This is the first of a three part series where we analyze Manning & Napier Inc. (NYSE:MN) The three parts are broken down as: 1) Recommendation and Overview 2) Valuation Analysis and 3) Risks and Outlook.
We recommend Manning & Napier, Inc as a Strong Buy based on strong organic growth in client AUM, fair value price of $18.20 per share, approximately 27% above current levels. We expect to see the company generate earnings per share of $.97 a share in 2012 and to increase EPS by at least 22% annually over the following three years. We recommend MN to aggressive investors who are interested in a fast-growing small-cap company that recently went public. We also recommend MN to conservative investors interested in high-quality businesses with consistent growth, strong returns on capital & cash flow generation, a wide economic moat and an exceptional business operations franchise.
Manning & Napier, Inc. is the holding company and sole managing member of Manning & Napier Group LLC. They own 12.8% of Manning & Napier Group LLC, which is involved primarily in asset management and investment advisory solutions through their Manning & Napier Advisors, Inc. subsidiary. Manning & Napier Advisors was founded in 1970 in Rochester, NY by William Manning and William Napier. They are headquartered in the nearby village of Fairport, NY and have branch offices in St. Petersburg, FL and Dublin, OH (suburb of Columbus). MNA serves as the investment advisor to the Fund and Exeter Trust Company.
The firm is currently a family of 28 open-end mutual funds that offer no-load share classes designed to meet the needs of a range of institutional and other investors. Exeter Trust Company is an affiliated New Hampshire-chartered trust company that sponsors a family of collective investment trusts for qualified retirement plans, including 401(k) plans. They market and distribute their investment management products and services through Manning & Napier Advisory Advantage Corporation (targeting independent financial advisor professionals) and Manning & Napier Investor Services, Inc., the distributor for their series of diversified mutual funds. Their 98% owned custody and trust operations subsidiary Exeter Trust Company provides services to approximately 6,000 client accounts.
The company also includes several non-investment businesses that are technology related and are under common ownership and/or management. These companies include Perspective Partners, LLC ("PPI"), and Manning & Napier Information Services, including its wholly owned subsidiary Manning & Napier Benefits, LLC (collectively referred to as "MNIS"). PPI, established in March 2000, designs software and provides services to the 401(k) industry. MNIS, established in January 1995, is a web-based company which designs and develops web-delivered software to assist the human resources function of employers in streamlining benefits administration for health and welfare plans including enrollment, employee education, benefits analysis, and benefits management.
When all units of Manning & Napier Group, other than those held by Manning & Napier Inc., are exchanged for shares of MN Class A common stock after the consummation of this offering, 90M shares of Class A common stock would be outstanding, which we use as our assumed shares outstanding in order to calculate Earnings per Share in our model.
Management: The current Chairman of the Board of Directors, William Manning was a Co-Founder of the company in 1970 and was Chief Executive Officer until 2010. He has also served as the Director of Investment Process at Manning & Napier since 2003. Patrick Cunningham was promoted to Chief Executive Officer in 2010. He joined Manning & Napier in 1992 and was appointed to the executive management team in 2000, serving as the team's co-chair from 2003 to 2010.
Ownership: William Manning and the executive team will own 86% of Manning & Napier Group, LLC after the Initial Public Offering was consummated. M&N Group was previously 100% privately owned by the executive employees. William Manning owns over 59.16M Class A Units of Manning & Napier Group LLC, which can be converted into Class A shares of Manning & Napier, Inc. Class A common stock at a rate of 15% of such units each year. He effectively owns 67.4% of the company and his shares are worth nearly $792.6M. The rest of the executive team owns over 16.11M Class A Units of Manning & Napier Group LLC which can be converted into Class A shares of Manning & Napier, Inc. Class A common stock at a rate of 5% of such units each year. They effectively own 18.5% of the company and his shares are worth nearly $217.6M.
Summary of Observations
Manning & Napier has seen tremendous growth in the last five years while many of their peers have seen stagnation, declines, losses and buy-outs. They have grown their revenue from $95.9M in 2006 to $330M for 2011, representing a compounded annual growth rate of 28%. The firm first came to our attention in 2006 in a Wall Street Journal article about boutique asset managers who had strong and consistent performance in their mutual fund offerings. We were intrigued by the article as the principals of our research team had previously worked in the performance measurement, attribution, analytics, evaluation and investment manager research areas of Bank of America's (NYSE:BAC) Global Wealth & Investment Management Division and Manning & Napier's funds were exactly the type of funds we would recommend to portfolio managers on behalf of their clients while we worked at BofA.
Manning & Napier enjoyed good growth in client assets under management prior to that, as AUM went from $6.9B in 1999 to $14.7B in 2006, to $40.2B as of 2011, which represented a compounded annual growth of 15.8% over this nearly 12 year period, which is impressive considering the two stock market crashes, subsequent bear markets and demoralization of investors during this period.
We also like the rich operating margins the company enjoys. We expect asset managers to generate high operating margins of at least 25-40% and M&N does not disappoint us. Operating margins were about 40% in 2006 & 2009 and 44%-47.5% in 2007-08 & 2010-11, which exceeds the 34% average margin for the industry. Net Income has more than doubled, in spite of the increased interest expense associated with employee-owned shares subject to mandatory redemption. As Manning & Napier has gone public, this non-cash expense will no longer apply in 2012 and afterwards.
We also like the fact that asset managers do not require the massive expenditure for property, plant & equipment in order to continue operations and Manning & Napier is no exception. They only spent $4.86M in net capital expenditures over the 2008-2011 periods. In comparison, they spent nearly $2.55M on investments in liquid, marketable securities. They averaged about 90% conversion of Net Income to Free Cash Flows, which shows their strong cash generation abilities. A glimpse at their balance sheet shows that Cash and Marketable Securities account for over 40% of their assets and they have only $3M in net Property & Equipment on their balance sheet.
Nearly 50% of assets relate to accounts receivable, which are secured by client assets, earned daily and typically paid on a monthly or quarterly basis. While they had a negative book value before the IPO, it was due entirely to the Employee share ownership liabilities subject to mandatory redemption, as well as the fact that they were previously an S Corporation in which the shareholders took their distributions immediately.
Their strategy for continued success is focused on the pursuing the following objectives:
Expand their Direct Distribution Channel. Their high-touch direct distribution channel has allowed them to build strong relationships with their clients over time. They plan to expand their direct sales presence geographically, filling in new regions along the east coast and expanding farther west. They remain focused on identifying geographic regions within which their representatives form key relationships with centers of influence, business owners and other referral networks.
Broaden their Intermediary Channel. They are focused on the attractive 401(k) marketplace, which is characterized by positive cash flows and low cancellation rates. In addition to building relationships directly with plan sponsors, they are focusing their wholesale staff on identifying advisors and other financial intermediaries that work primarily with defined contribution plans. We expect significant future growth opportunities within this channel as firms are replacing defined benefit pension plans with defined contribution 401(k) plans. They target national brokerage firm advisors, retirement plan advisors and other intermediaries that work with small- to mid-sized 401(k) plans.
Focus on the Convergence of Health and Wealth Benefits. Their strong relationship with employers puts them in a strong position for the opportunities provided by the convergence of health and wealth benefits in employer decision making. They focus on providing consultative services to employers to address these key concerns through unique plan design alternatives and technology-based tools to help employers and advisors effectively reach large numbers of employees with tailored retirement and health plan guidance. They will continue to develop and potentially acquire products and services to help employers best address these key issues regarding retirement and health benefit plans.
Develop New Products in Response to Market Opportunities. The on-going development of products and consultative services in response to current and prospective client needs has been a source of significant growth. They remain committed to understanding the key areas of concern for various client types and developing solutions to meet these needs. Continued product and service development will likely require building additional resources and areas of expertise, and they are continuing to add resources where solving key problems can strengthen their relationships with clients.
The next part of the series, Part 2 of 3, we will discuss the valuation of Manning & Napier Inc.
Additional disclosure: Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this MN report.