There are a few large research reports out on the company.  I suggest you read them if you’re interested.

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