Gamco Investors (GBL) is a textbook example of the disconnect between a strong company and a weak stock due to the recent market pullback, which creates an asymmetric opportunity.
The implied discount due to the controlling ownership of Mario Gabelli is completely unwarranted given his significant skin in the game and history of returning excess cash to shareholders through buybacks, regular dividend increases and special cash dividends.
GBL should trade in line with peers due to the comparable operating margin, expected AUM growth driven by new market initiatives and relatively higher exposure to actively managed equities (with their higher fees).
GBL is an asset manager providing investment advisory services to investment partnerships, open/closed-end funds as well as institutional and high net worth investors.
GBL is "killing it" but the recent market pullback killed the stock
While the S&P 500 declined 6% from mid-January through the beginning of February this year, GBL declined 21% as asset managers are essentially a levered long play on the rising equity market, especially if equities represent an extremely high percentage of AUM as is the case with GBL.
However, GBL did not participate in the subsequent market rebound, which presents an asymmetric opportunity as only the stock is suffering and not the underlying operating performance.
For example, in 2013 AUM increased 29% to a record $47 billion. Revenue increased 15.5% to $397.6 million while operating income increased 30% to $161.2 million (due to the inherently high operating leverage) and the operating margin expanded 450 basis points to 40.6%.
Going forward, there are three additional drivers that should result in continued strong performance. First, while incentive fees are still small on a relative basis, they should continue to contribute a growing portion of overall fee income. For example, assets with incentive based fees increased from $2.8 billion in 2009 to $4.1 billion in 3Q13.
Second, a growing distribution network (e.g. national/regional brokerage firms), new share classes (e.g. no-load Class I shares with higher minimums) and wholesaling efforts designed to increase awareness of its products for financial consultants should generate greater sales. Moreover, the use of third-party distributors reduces fixed costs.
Third, recent efforts to increase penetration in the large institutional and growing private wealth management markets are paying off as AUM in these two categories increased from $11.2 billion in 2009 to $20.3 billion in 2013.
The myth of the control discount
The minimal analyst coverage on GBL, despite its ~$2 billion market cap, is probably due to the low float as a result of the high insider ownership, which results in lower institutional trading and therefore less research-driven commission dollars.
However the controlling interest of Mario Gabelli is arguably the greater contributing factor to the unwarranted low valuation. Mr. Gabelli owns a majority of the class B shares that have 10 votes per share compared to only one for the A shares, which gives him voting control of the company.
Investors should remember that the existence of a controlling shareholder is only a problem if they are not doing what you want. This is even less of a problem (and should actually be considered a positive) if they have significantly more skin in the game than you and are focused on the same performance metrics. For example, Mr. Gabelli receives no salary and instead receives a management fee that is incentive-based and entirely variable. Unlike some CEOs who make millions just for getting out of bed in the morning, Mr. Gabelli is forced to perform otherwise there would be quick and massive investor redemptions (no lockups!), resulting in a significant decline in compensation.
GBL consistently returns excess cash to shareholders in the form of buybacks, regular dividends (doubled since 2009 to $0.06 per share) and special dividends ($10.60 since 2009) as shown in the chart below.
GBL would receive a higher valuation if investors used the same investment decision-making process as its managers use to evaluate stocks. For example, the Private Market Value (PMV) with a Catalyst approach focuses on stocks whose "intrinsic value...is significantly different from the value reflected in the public market" with the PMV being the price an informed buyer would pay to acquire the business. While GBL as a whole is unlikely to be sold, this does not mean the stock is not undervalued.
This approach also looks for company specific catalysts such as the realization of hidden assets, buybacks, balance sheet changes and new products.
GBL has one of each of the above. For hidden assets, GBL has cash and investments of $578.7 million and only $111.9 million of debt. These net cash and investments represent ~24% of the market cap and could be used to provide another catalyst (buybacks) or additional dividends (increase in regular or special). For balance sheet changes, in May 2013 GBL repaid $99 million of 5.5% senior notes and in 4Q12 repurchased $64.1 million of 0% subordinated notes. For new products, GBL continues to diversify by introducing new products (e.g. fixed income, global equities) and is less dependent on U.S. equities, although this category still represents a significant portion of AUM.
However, as shown in the chart below, these positive fundamentals are not reflected in the valuation. Moreover, GBL trades at a discount to Federated Investors (P/E is 17.7), which is for all intents and purposes a giant money market fund that earns the lowest fees in the asset management industry.
The higher equity concentration deserves a higher multiple for two reasons. First, active equity products typically generate significantly higher fees than fixed income. Second, the end of the 30 year bond bull market presents unique challenges for fixed income managers as they will be forced to become more tactical due to the lack of an interest rate tailwind going forward.
The following are the primary risks to the investment thesis, in order of importance:
- Poor investment performance would result in lower advisory and incentive fees. This may result in investor redemptions, especially if the products underperform their respective benchmarks or peers. Moreover, given the high fixed costs, a decline in fees would have a significant negative effect on operating income.
- In addition to the traditional (and intense) competition from other actively managed products, the growing shift towards using a passive approach and/or ETFs may require lowering fees in order to remain competitive. However the risk for GBL is mitigated by its superior performance (e.g. since 1977 its traditional value-oriented institutional and private wealth management composite earned a compound annual return of 15.8% net of fees compared to 11.2% for the S&P 500 through 12/31/12).
- There is "key man" risk (similar to Bill Gross at PIMCO) given the multiple and critical roles assumed by Mr. Gabelli including chairman of the board, CEO and primary portfolio manager for a significant majority of AUM.
A target price of ~$91 is based on a 20x P/E, which is supported by the previously mentioned strong fundamentals. A tight stop loss could be placed below the recent support at ~72 while a larger stop could be placed below the 200 DMA ~10% below. The time frame is 12-18 months.