Description

Seamark represents a 50% upside with minimal downside risk, in my opinion. The stock is down 55% from its highs, and the short-term voting machine has overreacted to negative news. (All figures are in Canadian dollars)

Overview
Seamark is a Canadian money manager and full-service investment counsel. The company provides investment management services to a variety of clients, including institutional clients, mutual fund companies, and private clients. They service pension funds, endowments, foundations, group retirement plans, mutual fund companies and other high net worth individuals including wrap programs.

History
Peter Marshall and North American Life founded Seamark in 1982 with little money and a vision that there was a business opportunity for an investment management company based in Atlantic Canada. Peter put in the sweat equity and North American Life provided financing and the resources and was Peter’s early customer. By 1986, assets under management reached $100 Million. In 1995, Manulife Financial ( Ticker in Canada) merged with North American Life and became Seamark’s largest shareholder. By 1996, assets under management reached $1 billion and Seamark managed its first mutual funds and wrap program. In 2000, assets under management reached $5 billion. In 2001, Seamark became a public company. In 2003, assets under management reached $10 billion. As of Dec. 31, 2005, AUM is about $9.4B


Why stock price dropped from 20 to 8.6.
1.) October earnings disappointed because there were more withdrawals related to a subpar performance in 2004 and average performance in 2005.
2.) Clarington Funds, their biggest mutual fund client representing 21% of revenues, announced they are switching to a different provider. This represents about $3.1 Billion AUM. The biggest reason for the change is that Clarington Funds was acquired by another insurance firm in 2005. After April 2006, their AUM will fall to about 6.2B AUM
3.) The CEO resigned in May 2005 over differences of opinion with the Board. Since then, Peter Marshall, the founder and chairman, resumed the position of the CEO. The market expected a new CEO by December 2005. The expected new CEO announcement in December 2005 did not happen.
4.) Tax loss selling

So how much do they manage after Clarington leaves?
Starting April 2006, they will have roughly 6.2B assets under management. The breakdown and the annual management fees break down to
- Mutual Funds – 200 M / 20 bps
- WRAP/Private Clients – 2 Billion / 45 bps
- Institutional Clients – 4 Billion / 25 bps

The blended asset management fee will be 31 bps on 6.2 Billion.

CEO situation:
In March, 2005, the then CEO Bob McKim resigned. Bob McKim was the first investment professional Peter hired in 1984. He had worked with Peter until 2003 when Peter became Chairman. Bob succeeded as CEO. However, Bob and the Board disagreed over operations rather than strategic or vision issues. Bob resumed the role of CEO and is still in the process of looking for his successor. Peter is 65 and the company has told me they would not want to delay this uncertainty and it wants to have a successor sooner rather than later. It expects to announce the successor shortly although there is no definite timeline.


Opportunity

I believe that this price drop is an overreaction to the recent events and that there is no permanent loss of capital. Clearly, the decline in assets under management should assign a lower valuation to Seamark but the 50+% haircut is an overreaction in my opinion. Historically, this business trades at 2% of assets under management. Currently it trades at 1.4% of assets under management even after the withdrawal of Clarington’s assets. This is equivalent to about 5.7x EBIT. The Clarington assets represent 21% of revenues. After this loss of revenues, I still estimate EPS of about $0.85.

In my discussions with management, I am comforted by the fact that their investment discipline and philosophy has not changed and that their recent sub-performance is not an indication that their performance will not revert to its norm – which is quite good. Their explanation of the recent subpar performance is credible, in my opinion. Among the reasons they cite:
-underperformance of U.S. and Foreign Equities and the appreciation of Canadian dollar (Foreign and U.S. equities is one of the strengths of Seamark. )
-underweighting in energy sectors
-currency movement
-they maintained a shorter duration in their fixed income management portfolios than the rest of its peers


Performance Table for the assets they manage:

As of 31-Dec-2005 3 Year 5 Year 10 Year
Bonds 5.91 6.92 7.39
Canadian Equity 19.51 11.32 13.97
Foreign Equity 3.37 -4.46 12.44
US Equity 3.57 -3.30 11.28
International Equity 1.94 -9.72 16.39
Total Equity 12.98 4.58 13.24
Total Fund 10.09 5.72 10.74

Returns(Percentile Rank. The lower the better)
1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Yr 7 Yr 8 Yr
SEAMARK 1.2(74) -1(97) 3.7(66) -3.7(68) -2.2(45) 0.3(29) 4.4(15) 7.5(6)
S&P500C 2.3 2.5 3.4 -3.9 -4.4 -4.6 -2.1 2.2
5th Pctile 9.5 10.1 13.3 5.8 5.7 7.1 7.3 8.2
Upper Qrtle 5.9 5.5 6.5 -1.1 -0.2 1.3 2.5 4.8
Median 3.9 3.9 4.6 -2.5 -2.3 -2.7 -0.8 2.9
Lower Qrtle 1.2 1.9 2.8 -4.2 -4.4 -4.6 -2.4 1.0
95th Pctle -2.5 -0.9 1.1 -5.9 -7.1 -7.8 -4.3 -1.3
Number Funds 94 91 87 83 77 67 63 52

Any above average investment discipline that is value-oriented gets into a short-term period of lousy returns. I characterize them as GARPy as opposed to deep value. Over time, if the asset manager sticks by its principles, they can have one good year and attract more assets. So far, 2006 is starting out very well for them.

There are 2 potentially pleasant surprises that can benefit Seamark and increase long-term value to Seamark’s business.

The Canadian government surprisingly eliminated the foreign content restrictions on retirement and pension plans, as announced during the Budget Speech in 2005. Few believed this change would come as quick or be as extensive as announced.

Effective January 1, 2005, retirement and pension plans are no longer limited to 30% of the book value of their total assets in foreign securities. Many pension plans went beyond that percentage by using derivative-based strategies and were willing to accept the additional costs associated with them. According to the Canadian Pension Fund Investment Directory, plans representing one fifth of total industry pension assets exceeded the foreign property cap by an average of
10%. The new rules, however, have eliminated the need for those strategies.

This regulation bodes well for Seamark, in my opinion because they are known in Canada for their strengths in Foreign and non-U.S. equities.

Moreover, they had an exclusive contract with Clarington fund that prevented them from pursuing other mutual fund clients except for their business with John Hancock(which was bought by Manulife in 2004). Currently they have 200M Mutual fund assets under management because of their indirect connection to John Hancock. Now that they are free to pursue mutual fund business, they are focusing on their Canadian clients.

Finally, market’s short-term focus fails to realize the beauty of the money management business. It has very low overhead, very high operating leverage, no inventory, no accounts receivable. Most of the revenues go to the bottom line except for salaries of a few investment professionals. In the words of my famous value investing teacher who jokingly told me, “Asset managers are a license to steal”.

Fundamentals:

The company has never had a losing year. This is their income statement snapshot for the last 15 years.

1998 1999 2000 2001 2002 2003 2004 2005
Revs(Millions) 6.5 8.6 11.4 16.6 24 25.5 29 27
EBIT 4.4 6.2 8.6 12.8 18.4 18.7 21.3 19.1
Net(Millions) 2.5 3.3 4.8 7.1 10.6 11.3 21.3 19
ROE(%) n/a n/a 89 105 118 96 87 62
P/E Range n/a n/a n/a 28-29 18-39 17-25 18-24 7-19

Valuation:
The company is currently trading at less than 10x estimated earnings (P/E) for 2006. It is trading at 1.4% of Assets under management. It is trading at 5.8x EBIT. Historically, it has traded at about 20x P/E and about 2% of AUM. Assuming no new assets gathered, the Clarington withdrawal represents a 21% drop in revenues. The earnings power for 2006 is still around $0.85 a share. I think this stock should trade at 2% AUM. At that price, it is 50% move up from here. If they should get more business as a result of better performance in 2006, or the favorable regulation change, the stock can easily go back to the 20’s.


Peer valuation:
Mkt Cap AUM % of Assets Est P/E
SEAMARK 90 6.2 1.4 10-11
Addenda Capital 337M 26B 1.3 18
CI Financial 8019M 56B 1.4 24
Sceptre Investment 111M 6.8B 1.63 30
Integrated Asset Management 41M 2.1B 1.95 n/a
Dundee Wealth Management 1086M 49B 2.22 47
Blumont Capital 16M 768M 2.08 n/a
Saxon Financial 345M 10.5B 3.29 30

While some peers trade at %AUM lower than Seamark, clearly the earnings power is much higher for Seamark as demonstrated by the low P/E. Plus, I could not find a reason why the others can be mispriced by the market. With Seamark, the reasons for a mispricing are more evident.

Catalyst

Catalyst
-Cheap with high-quality assets and a high quality business
-Regulation introduced in 2005 should add long-term value to its business
-Make new headways into the mutual fund management business
-Announcement of successor to the CEO