About the only positive thing you can easily say about AllianceBernstein Holding LP (NYSE:AB) is that this limited partnership pays out a large portion of its earnings as a distribution to unitholders - not that management has any choice, given the rules that govern the taxation of limited partnerships. To be sure, AllianceBernstein doesn't immediately leap out as a great play on the investment management industry, given the company's troubles growing assets under management and maintaining a consistent payout.
Management does not seem to be kidding itself about the need to change and improve performance. Better integration between Alliance and Bernstein, as well as the addition of W.P. Stewart gives hope for better results in equity investments, and a greater focus on costs could lead to impressive earnings growth if better investment results can draw in more AUM. With a fair value in the range of $22 to $23, I don't think AB shares are all that cheap, but a 7% yield holds some appeal.
As is the case with all limited partnerships, the taxation of these investments is different than for normal equities and not appropriate for all investors/accounts. Look into the tax ramifications of owning units in a partnership like AB before investing.
When One Plus One Equals Zero
The combination of Alliance Capital and Sanford Bernstein in 2000 should have been a powerful one. Alliance was a successful and well-regarded growth-oriented equity shop, while Bernstein was a respected name on the value side (and 2000 marked the start of a six-year run where Bernstein was ranked first across the board in Greenwich Associates' evaluation of sell-side research).
Unfortunately, the real results have fallen far short of expectations. Alliance Capital got itself in trouble in the market timing scandal that hit the mutual fund industry a decade ago and there was never a good integration or synergy between the growth-focused Alliance and the value-oriented Bernstein. Assets under management peaked in 2007 at about $800 billion, and then plunged due to poor investments (AB was a major investor in Lehman Brothers, Fannie Mae, and Freddie Mac, all of which were basic bagel-shots) and and client outflows.
For the last five years, assets under management have basically bounced around between $400 billion and $500 billion, even as the company has shifted from an equity-heavy focus (72% of AUM in 2007) to more reliance on fixed income (60% now) and a greater global client base (more than one-third of AUM is sourced from outside the U.S.). AB generates about 70% of its revenue from management fees tied to AUM, so that inability to grow AUM has been a serious limitation on distribution growth and stable appreciation in the units.
The Fix Is In, But It Will Take Time
Management is working to fix these problems, though skeptics may rightly note that management has been talking about generating better results for quite some time now.
Although institutional money can be surprisingly sticky, there is no argument with the basic idea that fund flows follow returns. With that, AllianceBernstein is working harder at better blending the relative strengths of Alliance and Bernstein. AB also continues to work on new investment products. AB lacks the ETF businesses of other managers like BlackRock (NYSE:BLK) and Invesco (NYSE:IVZ), but the company has nevertheless been rolling out a variety of new equity investment products for institutional and private clients.
Management also continues to build the fixed income platform. Expanding a fixed income product suite during a period of where rates are expected to rise certainly carries some risk, but the betas and relative performance of AB's fixed income products has been encouraging. It's also well worth noting that the sheer size of the fixed income management space all but demands a sizable presence if AllianceBernstein really wants to be a major destination for large institutional fund flows.
Last and not least, AB management is focused on cost containment and margin leverage. Given that this is the most controllable part of management's plan, I'm not surprised that it is the one that has attracted the most investor focus. It is also true that a leaner cost structure can allow for significantly better scale and operating leverage if the company can return to a sustained period of fund inflows.
I understand the focus on margins, as AB's operating margins have notable lagged those of BlackRock, Franklin Resources (NYSE:BEN), and Invesco for some time. Management will need to be cautious, though, as compensation expenses are a meaningful part of overall operating expenses (more than 40% of revenue) and talent will walk out the door and across the street if management goes too far in trying to limit compensation packages and/or spending on research and trading tools.
Stabilize, Then Grow
AXA's (OTCQX:AXAHY) sale of the MONY Life Insurance business to Protective Life led to $7 billion in redemptions of low-fee business and the fourth quarter will probably see outflows in excess of $10 billion. Even so, it looks as though institutional flows are improving and I'm optimistic that AB has stabilized the business.
I approach valuation with a P/E and excess returns approach. AB has long traded at a discount to other fund managers, and I see no reason for that to change until the company proves that it can grow AUM and deliver better margins. With that, a 13x multiple (1.75 times the expected five-year growth rate) to the 2014 EPS estimate leads to a target of $22.50. The excess return model generates a similar target ($23) on an assumption of improving returns in 2015.
The Bottom Line
Investors should note that AXA owns over 60% of AB and shareholders have effectively no control or say in the management of this business. Nevertheless, if the efforts to turn around equity investment returns and grow the fixed income platform bear fruit, I can see a path for higher distribution payouts in the future and a better multiple for the units. For now this business is definitely still a "show me" story that deserves healthy skepticism, but investors can at least pocket a worthwhile distribution while waiting for these self-improvement efforts to show results.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.