Investors are rightfully worried about macro trends, but this atmosphere of fear has resulted in financials trading well below intrinsic value. The Street currently rates Invesco (IVZ) near a "strong buy," Blackstone (BX) at a "buy" and Fortress at a "hold." Based on my multiples analysis and DCF model, I find that Blackstone and Fortress are the most undervalued due to the attractiveness of alternative assets, such as private equity.
From a multiples perspective, my picks are the cheapest of the three. Blackstone and Fortress trade at 9.3x and 6.5x forward earnings, respectively, while Invesco trades at 12.6x forward earnings. Since I am bullish on capital markets overall in 2012, I believe that the higher volatility in Blackstone and Fortress will only serve to generate high-risk adjusted returns. In any event, Blackstone offers a dividend yield of 2.5%, which is just 30 basis points higher than that of Invesco.
With that said, there are several reasons to be attracted to Invesco. On the third quarter earnings call, Invesco's CEO Marty Flanagan noted strong results:
"And to start with, long-term investment performance remains very strong across Invesco for the third quarter with areas of absolutely exceptional performance. And our strong investment performance contributed to a trend of - a continued trend of positive long-term net flows for the firm, in spite of very volatile markets. And also during the quarter, we saw net long-term inflows across all distribution channels.
And during the quarter, we increased cash by $136 million and reduced long-term debt by $194 million, further strengthening our balance sheet. And looking ahead, reflecting confidence in our fundamentals, we expect to purchase $100 million of Invesco shares during the fourth quarter, also bringing the total purchased shares during 2011 up to $443 (sic) ($433)million."
The company impressively ended the fourth quarter with $625.3B in assets under management. Put differently, AUM grew 4.5% sequentially. This is now the fourth consecutive quarter that AUM growth has outpaced that of Franklin (BEN). In December, Invesco's AUM grew 0.7% m-o-m, while Franklin's fell 0.6%. In particular, the company is outperforming with its hybrid and fixed income assets.
Consensus estimates for Invesco's EPS forecast are that it will grow by 21% to $1.67 in 2011 and then by 6.6% and 16.9% in the following two years. Assuming a multiple of 16x and a conservative 2012 EPS of $1.73, the rough intrinsic value of the stock is $27.68, implying 23.4% upside. If the multiple were to decline to 13x and 2012 EPS turns out to be 8.4% below consensus, the stock would fall by 5.6%. While this is favorable risk/reward, there are more undervalued investments within financials.
One of those more undervalued investments can be found in Blackstone. The company has shown strong fundraising ability beyond what the market has acknowledged. The BCP VI fund raised $16B, approximately $2B above the target. It is now raising capital for its $3B Energy Fund, BREP VII, which will target China. The company is run by stellar management and I am confident that it will succeed in raising capital here. As volatility in the equity markets continues, I foresee a greater transition to alternative assets. Signs of better capital formation will, of course, raise management fees while an improving macro environment will raise performance fees.
Consensus estimates for Blackstone's EPS forecast are that it will decline by 4% to $1.21 in 2011 and then by 41.3% and 19.3% in the following two years. Assuming a multiple of 12x and a conservative 2012 EPS of $1.66, the rough intrinsic value of the stock is $19.92, implying 25.1% upside. Modeling a CAGR of 17.4% over the next three years and then discounting backwards at a WACC of 9% yields an even higher fair value figure of $25.71. This company, put simply, has very little downside and plenty of upside.