FPS.ax - Fiducian Investment Service

[Baoxiaodao]

Let me know if you have any comments or questions. I will try my best to answer them. It is OK no one is interested in the idea. But the bottom line is, read the annual reports before you comment on this idea. Intelligent discussion is very welcome and appreciated.

 

The Business

 

Fiducian is a tiny asset manager listed in Australia since 2000, with 1.3 billion under management. Unlike many other asset managers, Fiducian is a one-stop shop where it starts from dealing with retail customers to managing investment. In other words, Fiducian does not rely on anyone for any of its corporate functions. For example, Fiducian has its own software developed internally to support its own salaried financial planners(FP). It costed 6 million to develop the software, yet it was carried on the book for only 200K. Despite the heavy cost incurred in the start-up stage, in the last decade, and since the first time Fiducian posted a meaningful profit of 430k, EPS has been growing at 17% compounded annually. The company was tested twice in the last 10 years, the tech bubble and the financial crisis recently. In all those years, Fiducian was profitable except for 2003.

 

The founders made it clear from the start that they want to be in charge of their own destiny by building Fiducian into an integrated financial service and asset management company. In the old days, Fiducian relied heavily on dealer groups to supply it with AUM. This year, 98% of the inflow was brought by its own FPs or franchised FPs, and only 15% of the AUM is from independent FPs. Adopting such a business model means the AUM will grow relatively slower than its competitors in good times, but AUM, once collected, tends to be much more stickier than the AUM from wholesale channels. Look at the charts below:

 

FPS AUM         ASX 200 performance

2003 -12%  -9.4%

2004 28%  16.7%

2005 29%         20.9%

2006 25%         20.2%

2007 29%         23.7%

2008 -6.6%   -20%

2009 -21.4% -24.7%

2010 16.3% 10.7%

2011 ?           12%

 

As we can see, FPS generated positive net inflows even in 2008 and 2009. In fact, 2003 would also see positive inflows if a dealer group did not withdraw 100 million.

 

One important implication of Fiducian's business model is its high profitability. FPS can be break-even with only 550 million under management. Last year, FPS generated 23 million revenue with 1.3 billion AUM. That is 1.75% of AUM. I have looked at major public asset managers with many times more AUM, but no one can even come close to this ratio. Most of them lose money upfront on acquiring assets and make it up by charging management fees later. FPS makes a profit bringing in assets.

 

On the investment management side, FPS is quite special as well. Unlike many other investment management companies, it does not hire expensive 'star' managers and incur astronomical compensation expenses. Instead, FPS is functioning as 'fund of funds' and 'manager of managers'. It uses in-house software to identify outperforming long-term funds and stick with them for a long time. By its own judgement, FPS also rotate from sector to sector to reduce volatility. The compensation expense is around 60 bps of AUM at the moment, compared to 20 bps for US public traded asset managers. It will improve over time as the AUM grows. Here are the links to the funds and managed account performance. I do not really know how the MorningStar ranking works, but the long-term record sounds good.

 

http://www.fiducian.com.au/fundsmgmt_mpreturns.htm

http://www.fiducian.com.au/fundsmgmt_ffreturns.htm

 

As any other asset management business, it requires very little incremental capital to grow.

 

The People

 

Just like insurance industry, the investment management industry tends to magnify the significance of management's capability and integrity, especially the later since the operating leverage is tremendous. More often than not, the value created is distributed mostly to insiders, rather than shareholders. I still remember many years ago we were discussing BKF capital where the insiders were taking out as much as they can. FPS seems to be the case quite the opposite.

 

FPS has a track record to control expenses and deploy capital in a shareholder friendly way. I will let the numbers speak for themselves:

 

                Revenue  Operating Expenses      NPAT

2003 7.4%  48.9%                            N/A                                          Distortion due to an acquisition.

2004   9%      1%                            N/A

2005 26.6% 8.6%                            1000%

2006 19%             7%                              85%

2007 20%         9.6%                              48%

2008 7.6%           3.4%                            18.1%

2009 -22.9% -11.5%                            -47.7%

2010 6.7%         -1.3%                              25%

2011 ?             ?

 

The operating leverage here is very significant. CEO Indy Singh owns around 30% of the company and he is very disciplined. In his compensation agreement, he is entitled to receive 20% of annual salary as bonus under certain conditions. Although the condition was met the majority of the time, he rejected the entitlement every time. I think over the years, he has forfeited at least 500k in cash bonus. Whatever the motive, it is very rare to be seen in today's corporate world. Another thing is that the use of options. In the early days, when FPS first went public, it used lots of options. But as the business stabilizes, the use of options has become very rational. It has to be noted that the majority of the options issued over the years did not go to top management or the CEO, but to the employees. Almost unsurprisingly, the CEO is also the company's corporate secretary. And believe it or not, the state-of-the-art software was developed by the company's FPs! No wonder the expenses was controlled so well.

 

Basically there are three things management does with the FCF. First, FPS pays out around 50%-60% as dividend. Second, it buys back shares every year. Finally, it uses cash to do small, but very accretive acquisition. For example, FPS did not make a single acquisition during the go-go days before the financial crisis; when it did, it paid 550k for two businesses in 2009 and it brought 400k income the next year.

 

The Culture

 

Fiducian obviously takes the pride of its culture. Normally I do not pay attention to those kind of things, but it seems management is not doing lip-service here. Management considers that employees, investors, shareholders and staff as a big family and really takes care of them. Fiducian does not lay off people because the business is bad or profit is down; but when someone leaves the business voluntarily, it trains existing staff to take over the workload instead of hiring someone new. There are more details in the ARs, so I will skip this part.

 

Where we go from here?

 

I think there is fair chance that Fiducian will grow from a business into a franchise over the next 5-10 years, if it insists on doing business this way. The company is very small with a market capital of 47 million. So whatever the growth lays ahead, this is just a start.

 

On the surface, Fiducian is not a screaming buy. It will have 11 million in cash by the year end, and the EV is therefore 36 million. It earns 4.1 million last year, so the P/E is just under 9 times. However, buying an exceptional business at 9 times trough earnings is a big bargin. But there is more. In Australia, small companies do not report first and third quarter earnings. Instead, they give OCF and revenue in the mandatory disclosures. In the First Q(fiscal year in AU ends in June), revenue was up 18% and OCF shot up 62%! Considering OCF always exceeds earnings somewhat, it is very possible the run-rate earnings has grown to 6 million. If this is true, we are buying a truly outstanding business at a ridiculous 6x P/E.

 

When we combine an outstanding business, honest and capable management, efficient capital deployment and high operating leverage together, it will surely be an explosive force. There is simply no way the market will valuate this business at 6x P/E.

 

The Ultimatum Bull Case

 

If Fiducian can earn 6 million after tax this year and assume the AU stock market performed relatively well in 2012 and 2013, it has a chance to earn 10 million 3 years from now. And this projection is not heroic considering the historical performance of Fiducian. If we slap a 25x P/E to the earnings, Fiducian is going to worth 250 million plus the earnings it generates, which is 250+11(cash on hand)+24(earnings over 3 years). This is a 600% upside from today's price. Yet this is not the end of story. Fiducian has been actively buying its own shares over the years and it pays out a large dividend. If we reinvests all the dividend and let the share buyback works its magic, we could have substantially more upside.

 

Fiducian is also a very good acquisition target since PE shops are making more deals in AU. It has all the infrastructure in place and lots of expenses had occurred many years ago. Once the market capital reaches a certain threshold, Fiducian is ripe to be taken over. Although I prefer Fiducian goes alone, this is a real possibility.

 

[beerbaron]

What is the equivalent of EDGAR in Australia?

 

BeerBaron

[twacowfca]

Looks interesting, Fan.  What's especially interesting is that they seem to have a shareholders orientation.  Many asset managers use their shareholders as an ATM machine.  Does the CEO have substantial equity?  If not, it would be surprising that he would give up his bonuses.

 

Thanks for posting.  Blessings on you.

[Baoxiaodao]

What is the equivalent of EDGAR in Australia?

 

BeerBaron

 

www.asx.com.au

 

Search the announcement section. All you need is in there.

[Baoxiaodao]

Looks interesting, Fan.  What's especially interesting is that they seem to have a shareholders orientation.  Many asset managers use their shareholders as an ATM machine.  Does the CEO have substantial equity?  If not, it would be surprising that he would give up his bonuses.

 

Thanks for posting.  Blessings on you.

 

CEO owns just over 30% of the company. He has never sold a single year since the IPO and bought quite a few over the years. In the thesis I did not mention the FOFA and "opt in'' reform, and this is a big factor anyone should think hard before putting money in. I did my homework though.

 

FPS has its upside, but bear in mind this is a leveraged play. Always, always put that in mind. When revenue increases, profits will increase faster; but when revenue falls investors will be hit really hard as well. Do the homework before committing anything significant. This is actually a preliminary note written to friends, so make it a starting point of one's own analysis.

 

I want to say you are welcome but I do not post because of my generosity. Hopefully some of the big guys here like this one and move the stock up :P

[twacowfca]

Blessings on you, not necessarily because I think you have altruistic motives, but in recognition of the excellence of your well thought ideas, including the potential pitfalls.

[Baoxiaodao]

What I wrote after the half-year result is out. Hopefully I will not be blamed for the faulty analysis.

 

 

The half-year result came out a few days ago and you can see how wrong I was. Ironically, we still gained 10 percent in the last month and 5 cents in dividend per share is in the making. I called the company and talked with the CEO's son for an hour. Here is the update together with my recent thoughts on the situation.

 

To begin with, I was overly optimistic about the revenue growth. The past result showed FuM always outgrew the ASX200 index and this time there came an exception and it will not be the last one. It showed once again how dangerous it is to predict things based on past performance. ASX200 index was up 10% for the last half fiscal year in AU, but AuM only increased by less than 5 percent. However, revenue increased by 8.5 percent, and NPAT is up 21.1 percent. This is a good performance, but compared to the period between Jan-Jun 2010, there is nothing to be excited about.

 

There are a few reasons that FuM rose less than the index, which indicated a net outflow of the funds Fiducian is operating. The decisive factor is the majority of Fiducian's customers are still uncomfortable to overweight in equities. My impression after reading so many annual reports in AU is that, without the consideration of resource stocks(which I skipped reading), AU market is not an expensive one, especially in the financial services sector. The financial crisis is still overhanging, and the incoming FOFA and other reforms are depressing the valuations(more on this later). The interest rate is quite attractive(1 year yield 4.81%) and it is understandable why the public has not been driven into the stock market. The real estate market is red hot, and the public is widely expecting a correction.

 

So how will FuM and EBIT go from here? Despite the stuff I mentioned above, there are several factors that will cause FuM and EBIT go up in the coming months. Let's start from the internal initiatives. Fiducian just added 6 financial planners to its existing crew, and that is a 10 percent increase. It is very obvious the market is getting better and Fiducian is now expanding. I asked Jai Singh(CEO's son) if those FPs are all seasoned and with assets, he said some of them are. It takes at least 2-3 years for a new FP to be productive, so we will probably see 3-5% organic growth from this side. We also talked about the incoming reforms and when I expressed my view that it will be overall positive for Fiducian, he said I was very spot-on. It turned out that Fiducian has been trying to buy FP business at a very attractive price. In 2007, when the market at its peak, a FP business was valued at 4x revenue(peak). But now Fiducian is paying 2.25x revenue in a bad market. So for the one closed, it will bring 100k in revenue and Fiducian paid 225k. As Jai said, those revenue will fall directly to the bottom line. In his own words, those are "pure" EBIT. It is very interesting to see that Fiducian, while the majority of its business is in asset management, was shunned by a lot of investors because of the incoming legislation to the financial planning industry. So if we expect the second acquisition is of the same size of the first one, we will probably see 1.5-2% increase in EBIT. The third source of increase would be from the SMSF(Self Managed Superannuation Fund) offering. As I said in the previous email, Fiducian has built a software platform with a carrying value of only 220k. Fiducian will promote this service both internally and externally. In AU, most of the SMSF account will have to be serviced by an account. Fiducian's role is to take care of almost everything the account does and reduce the workload without going directly to the clients. A typical account will be charged 5000 per year, Fiducian's fee is only 2000, and the margin is very good. Jai would not breakdown the exact number, but those kind of revenues are recurring, just like a software company. Internally, Fiducian will charge the full 5000 to its own planners which will be passed onto customers. So as Fiducian rolling those offerings over, I am expecting it will add 1.5-2% to the growth of EBIT. Besides, those businesses will help the FP side by generating more referrals.

 

Even though Fiducian is doing a good job on its own, the fortune will be made only when the market condition improves. It is impossible to predict the market movements, but 5% per year over the next decade is possible given current valuation. The advance in FuM will be decided by another factor, which is investor's confidence. Once the market starts to go up dramatically, more people will put money in the equities, and therefore any upswings will likely to be amplified. Longer term, I still believe Fiducian should grow its FuM faster than the general market. Another thing which might be good for Fiducian is the high housing price. The housing price is so high that nobody is expecting a reasonable return from investing in housing. Therefore, there might be a time people will flee the housing market pour money into equities. But that is a big if. I just read on article on Business Week about stocks and I liked it very much. It asked a simple question: Stocks are for the long run, but for how long? There might be a protracted period where equities will return just nothing. It is very impervious to assume that AU market will repeat the gain from 2003-2007.  Low expectation is the key!

 

When take all those things into consideration, the bottom line is Fiducian is a very cheap stock and we are being paid 7 percent a year to just wait. In addition, I like the exposure to a country which is resourceful, fiscally disciplined, and open to immigrants. USD and EUR have their own problems and I have a hard time to have any faith in them. If AU market can go up 5% year, it is reasonable to expect earnings will go up 10%. With dividend, it is not heroic to project a 15-20% return down the road without much risk, assuming no multiple expansion.. Fiducian has demonstrated again and again it will use its capital precariously, and this make a huge difference in the long run. If we are lucky and AU market can repeat the days from 2003-2007 for the next 5 years, it would not surprise me the share price will shot to the moon.

 

There are two stock forums I visit often in AU. The first one is Aussie Stock Forum where almost every stock has a thread, while Fiducian does not have one. The second one is HotCopper, where Fiducian has a thread but nobody made a comment for a good 2 years until I went there. The entire financial planning industry in AU was surrounded by great uncertainty. People are trying to avoid everything about financial planning business. However, Fiducian makes the majority of its money from asset management, and any regulatory change will be absorbed using transfer-pricing internally. I really do not know how these changes can affect the profitability. The valuation of FP businesses is dropping like a stone, and this is a good time for Fiducian to make attractive acquisitions. That said, I like to be a contrarian at this moment and put my capital into this overlooked industry. As Jim Rogers said, buy stocks when it has a P/E of 8 and yielding 6%, and sell them when it has a P/E of 22 and yielding 2%. We are doing exactly that.

 

All the best,

 

Fan

[turar]

If the Australian real estate bubble pops, how much will it affect AUM for FPS?

[Baoxiaodao]

If the Australian real estate bubble pops, how much will it affect AUM for FPS?

 

It can go either way, but I would be cautious to call the real estate market a bubble. AU's real estate market is not the same as US's. For one thing, there are huge immigrants inflows every year from places like China. Those people are mostly not sensitive to housing price. Another thing people overlooked might be AU's mortgage rate is well above 7%. Compared that to real estate price and interest rate in Canada, you might be wondering what will happen to Canadians once the mortgage rate goes to over 7%. There is only one thing I am sure, it will not be a pretty.

 

Another thing I'd like to add is that I have watched AU's politics and policies for some time. Generally, things are not as corrupted and counter-productive as those in the US and CA. There might be patriots disagreeing with me, but it is only my personal opinion. I am very reluctant to buy any commodity or juniors directly due to my ignorance, so it might not be a bad idea to put money in a conservative business in a good country at reasonable price.

 

In the next 5 to 10 years, I have got a feeling this is really a time to be defensive. I was kind of exhausted nowadays thinking hard about how to protect the portfolio, and the only conclusion I can draw so far is to buy excellent business at reasonable price. Delti, Fiducian, SMT Scharf fit squarely in this category, and that makes me sleep better at night.

[beerbaron]

Another thing I'd like to add is that I have watched AU's politics and policies for some time. Generally, things are not as corrupted and counter-productive as those in the US and CA. There might be patriots disagreeing with me, but it is only my personal opinion. I am very reluctant to buy any commodity or juniors directly due to my ignorance, so it might not be a bad idea to put money in a conservative business in a good country at reasonable price.

 

In the next 5 to 10 years, I have got a feeling this is really a time to be defensive. I was kind of exhausted nowadays thinking hard about how to protect the portfolio, and the only conclusion I can draw so far is to buy excellent business at reasonable price. Delti, Fiducian, SMT Scharf fit squarely in this category, and that makes me sleep better at night.

 

Baoxiadao, how do you manage to handle taxes and currency costs by investing with markets all over the world? For me, losing 2% at the buy and 2% at the sell is sickening. Plus the foreign retained dividends and you have a BeerBaron very very wary of foreign investment.

 

BeerBaron

[Baoxiaodao]

Another thing I'd like to add is that I have watched AU's politics and policies for some time. Generally, things are not as corrupted and counter-productive as those in the US and CA. There might be patriots disagreeing with me, but it is only my personal opinion. I am very reluctant to buy any commodity or juniors directly due to my ignorance, so it might not be a bad idea to put money in a conservative business in a good country at reasonable price.

 

In the next 5 to 10 years, I have got a feeling this is really a time to be defensive. I was kind of exhausted nowadays thinking hard about how to protect the portfolio, and the only conclusion I can draw so far is to buy excellent business at reasonable price. Delti, Fiducian, SMT Scharf fit squarely in this category, and that makes me sleep better at night.

 

Baoxiadao, how do you manage to handle taxes and currency costs by investing with markets all over the world? For me, losing 2% at the buy and 2% at the sell is sickening. Plus the foreign retained dividends and you have a BeerBaron very very wary of foreign investment.

 

BeerBaron

 

BB, as I said before, you can use InteractiveBrokers to manage those things. It costs you a 2 or 3 basis points to convert the currency and you can trade in most developed markets and some emerging markets. Because the stocks you buy through IB will be held under a US street name, any dividends will be subjected to withholding taxes, which is 15% for Canadian residents, if I am not mistaken. There is nothing scary about investing in a foreign company in a country like Germany or Australia, where corporate governance(especially Germany) is stronger than that in the US, and laws are enforced.

 

The only thing about IB is that they do not offer RRSP or TFSA account for Canadians. The minimum amount to open an account is 10,000 USD, but I suppose it is not a problem for most of the folks here.

 

[Baoxiaodao]

Q&A with Jai Singh

 

FUMAA - refers to the question how exactly Fiducian measure its FuM FuA and so on.

Ø Funds under Management, Administration & Advice (Around $3.5Bln) takes into consideration that Fiducian is an integrated model that generates revenues within each segment of the value chain. The difference in reporting plus perceived underperformance relative index ( I refer to your questions 1,2 & data) appears linked to the reclassification of a wholesale investment management contract (around $100Mln initially brought on around 2008) from Funds under Administration to Funds under Management. Revenue impact from the reclassification is nil. In summary, around 1.1Bln in Funds under Advice, 1Bln in Platform Administration and 1.4Bln in Fiducian Funds.

Revenue, Net margin and working capital

 

Revenue - How Fuducian generates its revenue

Ø Fees are extracted from the clients portfolio balance. This is performed by the platform which acts as the hub for collecting fees from the consolidated portfolio and pays the adviser and the fund managers their share. Net margin is the total fees less adviser share. The platform always retains minimum 3% in cash. This is where the fees are extracted from. Hence no bad debts and minimal working capital requirements

SMSF Admin

 

The economics of its recent SMSF offering

Ø Charges fixed dollar fees that average 2K per Fund. These are like annual fees charged by accountant for lodging your tax return

 

FOFA - refers to the incoming reforms on the financial planning industry. I would not say the impact is minimal.

Ø Relates more to corporate superannuation funds. Advisers signed on corporate superannuation clients where they advise employees on their employer’s mandated 9% of salary contributions. The issue is not many employees obtained proper advice but on going commissions were paid to the advisers by the corporate superannuation segment of the platforms. As such it appears the left of centre Government is seeking to rectify this issue. Around 8% of assets at Fiducian are in the corporate superannuation segment of the platform. Fiducian restricts advisers servicing employer plans with around more than 30 employees to ensure every employee obtained proper advice. In summary we are personal superannuation and investment specialists where each client receives appropriate advice, a properly documented financial plan and where the fees are agreed to by each client face to face. As such net impact - probably minimal.

 

FBS - Fiducian Business Service. This is not the core business, but a leverage on the existing software platform

Ø Is the Business Services division – it is a new venture. It has recently obtained a tax agent license. To date it has utilised staff in India to cost effectively process tax return work for suburban accounting practices that service local businesses. It seeks to leverage its low cost processing advantage to possibly develop its own national network of profitable accounting practices. Some of this development will be through acquisition of existing small practices. Each acquired practice will also offer financial planning services the Fiducian way.