Description

This idea is for an illiquid microcap (C$26m capitalization) and as such is only applicable for PAs. Others should stop reading now rather than call it non-actionable later.

Thesis is quite simple:

• Integrated Asset Management (IAM) is a profitable Canadian asset manager with C$1.83bn of AUM, great track record of investment results, focus on sticky-money from institutionals, high insider ownership, 6% dividend yield and large buybacks.
• Despite all these positives the company sells only for C$26m while having C$17m in TBV, majority of which is cash and level 1 proprietary investments. Thus investors only pay C$9m for the asset management operations on the pool of C$1.83bn AUM.
• Moreover, the company is positioned for growth and is launching new funds. AUM will likely increase by 50% during the next couple of years. Due to operating leverage this is expected to result in C$3.5m-C$6m of recurring EBITDA from management fees alone.
• At these levels of profitability IAM will likely be valued at least 100%-200% above the current market cap. Expected timeframe 2-3 years, unless market starts recognizing the opportunity earlier.

The company is cheap as its profitability and growth potential is obscured by declining AUM (due to divestures) and lumpy earnings (due to performance fees). Superficial look at financials shows quite a bleak picture. Low capitalization, illiquidity and absence of coverage add to the story.

Company description

The company was founded in 1998 by Victor Koloshuk (who still runs the company today and owns 37% of its stock). In the next few years IAM acquired various asset/property management businesses and had peak AUM of C$3.1bn in 2008. During the crisis IAM decided to re-focus the business and sold down property management operations 2009 and then BluMont Capital (retail asset management) in 2013, after which the company became pure play institutional asset manager offering alternative investment strategies. AUM in currently retained businesses has grown from C$1.38bn in 2005 to C$1.83bn now. Operations are split in:

• Private Debt (C$1bn AUM) – lending to mid-sized investment grade Canadian businesses. The group underwrites, structures, funds and manages every transaction in house. Currently 4 funds in operation (latest launched in 2013). Average annualized return of 9.4% (gross). Management fees are very low in the range of 30-50bps with one time commitment fee of 50-100bps.
• Real Estate (C$0.8bn AUM) – The company aims to invest in leased/leasable properties using minimal leverage. Investments are carried out through series of funds, which have duration of 12 years. In total 13 funds had been launched since 1982 and 4 are currently still in operation with liquidation dates set on 2018, 2021, 2024 and 2026. Average annual return since 1982 has been 12.5% (net) and 12.3% over the last 10 years. Management fees are c. 1% + performance fees above hurdle rates. Performance fees are realized only towards funds’ liquidation dates. Rental income is usually sufficient to cover the hurdle rates and thus appreciation of properties’ value translates directly in performance fees.
• Private Equity & Managed Futures (C$53m AUM) – Private Equity is rather standard PE operations with 2+20 fee structure. This was the original AIM business and area of expertise of Victor Koloshuk.  Managed Futures products refer to speculation in commodity futures/options as well as FOREX markets. Surprisingly the returns have been quite good (8% annualized since 2007) albeit monthly fluctuations are also quite high.

Full details on individual fund performance and etc. can be found on IAM website, but key take-away is that AIMs funds (both debt and RE) have generated very attractive historical results and have very attractive fee structure. This should keep the doors open for further growth in AUM.

Financial results

The table above indicates quarterly performance since the sale of the retail division (BluMont) with only institutional side of the business remaining. For longer term performance please refer to annual reports - these have 10 year charts for all key metrics. Financial year ends on Sep 30.

Lumpiness of IAM earnings are driven by a few factors:

• Performance fees from liquidating Real Estate funds (eg. C$3.6m in Q3 2014).
• Performance fees from Managed Futures business (eg C$0.5m in Q1 2015).
• Prepayments of loans within debt funds. These caused increase in management fees in Q1 2015 and Q3 2013 in the amounts of C$0.4m and C$1.7m respectively. These fees would have been realized over a number of years in the absence of loan prepayments. The same loan prepayments caused decline in AUM during the respective quarters.

When considering the recurring profitability, I ignore the first two and count in the third – this leaves me with management fees that average c. 0.6% of AUM per annum. Excluding net performance fees and investment gains and counting in full opex, the business operates around EBITDA break-even (EBITDA is roughly equivalent to pre-tax cash earnings as capex is negligible). So there is no cash burn within the recurring business at current levels of AUM and any performance fees or investment gains come in as a bonus. AUM in the existing funds is unlikely to see sharp decline due to sticky institutional investor base as well as long holding periods for RE and debt funds.

Recurring business – growth

EBITDA breakeven for the recurring business obviously does not sound very attractive, however AUM is expected to increase materially over the coming couple of years and this will add directly to the bottom line.  The whole idea behind selling down property management and retail asset management businesses was to refocus on institutional investors and grow this part of the business aiming to have higher recurring revenue base. Management seems to be on track with its growth strategy:

• There are C$285m of committed but not yet invested funds – only the invested part counts towards reported AUM and earns management fees. Private Debt Fund IV (C$387m) was 57% invested and Real Estate 13^th Fund (C$135m) was 10% invested as of Sep 2014. Thus fully investing these committed funds will result in additional C$285m of AUM.
• Three new debt funds are to be launched in 2015. Management already began marketing for longer term duration Infrastructure Debt Fund and also expects to launch the 5^th mid-term debt fund in H1 2015. Additionally, there is a shorter duration, higher yield fund under development. While I have no figures on how big these debt funds are expected to be, the smallest debt fund so far (no. 3) has been C$275m. Keeping in mind low interest rate environment and great track record of AIM debt funds, institutional investor interest should not be a problem. I would expect these three funds together to bring in additional C$800m to C$1bn of AUM, but there will be a lag before these funds get invested and start earning management fees (probably only by the end of 2016).

Recurring business – valuation

I consider the additional AUM from committed-but-not-yet-invested funds to be a sure thing (barring force majeure) rather than a likely expectation. These C$285m of further AUM will translate into C$1.7m of recurring management fees and C$0.9m-C$1.3m of EBITDA (assuming 50%-75% flow-through to the bottom line).  Attaching 10xEBITDA multiple gives valuation of C$9m-C$13m for the recurring part of the business. Adding back cash and equivalents results in C$26m-C$30m valuation for the company vs C$26m current market cap – or 0%-20% upside. Thus, additional EBITDA from already secured AUM as well as cash on the balance sheet more than supports the current market valuation. This gives a strong downside protection for my long thesis.

Now for a more optimistic view I add the expected AUM from the to-be-launched funds resulting in a combined C$1.1bn - C$1.3bn AUM increase during the upcoming couple of years. This should translate into C$6.6m – C$8m of additional management fees and C$3.5m – C$6m of EBITDA (50%-75% flow-through rates). Using the same 10xEBITDA multiple and adding $17m in cash results in C$51m-C$77m valuation vs C$26m current market cap – 100%-200% upside.

Thoughts on non-recurring revenue

My investment thesis does not rely on non-recurring revenue but rather considers it as a free option when paying for the recurring management fees. Non-recurring revenue can be divided into three parts:

• Performance fees from RE funds. Performance fees result mostly from the appreciation in value of the real estate held. The fees accumulate throughout the life of the fund and get realized when particular funds approaches liquidation (so once every few years). 25% of performance fees are paid out to the management. The company has C$10m of unrealized performance fees in 3 RE funds, which will liquidate on 2018, 2021 and 2024. During the crisis unrealized performance fees decreased from C$9m in 2008 to C$5m in 2010 (and then recovered fully later). Thus the current C$10m of performance fees could fluctuate either way before the liquidation dates. I would generally consider these to be outside of management’s control and rather tied to overall Canadian real estate market performance. Discounting currently recorded unrealized performance fees at 10% results in C$4m of additional value for shareholders.
• Performance fees from Managed Futures. As noted above managed future business is speculative in nature and it is hard to project what kind (if any) performance fees will be realized going forward. If the past is any guide, this business could deliver C$0.5m annually, so valuation of C$5m.
• Investment gains are primarily derived from proprietary investments on Managed Futures strategies. As such I do not attach any value to potential future investment gains/losses.

Management and shareholders

The key person within IAM is Viktor Koloshuk who founded the company in 1998 together with the current CFO Stephen Johnson (5.5% holder). He still runs it as Executive Chairman and owns 37% of the stock. There is not much information to be found about him. Viktor made his name in the investment world back in 1990s with the successful activist role in Poplar vs Crownx (more info here). Apparently, he was one of the first activist investors, at least in Canada. Quite insightful interview with his thoughts on the IAM business can be found here.

The second largest shareholder is Veronika Hirch with 19% holding. She is CIO of BluMont Capital, the retail division that was divested (together with Veronika herself) in 2013 after being part of IAM for 15 years. So far she has not sold a single share even though management confirmed that there are no restrictions on her stake. So it’s a positive sign for now, but could become an overhang in the future.

Since May 2013 the company has repurchased c. 10% of the outstanding shares (the latest purchase for 1m shares was in Dec 2014), and is likely to renew the buybacks program as long as the share price remains at current levels. Insiders have also been buying stock quite actively in the range of C$0.7-C$0.9/share during 2014. Company pays regular dividends yielding 6%.

There is still a large cash pile on the balance sheet and at current rate of buybacks and dividends it will take another 5-7 years before all of it is fully distributed to shareholders. Management started talking about bolt-on acquisitions that would help to grow the business. I would much rather prefer large special dividend and focus on organic growth, but in any case the value is unlikely to be destroyed keeping in mind high insider ownership and management’s track record.

AIM as acquisition target (random thoughts)

Currently the company is selling (after deducting cash and equivalents) for c. 0.5% of AUM. This is low by any standards and especially low for a recently streamlined institutional investor focused business that is positioned for further growth. Valuations in the range of 1%-2% of AUM are more in line with other Canadian asset managers, but there are no direct comparables due to specialized/niche nature of IAM.

I do not believe acquirer could achieve material cost synergies. Even though salaries for top 6 executives amounted to $3.3m during 2014, their roles are likely essential for superior IAM fund performance and thus could hardly be eliminated or replaced with cheaper investment professionals. And the business is already streamlined after recent divestures.  IAM is cheap on stand alone basis, but there are no clear material financial benefits of having it as part of bigger asset management organization.

Risks

• Scalability of IAM business. The investments IAM undertakes are quite specialized, limited in size and therefore likely to require certain amount of man-hours to initiate and subsequently monitor. So this is not a mutual fund that invests in public equities and can easily double AUM without any effect on overheads. My investment thesis relies on operating leverage of the business and I modeled 50-75% incremental revenue flow-through to EBITDA. If operating leverage is lower the upside might be significantly smaller.
• Also it is not entirely clear whether management will be able to expand the existing AUM without diluting the returns to funds’ investors – i.e. potentially profitable investment universe might be quite limited (special type of RE and senior corporate debt of SMEs).
• Ongoing legal issue with Arrow Capital Management (which bought BluMont) regarding misstated NAV in one of the funds managed by BluMont. Arrow seeks damages of C$1.4m, but my understanding that these should be targeted to financial services company which provided back office services to the fund rather than IAM. 

Catalyst

- Continued growth of AUM

- Launch of new funds