HNNA - Hennessy Advisors

[Tim Eriksen]

Hennessy Advisors, Inc. is a publicly traded investment manager offering primarily domestic equity mutual funds.  Many of the funds are quantitative with yearly rebalancing.  Others are sub-advised.  AUM is $6.5 billion. $2.5 billion in Focus fund, $1.4 bn in Gas Utility, and $1.2 bn in MidCap 30.  Five other funds between $100 million and $300 million in AUM.  Current price is $28.40 with 5.1 million shares outstanding.  Market Cap $146 million.  EV is $171 million  EV/EBITDA 6.8.  Company has used debt to make acquisitions, such as FBR, and for a tender offer in 2015.  Current debt is $30 million at 4%.  Great operating margins of 45%, after tax margins are 29%.  Annual net income is $15 million or $3 per share.  Cash earnings are a bit higher due to $1 million of savings because they can amortize the cost to purchase management contracts. 

 

Short term Catalysts: as a full tax payer they would get a huge benefit from potential decrease in corporate income tax rate.

Long term catalyst:  CEO is 60/61 so may sell in five years.

Risks: Active management is seen as in decline.  AUM could be quick to leave if performance waned.

 

note: second best performing stock I have ever owned as I bought in 2012 starting at $2.50 per share.

[KJP]

The negative flows in their funds are concerning, given the operating leverage of the business model.

[stahleyp]

HFCGX (I believe it was their largest fund - before they took over the FBR funds) was a tremendous performer at one time. It beat the market handily. It's been atrocious the past decade.

 

There are a lot of headwinds with funds like this though. Margin pressures and performance are some. Also, the fiduciary rule is another. I'll be interest to see how these "no transaction fee" funds do - from a sales perspective- once that is implemented (assuming it stays like it is). Asset management is a great business though. If I had to guess, the future will not be as great but still good.

[rb]

I don't want to rain on the parade because I appreciate what Tim is doing here by posting his ideas.

 

There are a number of asset managers that are attractively priced. However I think that the industry is at a cyclical top. As markets top out. Fund outflows invariably follow. In this space I think I'd be looking at BEN. Much bigger and a little pricier but they have very good distribution.

[KJP]

I appreciate what Tim is doing here by posting his ideas.

 

Same here

[stahleyp]

With loads probably going away (or be vastly different) how do you feel about Frankin's distribution? A lot of these asset managers are trading at seemingly attractive levels. I'd be surprised if a lot of them will be around in 10-15 years. Though a lot of clients might stick around due to inertia. I do not think it is nearly as attractive business model with so many folks being internet savy and DOL.

[Tim Eriksen]

I don't want to rain on the parade because I appreciate what Tim is doing here by posting his ideas.

 

There are a number of asset managers that are attractively priced. However I think that the industry is at a cyclical top. As markets top out. Fund outflows invariably follow. In this space I think I'd be looking at BEN. Much bigger and a little pricier but they have very good distribution.

 

I historically have liked BEN.  I once worked for them 20+ years ago.  I recently sold even though the valuation in terms of PE net of cash is low because of the higher fixed income exposure.  I think BEN needs to be more aggressive on its repurchase.

[StevieV]

Asset management has traditionally, I believe, been a good business.  US markets have gone up about 10% a year.  So, without any inflows, you get 10% growth in a year.  That's better than the tailwind growth of most companies.

 

I like and own several alternative asset managers.  They have capital locked-up for various terms.  Also, they provide exposure that can't be found easily in an index.  For example, I don't believe that the Blackstone (BX) real estate operation or the Apollo (APO) private equity operations are easily replicated in an index.  They also generally have traded at favorable valuations for any of a number of reasons (K-1; variable distribution).

 

I have some concerns about traditional asset managers.  Passive management is a big wave, and I think it has some room to run.  The loss of assets plus the fee pressure makes a significant headwind right now.

 

I like the Hennessy approach, but see elsewhere in this thread that it hasn't performed lately.

 

I hadn't thought about the fiduciary rule, but that might be something.  I don't know how most people come to the funds - through advisors or by themselves.  Also, really too early to tell how it will affect things.  FWIW - I don't think putting someone in the Hennessy fund would violate any type of fiduciary duty.  The question is more of how advisors could react.  Would they see the Hennessy fund as a risk they don't want to take?

[rb]

With loads probably going away (or be vastly different) how do you feel about Frankin's distribution? A lot of these asset managers are trading at seemingly attractive levels. I'd be surprised if a lot of them will be around in 10-15 years. Though a lot of clients might stick around due to inertia. I do not think it is nearly as attractive business model with so many folks being internet savy and DOL.

I think that the death of active management is highly overhyped. People need a lot of hand holding and have a need to feel safe.

 

Internet savvy doesn't really play a big part. More around the margins. For some reason ordinary people have some sort of allergy when it comes to educating themselves about financial matters (CoBF doesn't count. We're kinda freaks about this stuff). It's something I never understood. People are willing to spend countless hours researching a $800 TV but put very little research when making a $20,000 investment.

 

I agree that the industry may look different 10-15 years from now though. The fee structures definitely need adjustments.

[Tim Eriksen]

fund performance is good.  Based on Morningstar ratings:

 

One fund with 5 stars - Japan Small Cap.  29 million of AUM

Five funds with four stars - Focus, Gas Utility, Equity & Income, Small Cap Financial, and Japan.  4.6 billion of AUM

Four with 3 stars. 1.6 billion of AUM

Five with 2 stars. 356 million of AUM

One with 1 star.  only 4 million of AUM

Hennessy_Funds_-_Fund_Prices__Performance.pdf

[Tim Eriksen]

One other thing I like is that their AUM is posted daily so there are no declining AUM or revenue surprises.  For the last quarter my estimate of Management revenues was off by just $1,500 on a $12 million figure.  That doesn't happen at other companies.  To only have to "worry" about accurately projecting the expense side versus both revenue and expense is nice. 

[rb]

I don't want to rain on the parade because I appreciate what Tim is doing here by posting his ideas.

 

There are a number of asset managers that are attractively priced. However I think that the industry is at a cyclical top. As markets top out. Fund outflows invariably follow. In this space I think I'd be looking at BEN. Much bigger and a little pricier but they have very good distribution.

 

I historically have liked BEN.  I once worked for them 20+ years ago.  I recently sold even though the valuation in terms of PE net of cash is low because of the higher fixed income exposure.  I think BEN needs to be more aggressive on its repurchase.

Tim, again appreciate where you're coming from and your initiative but someone decided to try and Make Canada Great Again! Lol all this greatness is too much. I may get sick of greatness.

[CorpRaider]

This is the guy/shop who bought the mutual fund from O'Shaugnessy (from What Works on Wall Street), as mentioned a lot by Greenblatt (he doesn't drop the names).  He doesn't strike me as the brightest crayon whenever I catch an interview, but he was smart enough to buy that nice quant midcap value model and stick with it.  Wouldn't be surprised that fund underperformed over the last 5 or so.  If it hadn't, I would be looking for style drift.  I think I like IVZ better.  Scared that if you have no ETF exposure or you are a dinosaur walking the earth.

[Tim Eriksen]

In a market where value seem hard to find, I am a bit surprised how poorly this stock has performed in 2017.  It is down over 20% even though AUM has increased and the company will benefit greatly from tax reform.  The stock is trading at about $16.30 per share.  EPS prior to tax reform was expected to be about $2.10 in 2018.  Not many stocks trade at 8x.  With tax reform EPS jumps to $2.56 per share.  That is a P/E of under 6.4x.  As best I can tell it appears that tax reform will still allow for the amortization of their management contracts.  If so that adds another $0.22 to annual cash earnings.  They are rapidly paying down debt from prior acquisitions and tenders.  Net debt at the start of the year was $25 million.  At the end of 2017 it should be about $8 million.  Their latest acquisition was funds from Rainier for just 85 basis points, or 1x revenue.   

[Guest Schwab711]

In a market where value seem hard to find, I am a bit surprised how poorly this stock has performed in 2017.  It is down over 20% even though AUM has increased and the company will benefit greatly from tax reform.  The stock is trading at about $16.30 per share.  EPS prior to tax reform was expected to be about $2.10 in 2018.  Not many stocks trade at 8x.  With tax reform EPS jumps to $2.56 per share.  That is a P/E of under 6.4x.  As best I can tell it appears that tax reform will still allow for the amortization of their management contracts.  If so that adds another $0.22 to annual cash earnings.  They are rapidly paying down debt from prior acquisitions and tenders.  Net debt at the start of the year was $25 million.  At the end of 2017 it should be about $8 million.  Their latest acquisition was funds from Rainier for just 85 basis points, or 1x revenue.   

 

I've been trying to look at HNNA lately. Some of the things I don't like:

1. Considering the market returns in the past few years, HNNA has negative organic AUM flux. At 2% of AUM, I figure they will need to spend around 50% of FCF to maintain AUM, assuming flat markets and no change to past AUM flows. A downturn in the markets could hurt, but the tax plan certainly helps with that in the short-term.

2. I'm not sure the asset management industry will get much benefit from the corp tax rate change. There are essentially no barriers to entry and they are no longer limited by geography to the degree they used to be. I expect a large % of the tax cut to be competed away by some means (e.g. increased negative flow if fees stay unchanged).

3. Management increased share issuance to themselves as the stock has fallen, which makes me somewhat concerned that they will slowly transfer ownership of the company to themselves.

4. Assuming the trends mentioned in #1 hold true, I think ~$10m-$12m normalized FCF is closer to minority shareholder earnings power, with the new tax rate. Either way, my 1 standard deviation of expected FCF is a high % of expected normalized FCF. So even at 10x-11x FCF, the risk seems really high compared with some OTC banks trading at roughly the same valuations as HNNA (and much lower stnd devs, as one example of alternative investment options).

 

I'm interested if you agree/disagree with any of this and why

[Tim Eriksen]

In a market where value seem hard to find, I am a bit surprised how poorly this stock has performed in 2017.  It is down over 20% even though AUM has increased and the company will benefit greatly from tax reform.  The stock is trading at about $16.30 per share.  EPS prior to tax reform was expected to be about $2.10 in 2018.  Not many stocks trade at 8x.  With tax reform EPS jumps to $2.56 per share.  That is a P/E of under 6.4x.  As best I can tell it appears that tax reform will still allow for the amortization of their management contracts.  If so that adds another $0.22 to annual cash earnings.  They are rapidly paying down debt from prior acquisitions and tenders.  Net debt at the start of the year was $25 million.  At the end of 2017 it should be about $8 million.  Their latest acquisition was funds from Rainier for just 85 basis points, or 1x revenue.   

 

I've been trying to look at HNNA lately. Some of the things I don't like:

1. Considering the market returns in the past few years, HNNA has negative organic AUM flux. At 2% of AUM, I figure they will need to spend around 50% of FCF to maintain AUM, assuming flat markets and no change to past AUM flows. A downturn in the markets could hurt, but the tax plan certainly helps with that in the short-term.

2. I'm not sure the asset management industry will get much benefit from the corp tax rate change. There are essentially no barriers to entry and they are no longer limited by geography to the degree they used to be. I expect a large % of the tax cut to be competed away by some means (e.g. increased negative flow if fees stay unchanged).

3. Management increased share issuance to themselves as the stock has fallen, which makes me somewhat concerned that they will slowly transfer ownership of the company to themselves.

4. Assuming the trends mentioned in #1 hold true, I think ~$10m-$12m normalized FCF is closer to minority shareholder earnings power, with the new tax rate. Either way, my 1 standard deviation of expected FCF is a high % of expected normalized FCF. So even at 10x-11x FCF, the risk seems really high compared with some OTC banks trading at roughly the same valuations as HNNA (and much lower stnd devs, as one example of alternative investment options).

 

I'm interested if you agree/disagree with any of this and why

 

1.I probably don't share as pessimistic view on the overall market.  I understand looking at it the way you do but I consider a flat AUM without the need to do additional acquisitions as most likely, a down side scenario of a 20% market correction, and even an upside of a fund catching fire or the market going higher (10 to 20% increase in AUM).  Outflows have always been a problem for HNNA except from 2013 to 2015 after the FBR acquisition when a few funds caught fire.

2. I don't expect tax reform to result in firms lowering their fees by ~20% in order to try and win additional assets.  Going from 80bps to 60bps is not the determining factor for actively managed funds. Past Performance is what draws in buyers.  Unlike banks they do not need to raise salaries.   

3. Since stock comp is based on dollars they would get more shares when the share price is lower and less when it is higher.  Is what it is.  I don't see management trying to take control since they participated in the tender offers on a pro rata share. 

4. I am not that pessimistic.  At current AUM levels they should have $23 million of annual FCF, I don't expect them to need to spend half to maintain AUM.  If they do need to, then the stock is just under fair value.  If they don't it is half of fair value.

I appreciate the thoughts.  It makes me think through potential scenarios.

[valuedontlie]

Tim,

 

Any updated thoughts on this name? Down significantly again this year and looks interesting given the net cash position and lower tax rates... They  also made a small-ish acquisition after yearend which should add another $215m in AUM.

 

On the flip side... their website shows AUM (as of 12/4) at $5.6bn compared to $6.2bn as of 9/30 and $6.6bn average AUM for FY18... part of the trouble inherent in asset management businesses...

 

 

[aws]

It's definitely an interesting proposition if revenues are stable in the coming year, but that may be a tall order.  AUM down to 5.3 billion now which according to the prior poster is 300mm less than a week ago, although some of that may have been influenced by very large capital gains distributions on their funds (about 25% of net assets) if not all were reinvested. 

 

The entire book net worth of the company is in management contracts which they do not amortize, so if the declines continue there should be big write downs, perhaps eliminating GAAP net income.  The carrying value now seems to be pretty close to what they just paid for that recent acquisition which is approximately 1.55% assuming flat AUM for a year (200mm of AUM for 1.6mm down + 0.75% of AUM after 1 year).  At 9/30/18 management contracts at 78 million represented 1.26% of the 6.2B in AUM.  Today if you add the 3.1 million they paid for the new acquisition and divide by current AUM that would be 1.53% of AUM.

 

I'll definitely be watching the AUM on their website like a hawk, as if it stabilizes or better yet starts to tick up this could be an amazing value.

[valuedontlie]

Looks like average fees have moved up over the years... Last time they had ~$5.3bn in AUM they were generating less than 70bps but today looks like ~82bps...

 

Say AUM drops another 20% from here = $4.3bn AUM x 80bps = $35m revenue... if you assume comp + G&A is fixed ($18.8m) but sub-advisor fees are variable, then could be $25m in total expenses or $10m in EBIT... less $1.2m interest and 25% taxes = $6.6m net income or $0.85/share...

 

I actually like the product lineup... have owned HJPSX for years... better set of funds than a plain-vanilla large cap value fund...

 

 

[aws]

Quarterly results were out this week and down quite a bit as you would expect.  AUM down about 3-4% relative to the general market based on my reading at the end of last year vs. today.  Certainly doesn't seem incredibly cheap right now, but if they could go another year without any substantial drop in AUM plus catch some of the tailwind from a rising market it could get cheap quickly.  I guess a super simple way to value it would be just whatever they would pay for the amount of AUM they have right now.  Last purchase was at 155bps, and multiplied by the current AUM of 5.27b = 81.7mm.  Their current assets basically cover the current liabilities and debt, so no subtraction is needed for that.  And with 7.917mm shares outstanding x 11.10 current price you get 87.9mm market cap.

 

At this price I'll hang on to my small position and see what develops for their AUM throughout the year.  If it keeps dropping at 2% a month relative to the market I think I'd have to sell.

[valuedontlie]

still seems decently cheap to me... they earned $0.39/sh in the Q and avg assets were just under $5.6bn... current AUM within spitting distance of that figure which would put them on pace for $1.56/sh earnings for the year... trouble is they still fight outflows... they could be sitting in a $7-10m net cash position by end of this fiscal year...

[aws]

I agree that any day they are accruing management fees on $5b+ AUM is a good day.  And it would certainly be cheap if their average AUM for the full year is the 5.6b it was for their first quarter.  It's just not a slam dunk or anything as if they were to sell themselves on terms similar to the funds they've acquired it might have to be at around this price.  I looked back at the prior acquisitions and they are about the same on average:

 

2012 FBR acquisition was 2.2b at a cost of about 177bps

2016 Westport acquisition was 644mm at a cost of 175bps (although the assets disclosed being purchased at the time were a lot more than reported later - 644mm at purchase vs. 435mm reported additional AUM in later disclosures)

2017-18 Rainier acquisition was 375mm at a cost of 83bps

2018 BP acquisition was 200mm at a cost of 155bps

 

HNNA right now is trading at about 165bps and they have about zero net tangible assets as 100% of the book value is in the management contracts.  Let's just hope they don't lose assets faster than the market appreciation.

 

[aws]

I figured I would post a quick update as I have been tracking fund flows reasonably closely.  AUM is up about 6.5% since the end of last year, while the S&P is up about 11%.  I checked their 4 biggest funds which comprise about 70% collectively of AUM and those are up a weighted average of 10.8% YTD, so that points to about 4.5% organic net outflows in 10 weeks. Since 2/13 their AUM is down 1% and their average fund is up 0.8%.  So we continue to see organic net outflows in the range of almost 2% a month.  If that rate continued for a full year it would be extremely bad.

 

However I won't sell yet because HNNA is dropping fast enough to offset this.  On 2/13 the company traded at 165 basis points times their AUM, while today it's trading at about 151 basis points.  Even if the long-term value is eroding quickly, their current earnings will give them an amazing PE ratio and I expect if I'd need to sell I could find a better opportunity to do so.

[aws]

Anyone else follow this name?  It keeps getting cheaper to the point where I never really want to sell but I can't really justify adding anything to my position.  Outflows continue to be a pretty big problem and appear to be accelerating.  Over the past five weeks or so the S&P is up another 5%, but their AUM is down a tiny bit.  Maybe outflows are exaggerated a bit by people taking profits with the big run-up YTD, but if that reverses I'm not sure how confident I am in flows into their funds.

 

Their average AUM was about 5.2b for the quarter, down about 9% from prior quarter.  With slightly lower bonuses and sub-advisory fees I would expect they had an after tax profit in the 2.5 - 2.6mm range, or about 32 cents a share last quarter.  That's about an 18% decrease from a 9% decrease in revenues.  The leverage to the downside is quite a problem if organic revenues are going to keep declining by 2-3% per month.  Doesn't seem like a 7 P/E would be that cheap if the earnings are declining so much.  Still cheap on an AUM basis, which has been bouncing around a low of 138bp to 150bp or so.

 

How do you think this plays out?  I would think Neil would want to sell the business as soon as possible if he sees these declines as irreversible.  The decline in the value of his shareholding far exceeds the compensation he is getting from running the business.  His total compensation in 2017 was $4 million, down to $3 million 2018, and for 2019 should be under $2 million now with 35% of the bonuses going to the president and the much lower pretax earnings base.  Neil's stock at current market price is worth about $20 million which is down from over $50 million at the peak, so that is certainly eroding far more quickly than the money he is pulling out of the company. 

 

I guess we'll see what happens.  Hopefully there are some surprise inflows to things like their Japan fund, or dramatically lower expenses which help offset the lost income.

[stahleyp]

First, I don't think the decline in AUM is reversible. I say that for a few different reason. 1) information is way better now so people are buying index funds. Even advisors are putting their clients in index fund and shying away from active managers.

 

2) There is a squeeze on these guys from the fund supermarkets: https://www.forbes.com/sites/edwardsiedle/2019/03/05/fidelity-infrastructure-fee-wells-fargo-pension-rebates-intermediaries-enjoy-fund-payments/

 

This hurts their profits (because they pay more to the fund supermarkets...who are also being squeezed) and it makes it harder to lower expenses to compete with index funds. You're really behind a rock and a hard place.

 

3)  Markets are super efficient now. We're no longer in the Peter Lynch days. Why pay 1%+ for a fund that probably won't beat the market and pay more taxes due to turnover? This is becoming more and more known as time goes by.

 

4) even if they have lights out performance, people are still leaving active managers. The Japan fund has absolutely killed it...and it has a little over $150 million in it. That's not a big mutual fund.

 

Even Fidelity Growth Company which has killed it has lost assets:

 

https://www.nytimes.com/2018/05/27/business/fidelity-mutual-funds.html

 

Now, keep in mind Fidelity has a huge sales force, wonderful marketing and a long time manager at the fund. It still has lost assets (the fund is closed so I'm sure that affects things)!

 

Now, truth be told, I'm not sure how accurate these flow numbers are because a lot of 401ks are switching to commingled pools (which have a lot lower costs). So I don't think the numbers are as bad as the article is indicating but it's still surprising. Just the performance alone should be helping the fund growth nicely.

 

So the big question with HNNA, in my mind anyway, is when will the AUM bled slow down (I don't think it'll really ever stop for any long length of time). There are a lot of people who will hold until they die - regardless of performance. Now perhaps they'll have some killer performance and folks will come for a while (and then eventually leave again). I could see that happening because they'll always be performance chasers.

 

None of this, of course, takes in what happens to the business in a prolonged bear market. I have no position but have been thinking it over. There are certainly risks and I don't like it long term but it seems pretty cheap.

 

By the way, his compensation is absolutely disgusting for how bad the funds have performance and how small the company is.