Description
U.S. Global Investors (“USG”) is a double from here.
USG is a San Antonio, Texas based mutual fund manager that has seen its assets under management grow from $1.3 billion (latest 9/30/04 10-Q filing) to a recent $1.8 billion on the back of its strong gold, natural resource, and foreign equity funds performance. The $1.8 billion was reported recently in the Wall Street Journal which profiled U.S. Global in its year end mutual fund review (U.S. Global’s Eastern European and Global Resource Fund won the 1 year and 3 year mutual fund performance award). The kicker is that all the growth has come into the higher margin equity funds versus USG’s money market funds. This favorable trend should become apparent in future earnings announcements. Surprisingly, the stock is down over 25% year over year despite an enormous and demonstrable increase in the intrinsic value of the company. The fact that the company has less than 300 shareholders, no Wall Street coverage, and a tiny market cap explain why.
Numbers First:
Shares Outstanding: 7.5mm
Stock Price: 3.46
Cash: $5mm
Debt: 0
Market Cap: $26mm
EV: $21mm
2004 NI: 2.2mm
P/E:12.0x
P/ EV: 10.0x
While nice, a 10% free cash flow yield (earnings and free cash flow here match up given minimal D&A and CAPEX) on a small, profitable and simple to understand business is not the primary reason why I’m so excited about USG. Rather, it is the recent asset mix shift and unaccounted for growth that are likely to show up in future results.
($mm, Year Ended June 30th,) 2004 2003 2002
Revenue 12.9 7.5 7.8
Net Income 2.2 .04 (.24)
CFO 2.7 .13 .006
(Average AUM) 2004 2003 2002
Equity 735 325 293
Money Market 609 746 872
Total AUM 1,344 1,071 1,165
Equity as % of AUM 55% 30% 25%
Equity Growth YOY 126% 11%
Total AUM Growth 25% -8%
Just from looking at the AUM breakout, one can see why USG was able to finally produce meaningful net income in fiscal year 2004. The higher margin equity assets grew 126% from 2003 to 2004 while overall AUM grew a healthy 25%. What is most interesting is looking at AUM as of December 31st 2004 and comparing it against June 30th 2004 numbers. Remember, December AUM numbers are not published in any filings. I had to do this myself from aggregating all of USG’s funds from the yahoo finance mutual fund service.
USG runs 12 funds, of which 8 are equity funds. Here is the AUM breakout as of December 31st, 2004. USG is a sub-advisor on the Eastern European fund (run by Charlemagne Capital in London) and the Megatrends fund (run by Leeb Investment Advisors) while all other funds are run in-house. The Holmes Growth fund just recently switched from being sub-advised to in-house after the Portfolio Manager, Art Bonnel, announced that he was retiring to take a sabbatical.
Eastern European 460
World Precious Metals 292
Global Resource 260
Gold Shares 76
Holmes Growth 72
China Region Opportunity 32
All American 20
Megatrends 14
Total Equity AUM $1,226
Dec.04 FY04
Equity 1,226 735
Money Market 574 609
Total AUM 1,800 1,344
Equity as % of AUM 68% 55%
Equity Growth 67% 126%
Total AUM Growth 34% 25%
It should be noted that an average AUM is being used for fiscal June 30th 2004 whereas I’m taking a snapshot for the December 31, 2004 AUM. This doesn’t change my thesis that one can confidently predict strong future cash flow from USG going forward based on AUM trends. In just the past few years, the AUM mix has gone from 25% equity to 70% while at the same time total AUM has grown over 50%. In January, USG continues to experience positive net flows although much have it has come from the more expensive broker dealer platforms.
Brief Background:
Before Frank Holmes took over U.S. Global in 1990, USG was strictly a gold oriented asset management firm known for introducing the first no-load gold mutual fund in the 1970’s. Holmes, who took over as CIO in 2000 (although all funds are team managed), has broadened U.S. Global’s focus by introducing foreign and natural resource funds to the lineup. Today, he considers USG a “boutique Global Resources fund.” This sector represents approximately 10% of the S&P today. The funds website, www.usfunds.com, has plenty more information on the background of the company and Holmes for those who want more information.
Shareholder Friendly:
Holmes eats his owns cooking and has all the incentives to get the stock price higher as the largest shareholder of USG with 23% of the Company. Additionally, unlike the BKF’s of the world, he pays himself and his staff a reasonable salary so that incremental AUM growth flows to the bottom line. Additionally, Holmes has bought back stock each of the past 3 years and taken down USG’s debt to zero. He also confirmed that he would be willing to use free cash flow to buy back stock at this level. While USG is cheap using any asset manager “comps” (see precedent M&A Asset Manager transactions list in latest Lehman Brothers report), theoretical value shouldn’t be an issue here if business trends continue.
Possible Morningstar Upside with recent performance:
USG has been able to achieve its AUM growth despite not having yet been blessed by the 800 pound gorilla – Morningstar. For instance, while Holmes’s three year returns for his World Precious Minerals Fund and Gold Shares Fund were third and ninth respectively out of 12,445 active open ended funds in the Morningstar Universe (as of Sept 30th 2004), Morningstar only gives his Gold Fund one star. While Holmes is dumbfounded as to why this is the case (sounds like he has gone to great lengths to try and rectify this), he has instead turned to the broker platforms like Schwab (which typically only take 4 or 5 star funds) and landed USG funds on their One Source platform by aggressively making his case. The downside here is that Schwab and Fidelity are more costly means of gathering assets (charge roughly 40bps). Should Morningstar ever turn the corner (not out of the question given recent fund performance), AUM growth should substantially increase.
The Wall Street Journal recently profiled USG in its annual mutual fund review. In the article, the Journal named the Eastern European Fund and World Precious Minerals Fund as "Category Kings" with the best one-year returns of emerging market funds and gold-oriented funds. This sort of recognition and performance will hopefully help the case with Morningstar.
Balance Sheet – Downside Protection:
The balance sheet is very clean with $10mm in total assets, $5mm of this being cash. Total liabilities are $1mm. It should be noted that PPE is listed on the balance sheet at $1.7mm but USG owns the office building they are in (46,000 square feet on 3 acres). The fair market value of this PPE is closer to $7mm. The downside is about $2 of protection. And this is forgetting the 85,000 mutual fund shareholder the company reported in their latest 10-K. Holmes, in a 2001 interview with Wall Street Transcript, put the value of each of his customers at $300 (the cost to acquire a customer in the mutual fund industry). While my ownership is not contingent on USG’s customers being worth over $25mm, it does add another layer to the margin of safety here.
Valuation:
My projections for 2005 have revenue coming in between $16mm and $18mm and net income falling between $3mm and $4mm. This is assuming no further growth in AUM from December 31, 2004 and the current equity versus money market AUM split. This equates to a 14% FCF yield on EV should earnings come in at the lower end of my range. I think this is too high for a company that is growing in the manner of USG and believe that the share price will adjust accordingly.
Details on Projections:
Revenue:
There are two components to equity revenue – the in house funds (USGIF) and the sub-advised funds (USGAF). While the sub-advised funds generate more revenue per AUM dollar, the in house funds are more profitable. Here is the historical AUM breakout, with the corresponding revenue per line item.
(AUM- $mm) Dec04 2004 2003 2002
Money Market 574 609 746 872
USGIF 680 549 224 167
USGAF 546 186 101 126
Total AUM 1,800 1,344 1,071 1,165
(Revenue -$mm) 05P 2004 2003 2002
Money Market 1.6 1.7 2.3 2.7
USGIF 5.8 4.7 1.6 1.1
USGAF 6.2 2.1 1.0 1.3
Other 1.0 0.7 0.4 0.0
Total Advisory Fees 14.6 9.2 5.3 5.1
Transfer Fees 3.0 2.6 2.3 2.6
Investment Income 0.0 1.0 (0.3) (0.1)
Total Revenue 17.6 12.9 7.4 7.7
In calculating revenue projections for fiscal year 05, the biggest assumption I have made is that “snapshot” year end December AUM becomes average AUM for 05. Most of the line items are easy to project based on the past relationship between AUM and revenue and from speaking to management. Transfer fees are driven by number of clients and not AUM so I have made a conservative projection. I have zeroed out investment income as it is largely unpredictable and will likely go away in the future (perceived conflict of interest is my big issue here).
Expenses:
(Historical -$mm) 2004 2003 2002
Employee Compensation 5.0 4.3 4.5
General & Administrative 3.6 2.6 2.7 Subadvisory Fees 1.0 0.5 0.5
Advertising 0.4 0.2 0.2
Depreciation 0.1 0.1 0.2
Total 10.1 7.8 8.1
Projections for 05: 2005
Employee Comp: 6.9
G&A: 4.3
Subadvisory Fees: 2.5
Advertising 0.6
Depreciation 0.2
Total 14.5
Most of these projections are straightforward based on past historical numbers. Employee compensation as a % of total AUM has historically held between the .37% and .40% range. I just multiplied $1.8 Billion by the average of the last three years. The biggest increase will be in the sub-advisory line item given that the AUM in this segment jumped from $186mm to $546mm or 193%. This is almost entirely from the growth of the Eastern European Fund. This will be partly offset from the savings associated with the Bonnel fund coming in house. G&A is driven by the USGIF equity and money market account and is projected to grown in the 20% range.
Revenue of $17.6mm less expenses of $14.5mm equals profits of $3.1mm.
Risks:
Holmes is no James Hawkes (CEO of Eaton Vance) and is way too quantitative and promotional for my blood. Unlike Eaton Vance, this is not a stock that you put under your mattress for the next 5 years.
The natural resource sector could have a substantial correction.
Trades an average of 27K shares a day.
Two classes of stock – Holmes controls voting.
Catalyst
Catalyst:
•Continued flows into USG’s funds based on outstanding recent performance
•Earnings
•Stock buyback