Description

The writer of this note, related persons, and / or entities ("Writer") currently holds a long position in this security. The Writer makes no representation that it will continue to hold positions in the securities of the issuer. The Writer is likely to buy or sell securities of this issuer and makes no representation or undertaking that Writer will inform the reader or anyone else prior to or after making such transactions. While the Writer has tried to present facts it believes are accurate, the Writer makes no representation as to the accuracy or completeness of any information contained in this note and disclaims any obligation to update such information. The views expressed in this note are the opinion of the Writer, which may change at any time. The reader agrees not to invest based on this note and to perform his or her own due diligence and research before taking a position in securities of this issuer. Reader agrees to hold Writer harmless and hereby waives any causes of action against Writer related to the below note.  This note should not be construed as a recommendation to buy or sell any security.

Thesis Summary

Silvercrest Asset Management Group (“Silvercrest” or “SAMG”) is an under-followed, owner-operated wealth management firm (over 35% insider ownership) with an excellent track record. SAMG consistently grows AUM organically, has the ability to do so for the foreseeable future, and generates outstanding returns on capital. SAMG has generated a 16%+ ROE every year since the firm went public in mid-2013 and approximately doubled its book value from 2014 – 2019 (while also distributing $3.08 / share in total dividends). 

Silvercrest is effectively a publicly-traded multi-family office platform, specializing in high-touch wealth management and comprehensive financial advisory services for family offices and ultra-high net worth individuals / families. However, Silvercrest gets lumped in with lower quality asset management firms that have inferior business models and are more susceptible to AUM outflows and fee compression. SAGM trades at a forward free cash flow yield of 11%. Even after the last few days where Mr. Market has gotten excited, I believe SAMG shares could rerate by 50% - 95% over the next 12 months and I expect to generate an IRR ranging from 18% - 40% over a three-year hold using undemanding assumptions.

While you wait for the market to catch on you can also collect a sustainable 5.0% dividend. Management has expressed their dedication to at least maintaining the current dividend (and they have the financial wherewithal to do so), which should provide a solid “floor” and downside protection for the share price as well.

Industry Overview 

Wealth management firms are outstanding, highly scalable businesses that generate recurring revenue from sticky customers and exhibit high incremental margins. Furthermore, they require little capital investment to grow and exhibit scant working capital drag when they do. A cost structure that is largely fixed combined with a fee-based, AUM revenue model allows these businesses to generate increasingly higher returns to scale and benefit from both compounding value and inflation. Wealth management firms provide more comprehensive, specialized services than traditional asset managers and therefore exhibit higher retention rates and capture more value per client. Wealth management firms will benefit from tens of trillions in wealth that will be passed from baby boomers to millennials over the next 20 – 30 years. Even more specific to Silvercrest, the number of single family offices grew by more than 35% from 2017 – 2019 and is expected to continue to grow quickly as technological advancements create more wealth and emerging markets mature.

Asset management firms historically benefitted from many of these characteristics as well. However, asset management firms possess a less holistic service offering, have suffered from fierce competition and negative mix-shift toward passive investment strategies. While the proverbial flywheel is wonderful when it spins your way (compounding creates and attracts higher AUM, strong performance provides stable to higher fees), an unwinding in the other direction is painful (AUM outflows and fee compression) – the latter is what many traditional active asset managers have faced and continue to face going forward. While I, probably like many others on this board, believe the death of active management is overexaggerated, low-touch and commoditized players in the space do face headwinds.

Silvercrest Overview

Silvercrest was founded in 2002, primarily by ex-professionals from DLJ’s asset management group and has grown AUM at a CAGR of 32% while maintaining industry-leading client retention rates of 98% since 2006. SAMG has $24.4bn of AUM as of 3Q20, making it one of the 10 largest registered investment advisors in the U.S. by AUM and has grown quickly in recent years (AUM was ~$13.9bn went SAMG went public). SAMG business model is focused on providing independent financial advice to clients that is free of conflicts. Therefore, Silvercrest is not affiliated with other financial firms and does not generate commissions, placement fees, etc. and principally generates management fees based on AUM (along with a small amount of advisory fees that are based on agreed upon rates per hour, per month, etc.). 

Silvercrest provides tailored private and public asset management / allocation, liquidity management, tax planning and preparation, estate planning, accounting / reporting, fund administration, art management / consulting, and generally serve as the holistic “consigliere” to their family office clients. This includes advising on matters that relate to many family-owned private businesses (succession planning, liquidity events, corporate governance, etc.) and even the vetting of third-party legal and financial advisors. Five of Silvercrest’s ten largest clients use SAMG’s family office services and some of them closed their internal support infrastructure to outsource and consolidate such activities at Silvercrest. This approach is an effective strategy to maintain high retention rates, build deeper relationships with existing clients, and also differentiate Silvercrest in its quest to attract new clients.  

SAMG’s average client is a difficult-to-reach wealthy individual or family with $10+ million of net worth. As of 4Q19, Silvercrest had 790 clients, which equated to an average AUM per client of ~$31 million. Given the pareto principle, it’s important to note that SAMG’s top 50 clients represent 58% of total AUM and average ~$289 million per client, which makes SAMG’s high touch approach all the more important. New clients often come through referrals from existing clients or other professional sources developed through years of relationship building – SAMG’s senior portfolio managers (synonymous with “relationship managers” at other wealth management firms who establish and maintain client relationships) have an average of 33 years of industry experience.

SAMG offers both proprietary investment capabilities (funds managed by Silvercrest) and access to funds managed by other firms that are vetted by Silvercrest. It is well documented how difficult it is to beat the market, especially in recent years, which exhibited low volatility (until COVID) and a tidal wave of inflows to passive indices. Silvercrest’s proprietary offerings have historically focused on small cap equities and they have an extraordinary track record. Moreover, in a “what have you done for me lately” world, Silvercrest has outperformed its benchmark’s by a large margin over the past year, demonstrating the value of talented active investment managers and likely providing a tailwind to AUM inflows. I have included SAMG’s track record (gross of fees) from their latest 10-Q is illustrated below for reference.

Valuation

Note that SAMG is the general partner that operates and controls Silvercrest L.P., which is the underlying management / operating company that generates cash flows. SAMG owns ~64% of Silvercrest L.P. and the balance is owned directly by Silvercrest principals. 

Anyway you cut it, Silvercrest is cheap – whether by AUM, EBITDA, earnings, or free cash flow multiples. I have included a summary, back-of-the-envelope illustration below for reference.

SAMG’s existing client base and brand are valuable and the market also underappreciates management’s ability to add value through sound capital allocation and operating savvy (SAMG has completed nine bolt-on acquisitions since 2002). Given this combination of characteristics, I believe SAMG will compound value at high rates for a long time (all the members of SAMG’s management are in their 50s). I think my assumptions and projections are conservative and I also think the market misunderstands the underlying earnings power and growth trajectory of this business – Silvercrest’s YTD revenue growth (through 3Q20) has exhibited ~80% incremental margins.

Although I think Silvercrest would make for an attractive acquisition candidate for a number of private banks or sponsor-backed roll-ups that want to build their family office offerings, I don’t expect a sale of the business and this would likely represent a bull case to my current projections (Just this year, Morgan Stanley bought Eaton Vance for ~23x earnings and Franklin Resources acquired Legg Mason for ~20x earnings; horizontal synergies are enormous in this industry).  

Growth Opportunities

Although I don’t believe that overly strong growth is necessary or critical to the thesis at these price levels, I believe that Silvercrest has the ability to easily grow its AUM by multiples over the long run (aside from strong performance / asset inflation and new client wins) through a combination of other methods and initiatives.

• Geographic Expansion – Whether through organic or inorganic means, SAMG plans on establishing additional offices on the West Coast, Southwest, and Midwest to gain greater proximity to existing and potential clients
• Product Expansion / Cross-Selling – Silvercrest primarily offers small cap value and growth equity strategies and has the ability to grow and / or establish and cross-sell additional capabilities in various asset classes (e.g. grow large cap / international / emerging markets equity, establish new credit, real estate, ESG, etc. offerings)
  • Note that credit only represents ~20% of AUM and only includes municipal and corporate investment grade offerings
• Institutional Growth – Only ~1/3 of AUM is institutional versus family office / ultra-high net worth and Silvercrest is approved by several prominent institutional investment consultants who will now recommend Silvercrest to their pension fund, endowment, and foundation clients
  • Silvercrest has already won several institutional mandates for its small / mid-cap equity strategies
  • In the institutional investment business, success in garnering commitments / allocations begets additional success due to the herding psychology and tendencies of institutional investors
  • Management noted that Silvercrest’s institutional pipeline was $780 million on their 2Q20 earnings call (pipeline includes mandates where SAMG is a finalist or semi-finalist with a reasonable likelihood of winning the business)
• Outsourced Chief Investment Officer (OCIO) Services – Silvercrest launched an Outsourced Chief Investment Officer (OCIO) offering aimed at small and medium-sized family offices, endowments, and foundations in 3Q19 and the segment already has already gathered $750 million of AUM (as of 3Q20). SAMG expects to grow this into a $3bn+ AUM business over time, which seems very achievable given the strong one-year ramp up
  • It is also important to note that SAMG’s early OCIO wins were with a diverse group of institutions, which opens more doors, because, again, bureaucratic institutional investors don’t like being first (current clients include a college endowment, hospital (likely a pension fund), law firm pension fund, and a charitable foundation)
• M&A – As you would expect (given their track record), Silvercrest is a thoughtful and disciplined acquirer that shies away from auctions and is focused on near-term, “no brainer” value creation (not paying an inflated price and banking on growth for accretion). I am very skeptical of M&A and roll-ups in industries that are human capital intensive. However, Silvercrest has an outstanding track record in this area and is very selective. SAMG is focused on targets that are kindred spirits (value / GARP investing DNA), possess scalable family office / ultra HNW client bases (near SAMG’s current $30 million of AUM per client metric), and is ultra-focused on the culture, talent / temperament, and an appropriate incentive structure for targets. I believe that SAMG’s long-term focus on maintaining a strong culture makes it an acquirer of choice for asset management firms with limited product offerings or for wealth management firms that face succession issues (versus other large, bureaucratic firms or cut throat PE roll-ups)

It’s also worth noting that the institutional growth and OCIO avenues discussed above are particularly accretive to margins / profitability due to economies of scale (M&A offers large potential revenue and cost synergies as well).

Risks

• Market / Performance and Retention Risk – Asset management fees will fluctuate with AUM and there is the risk of AUM degradation due to poor performance or client outflows (sometimes good performance leads to outflows from rebalancing as well) 
• Fee Compression – Risk that I am wrong and Silvercrest’s fees compress (mitigated by average fees of 40bps – 50bps, which seems reasonable / cheap for a top flight active manager) 
• Key Person(s) – As everyone here knows, these type of businesses are always susceptible to valuable / talented human capital leaving the firm (SAMG has strong non-competes and recourse to cheaply repurchase SAMG stock from employees that are terminated for cause or violate the terms of their non-compete though) 
• Regulation / Compliance / Litigation – Increased regulation, regulatory non-compliance, or non-compliance with SMAG client guidelines could negatively affect Silvercrest’s financial performance and / or lead to expensive litigation 
• Consultant Relationships – If these relationships deteriorate, growth in the institutional channel would suffer
• New Product Risk – Costs of establishing a new team / investment strategy initially exceed revenues generated by such strategy. Failure / poor performance within a certain strategy / product could negatively affect SAMG’s reputation 
• Asset Class / Investment Style – Perception of / demand for financial products and strategies that align with Silvercrest’s offerings and investment philosophy could fall out of favor (if you really think value investing is dead, what you are doing here though?)
• Reputation – Reputation is everything in this business. Anything that negatively affects Silvercrest’s brand or reputation (poor performance, employee misconduct, litigation, etc.) could lead to outflows or difficulties in growing AUM 
• Counterparty Risk – Standard contagion / financial system fragility risk. If Silvercrest’s prime brokers, custodians, etc. become insolvent, SAMG will rank as an unsecured creditor and may be unable recovery the full value of its fund assets

Catalyst

• Steady compounding of value - "Eventually the market catches up with value. It realizes it in one way or another"
• Public acknowledgement of recent institutional and OCIO wins accelerate growth  
• Reputable sellside firms initiate coverage
• Activist involvement in the industry leads to "discovery" by other investors
• Accretive M&A
• Accretive buyback / tender
• Buyout / MBO