AB - AllianceBernstein

[WeiChiLoh]

Unlike my first post, I have not done up a valuation for AllianceBernstein just yet, mostly because I am still trying to understand the asset management industry economics. But it would be awesome if you guys can give some input to my idea.

 

Business Economics

 

AllianceBernstein provides investment services, such as fixed-income or equity funds, to a wide array of clients(institution and retail).

 

1. A huge portion of the company's AUM is derived external of the United States, such as SEA and China.

 

2. AllianceBernstein, a private limited partnership, is not subject to federal or state corporate income taxes, but is subject to a 4.0% New York City unincorporated business tax. Separate state and local income tax returns also are filed. Given this, the company has a tax rate below 7%.

 

3. AllianceBernstein pays out all of its cash flow, as a dividend to shareholders, which explains the high 6.7% dividend.

 

Considering how the company derive its cash flow from AUM and the cash flow translate to dividends. Projecting the future AUM, would in turn project the dividend growth rate.

 

Industry trend

 

1. http://www.iciglobal.org/pdf/icig_per01-01_exec_summ.pdf

 

From the research report above, there is an exponential correlation between GDP per capital and long term mutual fund assets % GDP. This make sense to me as when an economy grows, people become more well-off and will have more disposable income to deploy to other places, such as in their retirement, or investment. This is good for AllianceBernstein as they derive a good portion of their AUM from these regions where GDP growth is projected to be robust going forward. They will benefit not only from GDP growth, but also % invested in mutual funds, a double whammy.

 

At the same time, because of the nature of the asset management industry, incremental AUM capital do not require much incremental expenses (they dont need to hire 10% more staff with the company received 10% more AUM). What this means is that return on incremental AUM would be very very high.

 

Thus, if this idea plays out as expected, long term cash flow generation growth will be very healthy, and thus so will dividend growth.

 

What do you guys think? Can anyone chip in their thoughts?

[WeiChiLoh]

Could this be like British Tobacco (albeit more volatile) in the year 2000?

[cobafdek]

The usual market valuations of asset managers is 2-4% of AUM, although some high-powered private equity asset managers can command up to 10% of AUM.  Given AB's latest reported AUM of $480B, if the market valued it at a conservative 2%, market value would be $9.6B.  Current market value of AB is $26B, so it is selling at about 6% of AUM.  Therefore, it is probably already fairly valued, if not overvalued.

[WeiChiLoh]

@cobafdek

 

Hi and thanks for your comment. Why do you use % of AUM and not just simpler metrics such as P/E? Won't different asset managers have different strategies and products offering, which would impact fees generation? I.e. private equity focused fund has a very different dynamic from public equity focused fund.

[Packer16]

The issue with AB is flat to declining AUM and revenues.  Over the past 5 years, revenues have declined by single digits per year on average.  Based upon Graham's formula of 8.5 + 2G, even if the decline is reduced to zero this is overvalued by 40% (current P/E of 12 divided by formula P/E of 8.5).  Cash flow hit bottom in 2012 and has bounced back some since but the question is can AB generate growth going forward given its decline in the past.  In the AM world, it has been historically difficult to turn around a declining AUM firm.

 

cobafdek is correct that this is priced high for an traditional AM based upon AUM and is priced closer to an alternative AM that includes a carry component.  The reason % of AUM is used because this is how acquisition multiples are though of.  The other key parameters are fund inflows and outflows and asset mix. 

 

Packer

[cobafdek]

Using % of AUM, perhaps ironically, is simpler to appraise asset managers, but it can also be derived from a more conventional investment arithmetic.  The revenue of mutual funds is their fee they charge on total assets.  In a base case for a generic asset manager/mutual fund company, let's say that top-line fee is 1/2 of 1%.  Then subtract expenses of 60% to get operating income.  10X operating income gets you to that 2% figure. 

 

Another way of confirming AB's probable over-valuation is to invert this calculation.  The current market value of approximately $26B is about 6% of AUM.  By reverse-engineering the above formula, the market is implying that AB could command a fee of 1.5% to manage it's customers's funds.  I haven't looked into any of the prospectuses of AB's mutual funds, but I recall they are primarily fixed-income funds.  A fee of 1.5% on bond mutual funds would be considered way-over-priced by John Bogle and everyone on this message board.

[WeiChiLoh]

@Packer16

 

This is very insightful. Thank you. A couple questions though, if you don't mind.

 

1) You stated that AB has declining AUM and revenue for the last 5 years. I don't really see that. AUM and revenue in 2009 is $486.7B and $2.9B respectively while for the LTM, $480B and $29.2B. Also, I believe that Graham's 8.5+2G formula don't take into account the low interest rate environment that we are in right?

 

2) Why is it hard to turn around a declining AUM firm? Are there any specific reasons?

 

3) How would inflow, outflow and asset mix affect valuation?

[WeiChiLoh]

@cobafdek

 

Ah, since you put it that way, it makes much more sense. I will definitely incorporate that in my valuation.

[WeiChiLoh]

Using % of AUM, perhaps ironically, is simpler to appraise asset managers, but it can also be derived from a more conventional investment arithmetic.  The revenue of mutual funds is their fee they charge on total assets.  In a base case for a generic asset manager/mutual fund company, let's say that top-line fee is 1/2 of 1%.  Then subtract expenses of 60% to get operating income.  10X operating income gets you to that 2% figure. 

 

Another way of confirming AB's probable over-valuation is to invert this calculation.  The current market value of approximately $26B is about 6% of AUM.  By reverse-engineering the above formula, the market is implying that AB could command a fee of 1.5% to manage it's customers's funds.  I haven't looked into any of the prospectuses of AB's mutual funds, but I recall they are primarily fixed-income funds.  A fee of 1.5% on bond mutual funds would be considered way-over-priced by John Bogle and everyone on this message board.

 

Also, isnt AB market cap 2.6B not 26B? That would make it 0.55% of AUM.

[cobafdek]

D'oh!!! Embarrassing on my part!  Didn't have my glasses on - terrible excuse!  Thanks for the correction.  So it is probably not over-valued, but I would say maybe fairly-valued.

[Tim Eriksen]

 

Also, isnt AB market cap 2.6B not 26B? That would make it 0.55% of AUM.

 

You might want to spend a bit more time on the ownership structure.  From what I can tell, AB Holdings only owns a portion of AB.  Thus reported market cap as a % of AUM is not accurate.  CLMS has a similar issue.   

[cobafdek]

Also, full net asset value of these asset managers is book value + %AUM.  So I may be way off my initial cursory impression, and not just from my careless decimal point placement.

 

Great job so far with your research!  Let us know your conclusions. 

[Packer16]

The market cap AB is $6.6B fully diluted (268.4 m units of which 96m are traded as AB).  The last Q AUM is $454.1 billion so we are at 1.5% of AUM. 

 

Given the flat to down trend of AUM, they are actually losing assets as the markets are all higher than the starting point.  If they had no additions or withdraws, they would be up by the market return.  The firms that have been in a similar situation include Janus, Pzena, Federated and Legg Mason.  None of these firms revenues have recovered to pre-crash levels.  It is hard to turn around due to some key trends including indexing where the fees are much lower and declining asset fee as a % of AUM.  The mix effects it because of the differing fees for the type of asset managed.

 

I think Graham's formula does account for low interest rates because it was published in the early 1960s right after a period of low interest rates.  The LT gov't bond rate was about 4% (similar to today).  I have seen an adjustment for higher interests though.   

 

Packer

[topofeaturellc]

I can't help you with the valuation or if this is good investment idea ...the only manager's story in Packer's peer group list that might be close is Janus, although Janus' performance was really flash in the pan tech bubble, while AB is basically two boutiques that date to the 60's (Bernstein) and 70's (Alliance).

 

But I would suggest you read a bunch of 10-k's before you worry about what its worth.  Its been quite a thing to see - they've gone from 360 bln in institutional equity assets to 30 over the last 6 years or so.

[WeiChiLoh]

The market cap AB is $6.6B fully diluted (268.4 m units of which 96m are traded as AB).  The last Q AUM is $454.1 billion so we are at 1.5% of AUM. 

 

Given the flat to down trend of AUM, they are actually losing assets as the markets are all higher than the starting point.  If they had no additions or withdraws, they would be up by the market return.  The firms that have been in a similar situation include Janus, Pzena, Federated and Legg Mason.  None of these firms revenues have recovered to pre-crash levels.  It is hard to turn around due to some key trends including indexing where the fees are much lower and declining asset fee as a % of AUM.  The mix effects it because of the differing fees for the type of asset managed.

 

I think Graham's formula does account for low interest rates because it was published in the early 1960s right after a period of low interest rates.  The LT gov't bond rate was about 4% (similar to today).  I have seen an adjustment for higher interests though.   

 

Packer

 

Very interesting. From another perspective, given the massive 5 years total market bond inflow, the fact that AB (operating mainly in fixed-income) posted slightly negative AUM growth is a sign that AB is actually losing market share in the asset management industry. If we see a macro shift out of bonds, perhaps when the forward curve continues to steepen and the fed tapers, AB will be impacted asymmetrically bad. What do you think?

[topofeaturellc]

AB isn't a FI manager. Its a broken Equities manager.  The business still isn't stable.

[Spekulatius]

Also, full net asset value of these asset managers is book value + %AUM.

 

I don't think there is a reason to add book value to AUM. Book value could be intangibles,  which aren't really worth anything in liquidation. One could add excess cash after subtracting debt or other excess assets to the %of AUM but that is about it.

[cobafdek]

I can't help you with the valuation or if this is good investment idea ...the only manager's story in Packer's peer group list that might be close is Janus, although Janus' performance was really flash in the pan tech bubble, while AB is basically two boutiques that date to the 60's (Bernstein) and 70's (Alliance).

 

But I would suggest you read a bunch of 10-k's before you worry about what its worth.  Its been quite a thing to see - they've gone from 360 bln in institutional equity assets to 30 over the last 6 years or so.

 

 

 

topofeaturellc, I liked the longer version of this post better.  Your personal anecdote perspective was more interesting reading than a bunch of 10Ks.  I guess I was lucky to have seen it while it was up for the brief ?10 minutes.  I wish I could read it again!

[cobafdek]

Also, full net asset value of these asset managers is book value + %AUM.

 

I don't think there is a reason to add book value to AUM. Book value could be intangibles,  which aren't really worth anything in liquidation. One could add excess cash after subtracting debt or other excess assets to SUM but that is about it.

 

 

It depends.  If they've been managed well, they may have earned even more than the carry.  But if, as topofeaturellc is indicating, they've really bungled it, then you are right and AB needs to amortize more than what they have already.  AB still carries about $3B in goodwill, out of $4B in total book. They do report tangible BV of $3/share.

[topofeaturellc]

Thanks - but it isn't really my story to tell.

 

Yeah - BV not so meaningful for an AM. It doesn't represent a residual claim on productive assets so much as historic purchase accounting (as shown by the fact that Tang Book is de minimis and is mostly working cap and furniture.  The value of those intangibles is inextricably linked with the firms acquired, and if you were to liquidate the business the actual entities that produce the cash flows of those firms - the people who work there - will just walk out the door.

[Packer16]

The person I first heard this formula from was Martin Whitman.  He meant tangible book value (see page 106 of Value Investing) as the value of the AM intangible is captured in the value as a % of AUM.  In some cases TBV can be substantial as in the case of some of the alt AM's like Oaktree and KKR or AM who have brokerages attached (rarer today than in the past).

 

Packer

[cobafdek]

The person I first heard this formula from was Martin Whitman.  He meant tangible book value (see page 106 of Value Investing) as the value of the AM intangible is captured in the value as a % of AUM.  In some cases TBV can be substantial as in the case of some of the alt AM's like Oaktree and KKR or AM who have brokerages attached (rarer today than in the past).

 

Packer

 

 

Same here.  Nice to hear someone else survive Whitman's turgid prose.  I don't know how you did it, but for me it was extremely well-worth it.  That book came out in 1999, so his memory must have been fresh regarding Third Ave Value's purchase of several broker-dealers a few years prior.  I was reading his shareholder letters then, and I recall the names of Raymond James Financial, Legg Mason, Piper Jaffray, and Alex Brown (coincidentally, the latter had the ticker symbol AB back then, now held by AllianceBernstein.)

 

2% AUM of these companies covered the market cap of these companies, so the rest of each company, which included non-money-management arms such as brokerage operations) was free.  Tangible book was substantial, no debt, and selling at PE's of 5.  I bought Raymond James and sold later as my one and only 10-bagger (it pains me to look it up today and see it has gone further as a multi- multi-bagger.).  The others likewise are multi-baggers, and Alex Brown was taken out similarly.  They were also small-mid caps.

 

Different environment then:  not only Internet/tech bubble, but also Glass-Steagall repeal era, so that money center banks were looking for money management/mutual fund acquisitions.  Whitman emphasized they had to have client persistence and client growth.  All qualities maybe lacking with latter-day AB.