Description

GP Investimentos Write-Up – 12/4/14

I think GP Investimentos (GPIV33 BZ) offers the opportunity to make nearly 50% in the next 1-2 months due to an imminent catalyst. Longer-term upside is 300%+ 3-4 years out.

GP Investimentos is a publicly-traded private equity firm in Brazil, through buying into the public vehicle you own both the asset manager and stakes in about 15 businesses as the public vehicle co-invests alongside the PE fund into GP’s deals and was initially set up to be GP’s permanent capital vehicle. You are aligned with GP’s partners as they own 32% of the public vehicle and the free float is 68%; all of the fees from GP’s LPs flow into the public vehicle.

GP has a hidden asset which we have done a lot of work on and which is likely to go public imminently (next 1-2 months) highlighting its value. The asset, Par Corretora, is currently carried at cost on GP’s books at $28M USD when I believe the value to GP could be $211M USD; for perspective the current diluted market cap of GP as a whole is $328M USD. During Par’s roadshow and marketing process, GP is barred from speaking about it publicly and thus in GP’s presentations, earnings calls’ etc., you see little mention of Par and per GP’s management, they’ve received few questions on Par to date. Par’s prospectus is currently available in Portuguese only but it’s easy to get it translated to see the type of asset Par is. The IPO process has already begun and Par is holding investor meetings in NY and Sao Paolo in December.

Par is a unique, rapidly growing asset which we will elaborate on in detail later; the company has grown net income 10x in the last few years, is growing earning ~ 40% year over year in 2014 which we think will actually accelerate next year, is largely insulated from competition, and has a multi decade secular growth story behind it.

You are getting paid to own this asset as outside of Par, GP has stakes in 14 other businesses which after some adjustments both positive and negative we have made and detail in the write-up, have combined net asset value of $518M USD. So for the $328M current market cap, you get this $518M in addition to Par.

When Par’s hidden value is recognized in the IPO, GP’s stock should appreciate even with no change to the current discount to NAV as NAV is poised to increase by ~ 45%. In the long-term, we think the discount to NAV will close and combined with three or four more years of Par’s earnings growth, there is 3x type of upside potential.

On top of all of this, there is the potential value of GP as an asset management business with multi-billion USD in AUM and a storied franchise in Brazil.

Furthermore, GP is buying its stock back furiously. GP bought back 10% of its stock this year and last month announced another 10% buyback. We believe they will execute on it as they have a history of doing so and earlier this year, bought 10% in just one month as that was the only month they could buy given restricted information the company had and timing of earnings releases. We don’t include the accretion from buybacks in our analysis.

Finally, you have unusually strong downside protection in GP. By buying GP, you really are buying a portfolio of 15 companies at a meaningful discount to value even before any value to Par. The largest company in GP’s portfolio outside of Par represents just over 10% of NAV and much less of NAV if Par’s true value is included. We think GP can be sized aggressively as even if something goes wrong with any of one of GP’s investments at a company level, the impact to overall NAV is low. In fact, Par can be a 0 and you can write-off more than 30% of the value of the other assets and you still wouldn’t lose money on an intrinsic value basis. Furthermore, after exiting two of its investments so far this year (at large premiums to stated NAV), GP has no material net debt.

The real (no pun intended!) risks are Brazil currency’s the real and Brazil macro, but the duration of holding GP may not be long given the upcoming catalyst. And if the IPO gets pushed off or delayed, Par is growing earnings at a rapid rate so you compound implicitly if not explicitly.

GP Overview Before Par Corretora:

We will make this section short as the real new information we are bringing to GP is Par. GP’s presentations, earnings releases, etc. all do a good job of describing GP, the make-up of NAV, the history of the company, etc.

At a high level, GP was the original private equity firm set up by Jorge Paulo Lemann and his partners at 3G of Ambev, Heinz, etc. fame (as a side note, Dream Big is a great book about their history). As is typical if you study their history, they seek to promote up their junior people and give them opportunities for ownership. In GP’s case, the junior partners to Lemann, Telles, and Sicupira (the 3G founding partners) over time became the new managing partners of GP and they currently lead the company. GP is one of the pioneers of private equity in Brazil and one of the largest PE firms in the country with nearly $2B USD in assets primarily in private equity but also in real estate and soon potentially a new infrastructure fund. The firm continues to attract top finance talent with Brazilian HBS and Stanford GSB graduates frequently returning to Brazil to work at GP.

GP went public in 2007 with the idea of creating a permanent capital vehicle to co-invest with the private equity fund. The value of GP can be broken into the value of these stakes and then the value of the asset management entity itself.

The most important component is the value of the stakes. These are nearly 15 companies and are a mix of listed companies and unlisted. If you look at page 10 of their 3Q14 earnings release, the value of each stake to GP’s NAV is shown. The public companies are Magnesita, BHG, Tempo, and Apen which are all carried at a 10% discount to the publicly-traded share price as of 9/30/14 and summed to $128M USD. Then you have the private companies such as Centauro (dominant sporting goods retailer in Brazil) at $51M USD, a diversified portfolio of real estate projects at $43M, $28M to EBAM (a portfolio of quarry/aggregate assets), Par Corretora at $28M (much more on this one later), Beleza Natural (fast growing hair salon chain) at $12M, etc. The portfolio is diversified with no one asset being a large % of NAV. You will see BR Towers carried for $83M USD but that represents the sale price of their cell phone tower company to American Towers which has since closed and at a large premium to previously stated NAV.

We have done the work on each of their major assets and think there is room for upside on the valuations but not material upside except for Par and GP’s 80% stake in BRZ Investimentos. We also think one write-off may be needed which is a senior loan GP has made to an oil services drilling company.

Below we discuss these three adjustments with Par being by far the most important. We end by discussing the potential value of the asset management entity itself.

Par Corretora:

The information on Par Corretora comes from its IPO prospectus from October of this year which is filed at CVM (the Brazilian SEC). This is in Portuguese but it’s worth getting it translated. GP won’t talk to you about Par as they are restricted. We will hit on the main points here and can go into further detail if there is interest in the Q&A.

Par Corretora (Par) is the exclusive insurance broker for Caixa Economica Federal (Caixa), Caixa is the second largest bank in Brazil with nearly 4,000 branches, over 75M customers, and is owned by the state.

Insurance is underpenetrated in Brazil with the market growing at a 13.4% CAGR since 2008 and a 13.3% CAGR since 2003. Unlike in the US, Brazil consumers generally purchase insurance through their bank. As the Brazilian banking industry is heavily consolidated, this leads to high profits as each bank’s customers are in a sense captive to their own line of insurance products. Banco de Brasil’s insurance unit (BB Seguridad) earned a 35.9% ROE in 2013, Bradesco’s insurance unit earned a 21.4% ROE, and most importantly Caixa’s insurance unit earned a 57.7% ROE.

All this matters indirectly to Par as Par is purely the broker, not the insurance carrier, and is completely asset light. As such, what Par obviously cares about is growth in volumes and here the news is very good and not only because Caixa is driven to sell more insurance given the very high ROEs it earns. First, overall insurance is growing low double digits in the country for many years. Secondly, Caixa is growing rapidly; Caixa is opening 500+ branches a year on a base of ~ 4,000 and has grown loan volumes at a 40% CAGR in recent years. Finally, Caixa is underpenetrated in insurance sales vs. the other large banks in Brazil. For example, 3% of Caixa customers currently purchase life insurance vs. 7.3% at Banco de Brasil (BB). This is partially due to a higher income clientele at BB, but our checks indicate that there is a meaningful catch up opportunity to somewhere in between where Caixa is today and BB’s take rate level (which itself is increasing each year). For all these reasons, Caixa’s insurance segment has been growing premiums at a 22% CAGR from 2011 to 2013.

In addition to this secular growth, Par was poorly run (not surprising for a state owned entity) until just a couple of years ago when Caixa invited GP to have a small stake in the firm (18%) and to bring in better management. Since then Par has been completely turned around, with revenues growing from 147M real in 2011 to ~ 300M in 2014 (the prospectus is through 9/30/14, we estimated 4Q14 based on the 2014 first nine months growth rate) and net income going from 9.2M real in 2011 to ~ 91M real in 2014 (again estimate for Q414).

This is not only because of the secular growth in Caixa’s insurance premiums discussed above but through GP eliminating costs and implementing basic business practices such as just this year having a real CRM system where customers are being called for the first time to renew their policies. From speaking with former Par and Caixa executives, there is a lot of room left to go on both the cost side and the revenue side. For example on the revenue side, Par is currently only functioning in 40% of Caixa’s branches and aims to grow that % significantly over the next few years. Another example: Par right now is only in Caixa’s official branches but in addition to branches, Caixa has tens of thousands of smaller locations where Caixa is located within a supermarket or a retailer. The executives we spoke with thought that Par can build a presence in these locations over time. Finally, Caixa is continually introducing new insurance products to sell to its captive base of customers which means more commissions for Par.

Let’s say Par grows revenues at 25%+ which doesn’t account for many of these opportunities as Caixa’s insurance premiums themselves have historically been growing at nearly that rate. At 25%+ revenue growth, this should leave to massive earnings growth as first, GP still is working on cost improvements and secondly, Par has already deployed one person at the branches it currently is operating in and doesn’t think it needs to add another employee per branch as volumes grow.

The former executives we spoke with think that 2015 will be a banner year for Par as Par recently increased the commission it charges on a key line of insurance, and all of that extra revenue will flow through. As such, we think earnings can growth faster than the already 40% net income growth we think Par will do in 2014. If we use 50%, that gets you to ~ 140M real in 2015 and using 30% in 2016, that takes you to 180M real. These are obviously very rough.

The closest company to Par is Banco de Brasil’s insurance unit (BB Seguridad) which is the only listed bank-affiliated insurance company in Brazil; it trades at 17x 2015 earnings. Crucially, unlike Par it consists of both the insurance carrier and the broker, whereas Par is completely asset light and is just the broker.

In Brazil IPOs often happen within 1-2 months after filing the prospectus and as mentioned, Par is already scheduling meetings with investors in Sao Paulo and NY. To be conservative, let’s say the IPO happens mid next year. Looking to 2016 net income and applying BB Seguridad’s next year’s earnings multiple of 17x, that get us to 3B real or 18% to GP or 540M real or $211M USD. Par’s multiple could be higher than BB Seguridad given its asset light business model and its faster growth prospects given the operational improvements being made, the under-penetration of insurance at Caixa, the opportunity to roll Par out across Caixa’s network vs. only 40% of branches today, Caixa’s rapid branch growth, etc.

Par should still be growing at a healthy rate 3-4 years from now, so if we use a 17x P/E multiple and a 25% earnings growth rate after 2016, that gets you to 6B in value in 2018 (17x 2019 net income) or $422M USD to GP.

What could go wrong? Par is obviously completely dependent on Caixa to operate. However, Par is owned primarily by Caixa and Caixa’s employee association (GP owns an 18% minority position), and Par has a 25 year agreement with Caixa’s insurance division to be its exclusive broker.

BRZ Investimentos:

BRZ manages assets for pension funds in Brazil primarily in private equity but also in fixed income and in public equities. It has a strong record of AUM growth with assets growing at a 31% CAGR since 2004 and now totaling 4.8B real or 1.9B USD. Even in 2014 which has not been easy for Brazilian markets, BRZ grew assets at a ~ 10% y-y rate.

The reason for this strong growth is that BRZ has competitive advantages. From talking to Brazilian asset management professionals, pension funds in Brazil are highly bureaucratic and require specialized asset management firms/products to service them. There are only a few other players outside of BRZ (Gavea and Patria were the two cited) and BRZ is considered the gold standard and the type of allocation a pension fund manager can make without worrying about career risk. The CEO of BRZ is a former senior official of the Brazil Development Bank and has significant public sector contacts which of course helps further.

BRZ differentiates itself further by focusing on private equity asset management for pension funds (66% of BRZ’s AUM is in private equity) and is the largest asset manager for pension funds in this asset class. According to a former BRZ executive we spoke with, BRZ has put up good returns which is helping to drive increasing allocations. Per this same executive, private equity is top heavy and has a high cost structure, so BRZ has invested heavily to build out its team and hasn’t shown much profits to date but is poised for significant operating leverage as assets grow.

With BRZ’s financials not disclosed, it’s difficult to value the asset but with $2B USD in assets and a dominant market position, clearly it’s more than the $7M USD GP is currently carrying it for which just represents book value; it goes without saying that book value is typically nominal for asset management businesses and no representation of actual value. One approximation for value is the value GP themselves paid in 2010 to acquire 21.8% of the company; they paid $18M USD which implies a value of $66M USD for GP’s current 80% ownership. We mark up BRZ to this value from book value of $7M.

San Antonio Senior Loan:

San Antonio is an oil and gas drilling services company in Latin America which GP previously invested in. The company’s operations are primarily in Argentina which is imposing restrictions on taking capital out of the country, which has made it impossible for the company to service its debt which is held outside Argentina. As such, the company is going through a restructuring with the debt holders likely to own a significant part of the equity. GP has written down its equity value to 0 already but also has $42M of senior debt to San Antonio.

San Antonio is a private company without public financials and it’s unclear where GP’s senior loan sits in the cap structure; GP management is not willing to provide further details beyond telling us that San Antonio operationally is performing very well and the only issue is the capital controls in Argentina and that overall the debt to EBITDA is ~ 3x.

This suggests the senior loan is money good which fits with GP not impairing it, but with the lack of transparency and falling oil prices likely to pressure EBITDA, I mark this asset down 50% which is a $21M USD hit to NAV.

We are still seeking to learn more about this asset through other contacts in the region. It’s possible in a scenario when Argentina eases capital restrictions that the value of the loan is actually more than face value because GP’s debt will become part of the new equity and the new company would have no debt.

Asset Manager Value:

The asset management entity is currently break-even in that the fees from third party LPs offset GP’s cost structure, so as a public shareholder you essentially shoulder no costs and benefit from a team working for you for free. GP has been unable to raise new capital as they made several poor deals several years ago which they had to write-off. Management of course states that they have learned from these mistakes and it is true that their recent deals have been much better including two home run exits (Sascar and BR Towers) this year. They believe this puts them in the position to raise a new PE fund in 2015, and a couple checks with allocators in Brazil indicates that this is plausible but not a sure thing.

In the case where this is not possible, the asset management fees will gradually decline as the prior PE funds wind down reducing fees. However, we don’t think this will create material operating losses as this decline has already been happening and GP has offset it by reducing expenses and gathering new assets through the following three ways: a) raising a real estate fund (plans to soon launch an infrastructure fund) b) structuring co-investments where they get fees and carry (see the recent deal with BHG Hotels as an example) and c) doing innovative transactions like purchasing into a closed end fund at a large discount to NAV and taking over the asset manager (see the deal with Apen). The legacy PE funds don’t expire until 2018/2019, which gives GP plenty of time to lower its cost structure combined with raising further assets outside of traditional private equity if necessary.

In the case where they can raise a new PE fund in the next year or two, the asset manager obviously has considerable value and with good investments, they can show real earnings as they can earn carry again. While this is obviously several years down the road at least in terms of carry hitting the income statement, KKR/Blackstone/Apollo etc. show the value the markets can ascribe to PE asset management businesses.

Qualitatively, we spoke with allocators in Brazil and with young Brazilian finance talent considering where to work in private equity. It’s clear that while GP doesn’t have the type of prestige it had ten years ago when it was one of just a few PE funds in the country and had no blemishes on its record, GP is still considered a premier fund and the type of place where Brazilian HBS and Stanford Business School students return to Brazil to work at. Here’s a quote from a professional at one allocator:

“GP made bull market mistakes. They aren’t the only ones. They are very smart with very good senior people, and they are still getting good talent because they are still considered one of the top five PE funds in the country. I actually recommended my younger cousin to work at GP because while they work junior people extremely hard, I know their people learn a tremendous amount.”

In short, it’s tough to value the asset management entity but we think at the least, GP shouldn’t trade at a hold co discount. The reason for hold co discounts is that to be accurate you should capitalize the G&A burden. Here, other people’s money is paying for the G&A. Furthermore, at some point in the future, there may actually be earnings which can be capitalized on the positive side.

Putting It All Together:

Assuming no value to the asset manager and with the adjustments to NAV we made, we get to true NAV of $729M vs. a market cap today of $328M. Note there are 157M S/O currently outstanding after the last buyback and there are two sets of options, 22M options at approximately a 6.2 real average exercise price (current share price 5.35) and another 17.6M options at a 9.45 real exercise price. We have diluted the share count for the first tranche (included in the 157M S/O) and added the cash to NAV. The second tranche if/when they get in the money will dilute the returns a bit from what is discussed in this write-up. On the other hand, we also don’t adjust for the accretion of the 10% additional share buyback.

Catalyst

IPO of Par Corretora 

Heavy stock buybacks