U.S. Global GROW W
July 31, 2006 - 9:44am EST by
tim321
2006 2007
Price: 19.13 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 145 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT

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Description

I think U.S. Global (“USG”) will report over $5mm in earnings this fourth quarter due to an unknown $3.5mm incentive fee accrual that is due USG from a firm called Endeavor Mining Capital (“EDV”). While this information doesn’t show up in any of USG’s public documents, Endeavor happens to be publicly traded on the Toronto Stock Exchange and one can figure it out by reading EDV’s latest Q3 filing. While I don’t think this “information edge” is of the same magnitude as my original USG posting (AUM really 40% higher than what was reported), it is still significant for a company with an enterprise value of $130mm. This would put USG’s 2006 earnings over $10mm or 13x EV/E which is much too low given USG’s past and prospective growth. I think shares will trade at least in the mid-20’s after earnings are released giving those interested in a 2 month trade (earning out in September) a meaningful AACR. Fortunately, I think this “trade” is also a quality long term investment and will update some of my thinking since my original write up.
 
The “Trade”: Background
 
Endeavour Mining Capital is publicly traded merchant banking company that is focused on the global natural resources sector. Frank Holmes, the CEO of USG, was recently appointed as Chairman of Endeavour and was able to get USG appointed as manager of EDV’s $180mm -$200mm portfolio (it has been very lucrative to both sides thus far). The fee structure is 2 and 20 with an 8% hurdle. The fees get split evenly between USG and EDV. The chart below lays out the economics for USG at $180mm AUM.   
 
 
Endeavor Fee Structure
 
 
 
 
 
 
 
 
Mgmt Fee:
 
 
Bonus:
 
 
 
 
 
 
<$50M
2.00%
1.00%
Return:
8.00%
13.00%
20.00%
25.00%
30.00%
35.00%
$50M-$100M
2.00%
1.00%
GROW Bonus:
$0.0
$0.9
$2.2
$3.1
$4.0
$4.9
>$100M
2.00%
1.00%
GROW Mgmt:
$1.8
$1.8
$1.8
$1.8
$1.8
$1.8
Assets:
$180.0
 
Total Fee:
$1.8
$2.7
$4.0
$4.9
$5.8
$6.7
Blended Fee:
1.00%
$1.8
Blended Rate:
1.00%
1.50%
2.20%
2.70%
3.20%
3.70%
 
 
The USG/EDV relationship officially March 1st (the beginning of EDV’s Q) so USG’s latest quarter only included one month’s worth of management fees. Below is what is reported regarding EDV in USG’s last 10-Q.
 
 
“In the third quarter of fiscal year 2006, the Company began providing investment advisory services to Endeavour Mining Capital Corp., an offshore company. The Company is paid a monthly management fee based on the net asset value of the portfolio and an annual performance fee, if any, based on a percentage of consolidated net income from operations in excess of a predetermined percentage return on equity. The Company recorded $106,230 in management fees for the three months ended March 31, 2006. Holmes is a member and Chairman of the Board of Directors of Endeavour Mining Capital Corp.”
To find the performance fee, one has to look at EDV’s latest 10-Q where for the 3 months ending May 2006, a $9.5mm performance fee is reported. EDV accrues the performance fee and reports the accrual on a quarterly basis.
 
http://www.endeavourminingcapital.com/uploads/EDVPressReleaseQ3EarningsFinal.pdf
 
USG’s policy is to only book its portion of the “annual performance fee” once EDV’s annual books are closed and audited (which is why mgmt fee for one month was the only item disclosed). USG is entitled to half this $9.5mm but there are a couple of items that need to be noted. First, the timing of USG’s recognition is unclear as EDV is changing their fiscal year to June.  According to Holmes, if EDV’s audit is completed in time, USG will recognize its share of the performance fee this quarter (what they are shooting for obviously, if not, you will see it in September). Second, there is one more month of EDV performance that will be included and that is June when EDV’s NAV went down 3% (so the $9.5mm will be a little bit less but remember that there will also be a $450K management fee for April, May and June).
 
The “Trade”: Do others know this?
 
For what it is worth, I don’t think others have put this information together. The stock price of USG has actually gone down since EDV’s released this information. Additionally, you will not find this on any of the message boards (see aggregator instantbull.com). Because USG’s stock price has done so well, the IBD crowd has joined the party which makes the stock extremely volatile (hit 28 after last quarter earnings and has come all the way down to 18) and a large portion of the shareholder base are unsophisticated, momentum players. This makes USG a wonderful stock to trade (if this happens to be your thing.)
Investment thesis:
 
For those interested in the longer term here, I think the story is compelling at this price:
 
 
 
 
3/31/2006
4/30/2006
5/31/2006
6/30/2006
JULY  E
MTD JUL
% of Total
YTD
Performance AUM
Inflows
 eastern europe
$1,600.0
$1,830.0
$1,453.0
$1,260.0
$1,340.6
6.4%
28.2%
10.9%
$119.9
$120.7
 natural resources
$1,174.4
$1,450.0
$1,366.0
$1,280.0
$1,267.2
-1.0%
26.6%
19.3%
$152.2
$326.4
 precious metals
$695.0
$1,000.0
$946.0
$914.0
$926.8
1.4%
19.5%
44.0%
$158.2
$408.5
 US Gov't Savings / Money Mkt
$414.2
$417.7
$417.0
$437.0
$437.0
0.0%
9.2%
0.0%
 
 
 US Treasuries / Cash
$112.1
$109.4
$109.4
$119.7
$119.7
0.0%
2.5%
0.0%
 
 
 All American Equity
$22.7
$22.9
$22.0
$21.6
$21.3
-1.7%
0.4%
3.6%
$0.7
$0.0
 Holmes Growth (midcap)
$71.9
$71.4
$67.0
$65.7
$63.0
-4.2%
1.3%
2.1%
$1.4
-$5.3
 Megatrends (large grwth)
$17.4
$17.4
$17.0
$16.8
$16.7
-0.8%
0.4%
-0.9%
-$0.1
$1.6
 China Region Opportunity
$57.5
$75.7
$73.0
$67.5
$67.0
-0.6%
1.4%
12.0%
$4.5
$25.2
 Gold Shares
$152.8
$208.6
$205.0
$205.7
$208.5
1.4%
4.4%
46.7%
$44.3
$69.3
 Global Emerging Mkts
$19.6
$19.6
$17.0
$26.7
$27.2
2.1%
0.6%
7.9%
$1.6
$6.1
 Near Term Tax-Free
$16.5
$16.4
$16.0
$16.0
$16.0
0.0%
0.3%
1.1%
$0.2
-$0.2
 Tax-Free Fund
$15.3
$14.7
$14.7
$15.7
$15.8
0.5%
0.3%
1.7%
$0.2
$0.7
 Hedge Fund Assets
$0.0
$0.0
$0.0
$200.0
$230.0
 
4.3%
 
 
 
 
 
$4,369.4
$5,253.8
$4,723.1
$4,646.4
$4,756.9
 
99.5%
 
$483.2
$953.3
 
 
While the stock price has come down over 30% since the middle of May, assets under management have only come down around 10%. Most importantly, this decrease has been driven by performance and not outflows. My AUM estimate for July has USG assets going up from $4.6 billion as of the end of June to $4.75 billion as of the end of July. If you look at the chart above, you will see that despite the recent market correction, the YTD performance of USG’s funds has been stellar. You will also see that YTD inflows have totaled almost $1 billion with the two full fee funds, natural resource and precious metals, taking the bulk of the flows. Holmes had been quoted earlier in the year when the market was going crazy as saying that they were receiving $10mm a day in inflows. My number suggests this has tempered a bit and the average for the year is closer to $6mm. Ultimately, I think owners of USG can go to bed at night with a smile on their face knowing that inflows of capital are trickling in to their company when measured over a 3-5 year timeframe. This thesis is supported by several facts:
 
  1. Performance – When screening for the best performing mutual funds over a five year period, USG has four of the top five funds (out of 7,000+ funds) as of June 30, 2006. And they only have 13 funds total!
  2. More exposure of the brand – Frank Holmes is appearing on CNBC and Bloomberg more regularly and the firm has increasing gotten more and more written press. We are still in the early innings.
  3. Past numbers suggest inflow assumption makes sense.
 
 
The numbers:
 
 
 
 
2006 Fiscal Year
 
March
June
Sept
Dec
March
June Estimate
 
3Q
4Q
1Q
2Q
3Q
4Q
Earnings
                                 448,911
                 360,000
              1,095,935
              1,168,000
            2,550,000
                   1,919,656
Core Earnings
                                 550,000
                 450,000
                 890,000
                 840,000
            1,490,000
                   1,919,656
Average AUM for Period
                       2,010,000,000
       2,101,000,000
       2,410,000,000
       2,830,000,000
     3,780,000,000
            4,870,000,000
 
 
Above are USG’s last four quarters and my estimate of $2mm for this quarters “core earnings.” Core earnings have been stripped of proprietary trading and represent earnings from the mutual fund business earnings (and an immaterial amount from hedge fund management fees) that can be used for forecasting purposes. I get to the over $5mm 4Q number, by taking half of the $9.5mm incentive fee taxed at 38% (a conservative estimate – the tax rate could very well be a blend of long term and short term rates) and adding the management fee of $450,000. This $3.4mm combined with the $2mm of “core earnings”, gets you over $5mm. 
 
2007 Earnings:
 
If you assume that AUM holds steady at the June average for the entire 2007 period, you have around $8mm in earnings power from the mutual fund business and $2.3mm in earnings from the hedge fund business assuming zero incentive fees. This gives you $10mm in earnings on a $130mm EV or an 8% FCF yield. I think this is a bargain given USG’s growth profile, long term rates, and the conservative assumptions that went in the projection. This number has substantial upside if you factor in positive net inflows or positive hedge fund performance.
 
 
 
 
 

Catalyst

USG has a blow out quarter coming and I don’t think “the street” knows it.

Dividend and stock split likely to be announced
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