Left for Dead: Manning & Napier – MN:NYSE

It’s no secret that the active investment management industry has seen better days. Decades of high fees and uninspiring returns have spurred investors to reallocate their dollars to passive index-following strategies. Declining assets under management not only reduces the earnings that active managers collect, but also the multiple at which the market is willing to capitalize those earnings. As the industry continues to struggle, active asset managers have seen their valuations and stock prices decline. And yet, active managers still hold trillions in assets under management. Active strategies aren’t going away any time soon. 

You wouldn’t know that from looking at certain asset managers. The heavy pessimism surrounding the active asset management industry has lead the market to price certain managers as if they will soon cease to exist entirely. A prime example is Manning & Napier, Inc.

By any benchmark, Manning & Napier is an extraordinarily successful manager. Founded in Rochester, New York in 1970, the firm grew its AUM to a whopping $50 billion by 2013. At one point, the firm’s flagship large cap equity fund beat the S&P 500 for 11 years running. M&N went public in 2011 with a slightly unusual structure. Manning & Napier, Inc. owns a minority interest in the underlying management company, Manning & Napier Group, LLC. In 2011, M&N, Inc.’s ownership in the management company was 13.2%. It has since increased to 18.2% as owners of the management company have converted their interests to shares of the public company over time. 

Unfortunately, the IPO represented the high point for Manning & Napier and its investors. Soon after, the performance of the company’s largest and most important funds began to suffer. The redemptions started coming and they haven’t stopped since. From the peak in 2013, AUM has now declined by more than half to $23.1 billion at September 30, 2018. Over the last five years, Manning & Napier shares are down nearly 90%.

Today, M&N appears to be a mere $25 million market cap speck. In truth, the company is a little larger. Remember that M&N owns only 18.2% of the underlying investment manager. On a full ownership basis, the market is valuing the entire manager at $138 million. 

An investment manager with $23.1 billion under management for $138 million. That’s a value of 0.6% of assets under management. That’s low, even for a shrinking company in a despised industry. By way of comparison, Hennessy Advisors is valued at 1.4% of AUM and Silvercrest Asset Management Group is valued at 0.9% of AUM. But that’s not the whole story. Turns out Manning & Napier has a wealth of cash and securities on its balance. The only meaningful liabilities besides normal payables is an $18 million tax liability which will come due over time as the company continues to exchange its shares for additional ownership in the underlying manager. Cash and securities, net of the full tax liability equals $128 million. That makes M&N’s actual market value something close to $10 million. That’s right, $10 million or a mere 4 basis points of AUM buys you $23.1 billion in AUM. 

So what’s the catch? There’s got to be some horrible issue facing Manning & Napier. An SEC action, maybe litigation by former employees? No and no, but the company does have some serious cost issues. With half the AUM it once had, it seems M&N has had difficulty cutting costs to match its new reality. And that has had a terrible effect on operating margins. In 2015, the company earned $129 million in EBIT on revenue of $138 million for an operating margin of 40%. In 2017, EBIT declined to $52 million on revenue of $202 million for a 26% margin. Through the first three quarters of 2018, EBIT has continued to plunge far faster than revenues. 

I understand Manning & Napier’s reluctance to let go of long-time employees and its desire to maintain a robust infrastructure in hopes of a turnaround. But at some point, there must be a reckoning. The last quarter’s EBIT margin dipped to 11%, and it could go negative in the fourth quarter given the market’s path these last few months. Again, for comparison, Hennessy Advisors put up a 45% operating margin this year, and Silverspring did north of 20% this last quarter. Slightly different models, sure. But the point remains there’s no excuse for earning so little on the revenue stream from over $20 billion in AUM. The glory days are over. They may come again, but for now it’s time to tighten the belts a few inches. 

Manning & Napier appears exceptionally cheap, but investors must be comfortable with the risk that the company fails to address its AUM slide or failing that, cannot address its cost issues. On the other hand, solving one or both of these challenges could result in a massive upswing in profits and equity value. 

Alluvial Capital Management, LLC does not hold shares of Manning & Napier Inc, Hennessy Advisors, or Silvercrest Asset Management Group. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

Alluvial Capital Management, LLC manages a value investing partnership, Alluvial Fund, LP. If you are a qualified investor and would like more information, please contact us at info@alluvialcapital.com or visit alluvial.capital.

Checking In With a Few Ideas

Checking in! Once again, life gets in the way. My wife and I welcomed a baby girl in September. (Everyone is doing very well!) And of course, Alluvial Fund keeps me very busy. But the search for value goes on, and I’d like to share a few interesting companies I’ve happened upon. These are only vignettes, but you may find them intriguing enough for further due diligence.

Societe Marseillaise du Tunnel Prado-Carenage SA – Euronext Paris: SMTPC

I’m a bit of an infrastructure nerd. I’ve always been fascinated by bridges, tunnels, ports, canals, pipelines, transmission assets, the list goes on. Even better when these assets are publically-listed! The grandly named Societe Marseillaise du Tunnel Prado-Carenage SA is a shining example. SMTPC holds the concession on the 2.5km tunnel linking the A50 motorway in Marseille with the A55 motorway. This critical tunnel saves motorists time, allowing them to duck under the ancient, winding streets to the hilly south and east of the city.

SMTPC holds this concession until 2025. The present value of conservatively estimated profits from now to the end of the concession, plus balance sheet net working capital, appears to be substantially higher than SMTPC’s market capitalization. The company pays substantial dividends, yielding 10.7%.

An important question for investors concerns SMTPC’s plans following the end of the concession period. The obvious path for the company would be an orderly liquidation, but perhaps the company has other plans. It could bid on brand new tunnel or bridge concession projects, though these seem to be few in number in France. It could attempt to purchase existing concessions, though they would face serious competition from much larger infrastructure investors like pension funds and insurers.

There is also the question of competition. Apparently, the Prado-Carenage Tunnel is known for high tolls and traffic jams. In October, the long-planned L2 North roadway opened up, allowing drivers a free means of avoiding central Marseille. It remains to be seen just how much revenue this costs SMTPC. Certainly some, but perhaps less than expected if the new roadway quickly becomes over-burdened and slow.

Brickworks Limited – Australian Stock Exchange: BKW

A brick company! What could a boring value investor like more than that? After all, mankind has been using some variety of bricks for several thousand years with no end in sight. Brickworks is a brick manufacturer, but it’s also a lot more. Thanks to a lucky and/or skillful investment made in the late 60s, Brickworks owns a sizable interest in one of Australia’s oldest and most successful holding companies: Washington H. Soul Pattinson. WHSP is listed on the Australian stock exchange under the ticker “SOL.”

Here’s where a dowdy basic manufacturer gets interesting. Brickworks is valued at less than its stake in WHSP. Brickworks’ market capitalization is AUD 2.55 billion, while its 42.72% ownership in WHSP is worth AUD 2.70 billion. Brickworks also has property interests worth more than AUD 500 million, let alone its namesake building products segment. In 2017, the building products segment produced operating income of AUD 76 million. A conservative 6x operating income would value the segment at AUD 456 million.

Based on these very simple estimates, Brickworks appears to be worth at least AUD 3.70 billion, quite a lot more than the company’s value in the market today. Lately, the company has increased its investment in US brick manufacturers. Brickworks sold off some WHSP shares to fund the deals. Despite the share sales, the value of the company’s holdings in WHSP will continue to be by far the largest driver of Brickworks’ value.

Mechanics Bank of Richmond – OTC: MCHB

It’s no secret that I like very high-priced stocks. Not a lot of retail investors are willing to pony up for shares with five digit dollar price, and that results in lower valuation. One such stock is Mechanics Bank of Richmond. Mechanics Bank is a $6 billion institution located in Southern California.

In 2015, Ford Financial Fund purchased a controlling interest in this venerable bank. Ford Financial is run by Gerald J. Ford, an extremely successful investor in banks and other financial services companies. Mr. Ford has a history of stewarding banks to greater profitability and scale before orchestrating a sale at a large premium. This is exactly what will happen to Mechanics, eventually.

Since the takeover, Mechanics has acquired two local competitors and has grown its balance sheet from $3.6 billion to over $6 billion. I don’t know how large Mr. Ford and his lieutenants expect to grow Mechanics before seeking an acquirer, but I do know that they have made progress and will make more.

US banks with $5-10 billion balance sheets trade have a median valuation of 1.3x book value. Mechanics trades at about 1.05x book value. A sale at even 1.5x book value would fetch over $45,000 per share. Whether a sale happens in 2019 or it takes a few more years, I fully expect to earn a healthy profit on shares of Mechanics Bank.

Alluvial Capital Management, LLC holds shares of Mechanics Bank of Richmond for clients. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.