Tarpon Investimentos (TRPN3) is a leading asset manager in Brazil that I believe is an attractive long.  TRPN3 is the remaining publicly traded piece of Tarpon Investment Group (TARP11), which I wrote up here in late 2008.  As a reminder TARP11 consisted of two parts at the time; 1) Tarpon’s fee-collecting management company, and 2) a portfolio of balance sheet investments in Tarpon’s own funds.  Since that time TARP11 has spun off its management company into TRPN3, wound down TARP11 and returned capital from the investment portfolio (note – all numbers below are in Reals, but you can basically divide by two to get the current USD equivalent):

In late 08 the balance sheet investments accounted for most of the share price and you got the asset management company basically for free.  To be clear the risk/reward today is not as asymmetric as it was then, but given that AUM has more than tripled since 2008 and Tarpon’s funds are now generating incentive fees, the shares do appear attractive again in my opinion.  For example compared to the current market cap of R$694 mm, the company has earned R$289 mm and paid out R$257 mm of dividends in the past three years alone.  Assets under management have continued to steadily grow, and at least one large holder appears to have been an uneconomic seller in recent months which might be the reason for the mispricing. 

Business Update

For a more detailed history and overview please see my first write up, but in short Tarpon manages Brazilian equity funds that invest in both public and private markets for institutional investors around the world.  Tarpon maintains a concentrated portfolio of long-term, value-oriented investments and has one of the best track records in Brazil or anywhere else for that matter, having compounded at 32% net of all fees for its first 10 years in business ending in 2012.  Performance has remained strong even as Tarpon has grown:

Tarpon’s returns are amongst the best of any large investment fund in recent years – for example in the following Barron’s database Tarpon’s 5 year return is the 5^th best of the ~700 or so managers reporting a five year number:    http://online.barrons.com/public/page/9_0210-hedgefundperformance-hedgefundperformance.html.   In addition Bloomberg’s FPC function shows Tarpon ranked 80th out of 14,520 funds based on five year return. 

I believe that over the long term demand for an alpha generating Brazilian fund manager will only increase from global institutional investors, and Tarpon is well situated to take advantage of that given its track record and strong brand name in Brazil.  If you’re a sovereign wealth fund or Canadian pension plan, Tarpon is a safe pair of hands in which to gain Brazilian exposure and an easy “sell” to your boss or board of directors.  The investor base is now 43% sovereign wealth funds and pensions and 26% endowments and foundations.  AUM has grown steadily, with healthy net inflows each of the past six years, and notably Tarpon raised more money in 2008 than in any other year:

Of the R$8.3 B total AUM, R$7.7 B is invested in Tarpon’s funds and R$0.6 B is in a co-investment SPV that was raised a couple of years ago and initially backed by the Alberta Investment Management Company, a $70 B institutional investor in Canada.  Of the R$7.7 B in Tarpon’s funds, R$4.7 B is in a vehicle launched in September 2012 called Tarpon Partners, R$1.4 B is in a long-only public equity fund, and R$1.6 B remains in the legacy hybrid fund that had previously been the bulk of assets.  The new vehicle, which was largely funded by existing clients migrating their capital from other Tarpon funds, locks clients up for longer (3 years on public investments, 8+ years on private investments) and allows Tarpon to put up to 75% of the fund into private investments in exchange for lower management fees (new fee structure is 0.75% and 20% over Brazilian inflation +6%).          

Valuation

A large share of Tarpon’s revenues comes from incentive fees so it’s impossible to precisely forecast any given quarter or year as a result, although I believe the shares are cheap with even modest assumptions for incentive fee generation looking forward.  For example the average net income over the past four years has been R$76 mm – if you consider that a sustainable level than the stock would be at a 9x P/E.  While fund performance has been strong over the past four years, the period also began with the funds all well under their high water mark (HWM), and AUM averaged R$5.5 B over that time period versus R$8.3 B today.  2012 is another interesting example – Tarpon began the year with 94% of AUM below their HWM (because of a large drawdown in Brazil generally in the 2^nd half of 2008), absolute returns were just ok (largest fund +6%, others up between +6-20%) and therefore incentive fees earned were minimal – and net income was still over R$40 mm, which would result in a 17x P/E at today’s levels.  Overall I think that’s a reasonable downside case – if incentive fees are minimal going forward I think the stock is trading between 15-20x earnings , while it’s not unrealistic that the company could earn a meaningful chunk of its market cap in incentive fees if the funds perform well in any given year.  In addition I believe Tarpon is likely to continue to grow its AUM and return he bulk of its earnings to shareholders via dividends and buybacks.

Barring a large market selloff 2013 is shaping up to be much better than 2012.  The % of AUM above HWM has steadily grown and is now over 30%.  In addition Tarpon accrued, but has not officially collected, over R$68 mm of incentive fees during the second half of 2012, and the bulk of that will be officially collected on June 30^th if it remains above the HWM (after up to 35% is paid to the team – so more like R$44 mm of operating income).  Finally according to Factset Tarpon’s portfolio is up a couple of percent on the year already which will further boost AUM and management fees. 

Potential Reason for Mispricing

Eton Park and Passport Capital were each major holders of the company in recent years, at one point owning almost 30% of the outstanding shares between them.  This past fall each completely sold out of their positions according to Factset and media reports, and Eton Park’s sale occurred shortly after the firm decided to exit emerging markets completely.  I believe this large overhang is one of the reasons why the stock has come down in the past year, and I’m comforted by the fact that Tarpon appears to have been on the other side of these sales purchasing back its own shares:

• April 20^th, 2012: Tarpon buys back 228,227 shares at R$13.90
• May 10^th, 2012: “Eric Mindich’s $11.8 billion hedge fund Eton Park Capital Management is relaxing its restrictive liquidity terms and cutting emerging market investments.  Founding partner Edward Misrahi, who led the emerging markets team, has also left the firm.” http://www.hedgefundintelligence.com/Article/3026048/Eton-Park-increases-liquidity-pulls-back-on-emerging-markets.html
• September 13, 2012: Tarpon buys back 1.3 mm shares at R$12.50
• September 18^th: Eton Park files on September 18^th that it sold its entire Tarpon stake: http://www.tarponinvest.com.br/english/pdfs/fatos-relevantes/2012/Notice%20to%20the%20Market%2019%2009%202012.pdf
• October 4^th, 2012: “Tarpon Investimentos SA announced that Passport Capital LLC has lowered its stake held in the Company and in result holds 0% in its share” capital.  http://www.reuters.com/finance/stocks/TRPN3.SA/key-developments/article/2618431

Conclusion

Overall I think this is a chance to participate in the long term Brazil story alongside intelligent, shareholder friendly investors in a stock that appears mispriced.  If fund performance is just ok I think this will be a decent investment, trading somewhere in the mid to high teens on a P/E basis for a high quality, growing asset manager.  What makes this asymmetric is the huge amount that can be earned if Tarpon’s funds generate incentive fees, which I think is likely over time.  The alignment of interests is strong, with the team owning over half of the shares (over R$400 mm) in addition to being one of the largest investors in its own funds (over R$900 mm).  Tarpon’s strong brand name, top-notch track record, and long-term capital base should continue to lead to impressive financial results over time. 

The key short term risk is a slowdown or market selloff in Brazil generally, however Tarpon navigated the global financial crisis extremely well, losing less money than the benchmark on the way down and raising and deploying capital into various undervalued securities after the drop.  In addition any asset manager has a certain amount of key man risk, which is always possible, although the key insiders are very motivated to stay on board given their large personal stakes both in the company and its own funds.