On October 21, Bill Simpson wrote an analysis of Pzena Investment Management (PZN). In its debut October 25, the company priced at $18 per share, the top end of the anticipated price range. The investment management firm had expected the IPO, which totaled 6.1 million shares of Class A stock, to price from $16 to $18 per share. October 26 the stock closed at $19.60.
The text of Mr. Simpson's original writeup follows:
• • •
Pzena Investment Management plans on offering 7 million shares (assuming over-allotments) at a range of $16-$18. Goldman Sachs and UBS are lead managing the deal, BofA, Fox-Pitt Kelton, JP Morgan an KBW are co-managing. Post-ipo PZN will have 65 million shares outstanding for a market cap of $1.105 billion on a pricing of $17. IPO proceeds will be used to redeem shares from non-employee insiders. Essentially think of the shares offered in this deal as being offered by insiders as PZN will retain no ipo monies.
CEO Richard S. Pzena will own 40% of PZN post-ipo and will retain full voting control post-ipo due to a separate share class.
From the prospectus:
Founded in late 1995, Pzena Investment Management, LLC is a premier value-oriented investment management firm with a record of investment excellence and exceptional client service.
We've seen a few investment management firms ipo this decade (notably Calamos (CLMS)), however I believe this is the first value-oriented firm coming public in a long time. Most of the management firms that have accessed the public markets via ipo over the years have concentrated more on growth investing.
As of 6/30/07, PZN managed $30.6 billion in assets. Revenues are generated on advisory fees earned on assets under management. For these type firms, the level of profits and growth are directly tied to the size and growth of assets under management. PZN earns about 1/2 of 1% annually on assets under management. The goal of PZN and those of their ilk is to invest those assets in a way that will generate strong annual gains as well as attract new money inflows to their funds.
PZN invests strictly on a value oriented approach, eschewing growth metrics. They've ten distinct value oriented strategies that differ by market cap and geographic focus. As of 6/30/07, PZN managed separate accounts on behalf of over 375 institutions and high net worth individual investors and acted as sub-investment adviser for twelve SEC-registered mutual funds and ten offshore funds. PZN has seen net-inflows annually each of the past five years.
PZN's value investment philosophy can be summed up as follows:
we seek to make investments in good businesses at low prices...we are focused on generating excess returns over the long term.
Asset growth has been impressive. On 12/31/03, PZN managed $5.8 billion in assets. They grew to $10.7 in 2004, $16.8 in 2005, $27.3 in 2006 and $30.6 as of 6/30/07. It should be noted that the first half of 2007 saw lowest dollar amount of net inflows since 2004. Net inflows the first half of 2007 were $1.3 billion, well below the first half of 2005 and 2006.
PZN's four main investment strategies, Large Cap Value, Value Service, Global Value and Small Cap Value have outperformed their benchmarks by 3%-5% since inception. Note that while PZN underperformed during the bull run of the late '90's, they outperformed massively in the difficult markets of 2000-2002. Since 12/31/95, PZN has easily outperformed both the S&P 500 and the Russell 1000 value index.
John Hancock Advisers - Part of PZN's rapid growth the past three years has been due to a strategy of forming strategic relationships with 'sub-advisers', essentially managing the assets of investment funds. PZN has a close relationship with John Hancock Advisers, managing mutual funds for Hancock. PZN acts as the investment 'sub-adviser' (read: asset manager) for the John Hancock Classic Value Fund, the John Hancock Classic Value Fund II, the John Hancock International Classic Value Fund (JICNX) and the John Hancock Classic Value Mega Cap Fund (JMERX). These four funds combine for approximately 1/3 of all of PZN's assets under management. In the past 18 months, 20%-25% of all PZN revenues have been directly from assets managed for John Hancock.
Note - The third quarter of 2007 was characterized by a period in which value stocks underperformed heavily, as evidenced by the huge losses sustained by quant funds heavily long value and short speculative stocks. The rough quarter for value stocks did not leave PZN unscathed. PZN's assets under management as of 9/30/07 declined $1.7 billion to $28.9 billion. PZN saw net inflows for the quarter of $0.4 billion, meaning markets losses were $2.1 billion for the quarter alone. In other words PZN lost 6.8% across the board on their investments in the third quarter of 2007 alone. Third quarter was a rough quarter for the value approach indeed.
PZN's value strategy - PZN generally invests in companies after they have experienced a shortfall in their historic earnings, due to an adverse business development, management error, accounting scandal or other disruption, and before there is clear evidence of earnings recovery or business momentum. PZN's approach seeks to capture the return that can be obtained by investing in a company before the market has a level of confidence in its ability to achieve earnings recovery. Obviously the risk here is that the troubled company is unable to manage a turnaround. PZN's portfolios are concentrated, generally with 30 to 60 holdings of companies underperforming their historical earnings. When PZN enters a troubled company, they usually enter in pretty good size due to the relatively concentrated approach. Top holdings as of 9/30/07 included Citigroup (C), Allstate (ALL), Freddie Mac (FNM), Wal-Mart (WMT), Alcatel-Lucent (ALU) and on the international side ING (ING) and Mitsubishi (OTCPK:MSBHY).
PZN will have about $50 million in debt (minus cash on hand) on the books post-ipo. Not enough to make much of a difference with $29 billion in assets under management. Should be noted, however, that the debt was taken on to fund a dividend payout to insiders pre-ipo.
PZN does plan on paying dividends of $0.11 quarterly. At an annualized $0.44, PZN would be yielding 2.6% annually on a pricing of $17.
2006 - PZN had total revenues of $115 million. Again revenues are generated from advisory fees based on assets under management. Unlike the hedge fund/private equity ipos we've seen in 2007, PZN does not generate revenues based on a percentage of portfolio gains quarterly or annually. Compensation and benefits expenses were a fairly low 30%. This is well below investment banking/private equity/M&A ipos of the past few years, all with compensation expense & benefit ratios in the 50%-60% ballpark. General and administrative expenses are minimal here, just 7% of revenues. Operating margins were 62%. Plugging in full taxes, net margins were 40%. Earnings per share were $0.71. On a pricing of $17, PZN would trade 24 times 2006 earnings.
2007 - As PZN derives revenues from total assets under management and not gains on those assets, the bad third quarter won't kill their year. That is, assuming the 3rd quarter of 2007 was an anomaly and not the beginning of a trend. PZN actually had a very solid third quarter operationally, as assets under management for the quarter, while they slipped, were still near all time highs for PZN. Through 3 quarters, revenues for 2007 are on pace to be $148 million, a 29% increase over 2006. With the ipo, the compensation expense and benefits ratio will actually decrease, as a chunk of this expense line will be shifted to equity compensation and ipo shares. Expect this expense line to dip to 23% or so, which will boost operating margins. 2007 operating margins should increase to 70%, with 43% net margins. Earnings per share should be in the $1.00 ballpark. On a pricing of $17, PZN would trade 17 X's 2007 earnings.
Looking across the publicly traded asset managers, nearly all trade 20-25 times 2007 earnings, indicating a bit of a discount here with the PZN pricing range. I suspect this in part due to the rough third quarter for PZN's investments. If you look at PZN's track record over the past twelve years, the odds appear in favor of the third quarter of 2007 being an anomaly and not the beginning of a trend. As long as that is the case, PZN is an easy recommend in range. One thing you do not want to see here, however, is another quarter of a drop in assets under management. I applaud PZN for having the fortitude to come public in a quarter in which their investments got knocked around pretty good. If PZN is able to return to their historic levels of gains on assets under management, the pricing range here offers good value mid-term plus.