Sculptor Capital: Turning A Corner
Summary
- Sculptor Capital has had a shaky history over a legal dispute. Settled in 2020, the main damper on the stock has been removed leaving an attractable company cheaply priced.
- There have been several changes towards the company's leaders, names, performance, and ratings.
- As of May, AUM has slightly decreased to $36.8 billion or the exact same level as the end of 2020.
- In a partnership with Diamond Communications LLC, Melody Wireless was acquired for $1.625 billion. This affects Diamond more in its stance as a communications tower company, but should still be addressed.
Sculptor Capital Management, Inc (NYSE:SCU) is a global asset management company centered in New York and other various offices throughout the continents. In 2016, the company embarked on a long, painstaking legal journey that had horrible effects on the company's balance sheet and stock. In 2020, Sculptor Capital Management announced all legal remains should be cleared up with the payment of over $136 million to investors. The scandal is over and the clouds have parted, but the beaten-down stock has yet to rebound to its original prices.
This legal case is nothing new and has been covered by several authors, so a summary of the incident is as follows: There was a conflict between Africo and a competitor over ownership of a copper/cobalt mine when a businessman offered C100 million, but was also involved in several bribes with government officials. Africo lost the mine and paid millions in a bribery settlement (not to mention individuals in the company having to pay as well). It wasn't over just yet, as certain investors argued they were victims by law. Some more information can be found here and here.
Management is organized under three categories: Real estate, multi-strategy, and credit. Real estate is self-explanatory, whereas credit is broken down into opportunistic credit, institutional credit, and private credit. Multi-strategy is centered around a variety of other assets. All of these seek to take advantage of opportunity in their respective category, as such, profit for Sculptor Capital is almost completely dependent on incentive fees and management expenses. Consumers make a differing base payment and a scalable payment dependent on the returns of whichever fund they chose. The conclusion from this shows the direct reliance on assets under management, since the more money the company regulates, the more it gets paid.
This legal case had a massive negative effect on the company's inflows, stock price, and assets under management, with the largest effect on a largely negative brand recognition. Gross profit, operating income, EBITDA, and net income all took a major hit, and the stock felt it:
Source
However, the beatdown, which the scandal caused, has left the stock in the dirt despite the case ending in 2020. It’s already begun to rebound, but still shows much more upside.
Fitch ratings had changed market outlook to negative and even "downgrade" at some point, while quant ratings deemed the stock a sell throughout nearly the entirety of the fiasco. However, despite the legal and financial tornado on the stock, it was still valued around the 30 dollar range (with a $40 high). Right now, the stock is just over $20 being backed by a largely more attractive/stable company and down 30% from the stock price during the legal mess.
Potential Upside
At a first glance, there isn’t anything incredibly interesting about Sculptor Capital’s balance sheet. As I’ll show next, the first quarter had its pros and cons, but otherwise a relatively bland quarter. Revenue fluctuated as expected, assets under management grew (before dipping), and assets/liabilities decreased. The biggest outline for Sculptor isn't necessarily their performance as much as the Africo case that handicapped the stock for years. My thesis revolves around looking at Sculptor before the case, during the case, and present day. Given that the victims have been paid and legalities cleaned up, the case is over, presenting a catalyst for the stock to return to its price (or at least recover a decent amount of ground). The following is a comparison of Sculptor in the middle of 2015, the end of 2016, and the middle of 2020.
September 30, 2015 | Dec. 31, 2016 | September 30, 2020 | |
AUM | $48.0B | $37.9B | $36.0B |
Net Income (TTM) | $132.7M | ($124.7M) | $184.3M |
Revenue (TTM) | $836.8M | $770.4M | $564.1M |
EPS - basic | $0.10 | ($0.72) | $0.35 |
Stock Price | $116.50 | $33.10 | $11.74 |
Source: Seeking Alpha and Filings
Six years ago, Sculptor had revenue of nearly twice what it is today and a whopping $12 billion more in assets under management, yet the stock price is just under five times the price it is today. At the end of 2016, the company had slightly more assets under management, with its biggest boast having made $200 million more in revenue. The quarter had a negative basic earnings per share and a negative net income, yet, again, the stock price was 50% greater than what it is now. I did want to use other price multiples, but the majority of them resulted as "N/A" and would be unnecessary information on the table.
But why the third quarter of September, shouldn't it be better to compare the most recent quarter? I originally used the first quarter of 2021, but demonstration-wise the third quarter was more presentable; the third quarter (2020) had weaker revenue and decent net income whereas the first had very strong revenue and much weaker net income. In other words, the first quarter of 2021 was much more polarized. Rest assured, Q1 of 2021 had a higher (TTM) revenue of both the 2015 and 2016 quarters, higher basic earnings per share than the 2016 quarter, and a higher net income than the 2016 quarter. Should I have compared Q1 of 2021, then the only numeric that the last quarter of 2016 wins on is assets under management by just $1.9 billion in assets, while still having a stock price 50% higher than that of March 31, 2021.
Currently, Sculptor Capital stands at around $23. Although still on the table, I doubt the stock will increase tenfold to its original 2015 price. Instead, I'll give the stock a 50% upside to over $30 should it rebound, since that was the price it hovered at for several years before dropping (during the legal case). The bear case is much less extreme, as displayed by the Q1 of 2021 and the company's buying power, given Sculptor's stability. The negative case isn't really negative, it's "non-moving" instead. Rather than rebounding, the negative outcome is the stock simply stays put. But past history has shown it's already jumping in performance compared to the S&P 500 and 5-year performance.
Source: Seeking Alpha
Notice the end of 2020 for both, the boost from the legal case sparked a decent amount of movement in the stock. But, considering the strong rebound, the stock still has an upside towards $30 given its prices during the scandal and the scandal itself being removed. Another important note is the "pre-covid" price, anyone who's brushed the markets before knows it isn't easy to find large or mega-cap companies who are cheaper than their pre-covid prices (except, of course, airlines and other targeted industries). Towards the beginning of 2020, it appears the stock was actually hitting its stride before the legalities had been completely cleaned up, but plummeted in the pandemic crash.
First Quarter Performance and AUM Growth
Sculptor Capital had a very noticeable year during 2020, with a spike in revenue during the fourth quarter. This jump to $604.8 million is no doubt unrepeatable and unsustainable. Revenue dropped back to $123.3 million, which is much more reasonable compared to 2020's Q2 and Q3 of $101 million and $112 million. The story is similar in other aspects of the company's financial statement; operating income peaked at $246 million in the fourth quarter when it was $23 million just months ago, net income soared from $10 million to $218 million, and EBITDA grew to $248 million from $24 million. Clearly, it's impossible to compare the first quarter of 2021 to the last of 2020 given these peaks. So, the performance of this quarter will be compared to the third quarter of 2020, given that it was the most recent and realistic. Negatives are highlighted by parenthesis.
2020 Q3 Results | 2021 Q1 Results | % Change | |
AUM | $35,984M | $37,374M | 3.86 |
Revenue | $112M | $123M | 9.82 |
Gross Profit | $46.9M | $34.1M | (27.29) |
Net Income | $10.3M | ($20.3M) | N/A |
EPS | $0.56 | $0.62 | 10.71 |
Total Assets | $1,296.5M | $1,161.5M | (10.41) |
Total Liabilities | $985.0M | $794.5M | (19.34) |
First quarter results were mixed, so let's separate the more positive and negative changes. Coming out strongly is the increase in revenue, EPS, and reduction of liabilities. Assets under management grew and total assets decreased, but the reduction doesn't prove harmful given the greater decrease in liabilities. Finally, gross profit and net income took a major hit, which again canceled out the increase in revenue.
Assets under management did dip in May to $36.8 billion or the same level as the final quarter of 2020. There is no sure reason behind this and no cause for alarm, such a massive pool of assets means there will be slight variation and volume of money coming in and out. Jimmy Levin in Sculptor’s shareholders’ letter stated, “There is one thing I can be certain of - we will never sacrifice returns, quality, or culture at the altar of short-term AUM growth. This should leave us ample room to thrive and prosper without jeopardizing the keystone to our fundamental success.” It is important to remember increasing assets under management is the best way to accurately increase revenue. Sure, there is strategy to be had with managing select securities, the company is already very focused on returns, but the more money being managed, the more Sculptor can make in fees. Returns are a lot more certain when increasing how much is controlled compared to how well the assets are controlled. Despite the recent fluctuations, there has been obvious long-term AUM growth in the past years seen in their credit and real estate funds, with the company focusing to continue this path.
As defined in the shareholders’ letter and Q1 earnings transcript, real estate funds are broken down into four-year “investment periods” and four-year “harvest periods”. Currently, the company is investing and building up its fourth real estate fund, with the majority of the second fund being juiced, and the third is in its back-end harvest period. 
The company has consistently had amazing growth in their real estate funds, and we can expect to see it continue in the upcoming years given the much larger fourth real estate fund, which has scaled considerably from previous funds.
Thesis - Risks and Stability
The number one risk and hindrance of Sculptor Capital has always been its legal troubles. The stock has dropped hundreds of dollars from its highs, inflows from fund performance dried up, and the image of the company was stained. In the company's efforts to put the case behind it, changes were made to leading executives (e.g. CEO and CFO), the company's name was changed from "Och-Ziff", and the ticker was changed accordingly. That being said, now investors can look over Sculptor's aspects as a company without needing to take a legal position into account.
Aside from the Africo case, there doesn't appear to be many risks in the company. There's always the chance of assets under management disappearing or disappointing returns from funds, yet for what reason would those occur (besides expected fluctuations)? Even if revenue hardly grew within the next couple of years, the company would be stable and its stock largely unaffected. This is displayed in a number of ways, with the first already being shown in the company’s Q1 2021 stance. There were returns not to be overlooked, but the point was to show the company didn’t have its best nor its worst quarter.
Secondly, is the acquisition of Melody Wireless Infrastructure. Sculptor Capital Management partnered with Diamond Communications LLC to buy the REIT for $1.625 billion with investment funds from Sculptor Real Estate. Sculptor Real Estate and Diamond Communications have served alongside each other for several years, and the acquisition no doubt strengthens the bond between the two. However, it is clear acquiring the communications infrastructure serves Diamond in more ways than it does Sculptor: first, and more obvious, Sculptor Capital's real estate portfolio is much more diverse, spanning across 25 asset classes. 
Source: Sculptor's website
Cell towers only make up a fraction of Sculptor's real estate portfolio, so although it does seem a worthy acquisition, it's hardly an influential portion of Sculptor's real estate portfolio. Should the investment turn sour or return incredible results, it shouldn't affect the majority as much as a loss might hit the bigger asset divisions. Secondly, buying Melody Wireless was much more targeted towards Diamond Communication's staple as a privately-held wireless infrastructure giant. Diamond's CEO, Ed Farscht, has already outlined this in a press release. More than anything else, the acquisition represents Sculptor’s increasing buying power and ability to make much larger acquisitions within means.
Finally is the change in ratings. Quant ratings deemed the stock a sell throughout the entirety of 2016, but now have fluctuated between neutral and bullish, with mostly A’s in the stock’s value. Fitch ratings have changed their market outlook rating to stable, compared to the negative outlooks throughout 2016:
That's why it's hard to see much downside to the stock, it has good potential upside at best while being stable at worst. In other words, the most likely negative outcome to the stock isn't a crash, it's that it just won't move. The biggest risk is the stock being stagnant, with the loss being time and potential gains in other investments.
Summary
A 2016 bribery scandal has tormented Sculptor Capital Management for years, originally starting from a dispute over ownership of a mine and snowballing into investors demanding pay, losing the mine, and shelling out hundreds of millions of dollars from the company's pocket. The stock was beaten badly, perhaps too badly, to the point of it being half the price it was years ago despite the company being better off financially. The legalities were cleared up in 2020 and what remains is a stable company (engaged in recent borrowing and acquisitions) and a stock passing the S&P 500 as a result of removing the hindrance. Now that the dust has settled, what's left is a stock backed behind a stable company while only costing a fraction of previous prices during the legal process.
It only makes sense that the absence of a scandal will allow the company to freely act and focus on itself more, and that the stock now has the catalyst to return to the prices during and perhaps even before the legal case. Given that the stock has already kicked off, there remains a 50% upside within a couple years, so long as the company remains growing or stable in its assets under management and the stock doesn't become stagnant.
This article was written by
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Recommended For You
Comments (6)
