Buy the Fund Company
Zeke Ashton runs Dallas investment firm Centaur Capital and manages Tilson Dividend Fund (symbol TILDX). Zeke is a brilliant investor who excels at finding opportunities in stocks that others ignore, and he has built a marvelous record at Tilson Dividend. The fund, launched in 2005, returned 10.2% annualized over the past five years. That beat Standard & Poor's 500-stock index by an average of eight percentage points per year. For 2010, the fund gained 18%, six points ahead of the index (all figures are through November 5).
One of Zeke's favorite sectors today is the money-management business -- specifically, firms that specialize in stock funds. Money management is a relatively simple and highly profitable business. Revenues come primarily from fees assessed as a percentage of assets under management. Assets grow as management firms receive new deposits and as the holdings in their funds appreciate. One of the beauties of the business is that costs don't march in lock step with revenues. If a fund grows from $1 billion to $2 billion, you don't need twice as many people to manage it. You may not need any extra people. In normal times, money managers can generate eye-popping net profit margins (earnings divided by revenues) of 25% to 30%.
Of course, times have been anything but normal for stock-fund managers in recent years. Even as the market has powered ahead since March 2009, investors have shunned stock funds. While bond funds experienced net inflows of $221 billion in 2010 through September, according to Morningstar, stock funds saw net outflows of $36 billion. Why this antipathy toward stocks? "Ten years of negative returns will do that for you," says Zeke.
Not surprisingly, valuations of stock-oriented money-management firms have shrunk. Zeke has focused his research on six small and midsize asset managers. The average ratio of the companies' enterprise value (market capitalization plus debt outstanding, less cash on the balance sheet) to assets under management is just 2%. That's roughly half the historical average, he says.
Consider Calamos Asset Management (CLMS). The Naperville, Ill., firm went public at $20 a share in 2004, when it had $32 billion in assets and $150 million of net debt. Today, it has roughly the same level of assets, $246 million in net cash, and the stock goes for $12.
Zeke thinks the market's pessimism toward Calamos is unwarranted. A leader in convertible bonds, the company has steadily diversified its fund offerings so that a majority of its assets are now in stocks, which generate higher fees than bonds. Calamos stumbled badly during the financial crisis, and assets under management were cut in half in 2008. But after several rounds of cutting costs and making investments to expand its roster of foreign and global funds, the company's profit margins are returning to more-normal levels as assets once again grow. But the market hasn't recognized Calamos's revival and is undervaluing the stock. Zeke thinks Calamos is worth $17 a share today.
Another beaten-up favorite of Zeke's is Artio Global Investors (ART), which was spun off last year by Swiss investment bank Julius Baer. The New York City firm's funds, which focus on foreign stocks, have excellent long-term records but have lagged in recent years. As a result, assets have fallen from a high of $75 billion in December 2007 to about $54 billion today. But Zeke believes that Artio's managers haven't lost their mojo.
As the funds' returns improve, he thinks investors will bid up the shares or another money manager seeking to increase its international expertise will buy all of Artio. Zeke pegs the current ratio of Artio's enterprise value to its assets at 1.5%. At a more reasonable 2.5%, he estimates the stock's fair value at $22, well above today's price of $15.
Columnists Whitney Tilson and John Heins co-edit Value Investor Insight and SuperInvestor Insight. Tilson has an economic stake in, but doesn't manage, Tilson Dividend Fund.