Since late July, nearly everything related to the financial sector has been sold off by panicky investors fearful of finding themselves holding worthless paper. Securities that have been particularly hard hit have been those related to the new alphabet soup of recently invented financial instruments, such as ABS CDOs CLOs & TruPS. The firms that hold these securities have been hammered indiscriminately, while some have gone under those that were well balanced have been left behind at ridiculously low valuations.
Resource America (NASDAQ:REXI) fits squarely into both of these categories. Resource America’s connection to these troubled securities poses no real balance sheet risk as it is purely an asset manager, collecting only large amounts of fees that result in a large free cash flow. The asset management division coupled with the company’s other divisions makes the company incredibly attractive with a low level of risk at its current price.
Resource America is first and foremost an asset management company that manages investors’ funds with long-term contracts through subsidiary companies targeting three different asset classes: financial funds, real estate and commercial leasing. The benefit of Resource America’s asset management model is that while Resource America manages some funds in toxic areas, Resource America is not exposed to any credit risk directly. The majority of Resource America's current value however comes from the funds that it manages that invest solely in solid asset classes.
Resource America, like most management companies, charges an annual management fee based on the assets in the funds it manages with additional performance-based incentive fees. Thus, even in markets that are harmful to the funds Resource America manages, it can still collect management fees and if the fund blows up, which is not likely, none of the credit risk will flow up to Resource America. The vast majority of the liabilities are thus essentially quarantined in Resource America’s subsidiary funds and not at the holding company level.
Managing assets owned by others is a very lucrative business. By managing funds holding the assets of others and taking the resulting cut of the profits, Resource America is essentially gaining the benefits of leverage on the assets it manages without being exposed to the downside risk.
Resource America’s financial funds segment has been hard hit by the credit crunch. The revenue generated from this segment has been impacted by asset write-downs. Resource America’s publicly traded REIT, Resource Capital Corp. (NYSE:RSO), originates and invests in commercial loans. Resource Capital has held up better than most finance REITs due to its funding being derived solely from long-term loans and strong credit performance in the securities it holds.
Resource America has been using the recent market dislocation to secure management contracts for new funds in the financial product space. Including the recent $1.3B addition of CLO funds, assets under management in the financial fund space have grown 22.8% over the past year. However, revenues have been impacted by asset write-downs and dropping incentive performance fees.
Financial fund management was formerly Resource America’s largest division prior to the credit crunch. However, in the current environment, cash flow from this segment has declined. As credit markets turn around in late 2008 and early 2009, this division of the company should be able to increase its growth going forward.
Real Estate Funds
Resource America’s real estate management segment manages real estate investments for investors. Primarily, these funds manage apartment buildings. Resource America has also been using the recent real estate market dislocation to add to its assets under management in this area. Assets under management in the real estate segment are up 31% over last year. This business segment is quite stable.
Resource America’s commercial leasing company LEAF Financial is the real crown jewel of the company. LEAF Financial uses investor funds to purchase office, medical, dental, industrial & HVAC equipment and LEAF then leases this equipment to businesses. LEAF Financial's services are also used by vendors who want to provide leasing arrangements to their end users. The division has also managed to build significant relationships with regional leasing firms.
For the LEAF Financial division to have any real problems would not only require widespread business failures resulting in significant businesses going bankrupt, but also would require LEAF Financial to be unable to find new customers that need to lease its equipment. Such a deep recession is not likely, as the Federal Reserve has shown its willingness to mitigate such an event. Commercial leasing has historically been one of the most stable areas in the financial sector. Industry wide, commercial leasing's strong performance can be seen in the continuing low default rates.
Another trend in the industry has been for larger and more credit crunch exposed companies to begin selling off their leasing operations and lease portfolios. One example is CIT Group; this trend will allow Resource America to expand its market share significantly in the coming years.
Resource America has used the credit crunch to expand substantially the assets under management at LEAF by purchasing the leasing operations of many distressed companies. Even more important, LEAF's ability to raise capital through its investor partnership program continues to exceed management's expectations. This gives LEAF a unique ability to access cheap capital to expand when most companies are just trying to raise liquidity to prevent bankruptcy.
Resource America also uses investor partnership programs to raise funds in other areas as well. Raising substantial investor funds through partnership programs requires a huge network of dealers and a long history of solid performance, the combination of which is difficult for other companies to replicate. This represents a significant moat for the company's business as well as allows for significant cost advantages over its peers.
Resource America built from scratch a similar leasing operation in the late 90s called Fidelity Leasing. Resource America sold Fidelity Leasing in August of 2000 for $152M plus the assumption of all of its debt. At the time, Fidelity Leasing had assets under management of $479 million and Fidelity Leasing was originating at the rate of about $500 million a year. Today, LEAF Financial is managing $1.7 billion and originating in excess of $1 billion per year. These metrics make LEAF appear to be worth somewhere north of $400 million. The value in this division alone dwarfs that company’s market cap.
Resource America has also been expanding its efforts in the management of distressed loan funds and distressed real estate. This has been a popular area for many companies to expand into. The company has decades of expertise to draw on in this area while most firms are just starting their operations.
Ownership of Other Publicly Traded Firms & Real Estate
Recently, Resource America has filed an IPO for a blank check company named RAI Acquisition Corp. that will focus on acquiring banking assets. Resource America owns 7,187,500 shares of RAI, which will IPO sometime in the coming months at $10 a share This will make Resource America’s stake worth almost $72 million. Once RAI acquires assets, it will also further increase the funds that Resource America is receiving management fees on.
Resource America owns 2 million shares of Resource Capital and 118 thousand shares of The Bancorp (NASDAQ:TBBK). These positions are worth a little more than $20 million. By the end of the year, Resource America should own control over $90 million dollars worth of publicly traded companies, all at the holding company level.
Resource America also owns real estate that is worth in excess of $30 million that is on its books for about $15 million. As for debt, Resource America is only responsible for $70.0 million of corporate level secured revolving debt; and $16.8 million of other debt, which is principally mortgage debt secured by properties owned by the company's subsidiaries. Management anticipates being able to reduce or eliminate all of this debt by the end of the year due to the firm’s large free cash flow.
Valuing the Company’s Assets
So, what is Resource America worth? In short, it is worth a large multiple of the current stock price. Resource America’s market capitalization is a mere $142 million. Below are the easy to value segments of the company:
- $400 million for LEAF
- $72 million for REXI's RAI acquisition shares
- $20 million for the RSO & TBBK shares
- $30 million in real estate
- $11 million in unrestricted cash
- Minus corporate level debt of $87 million.
If you add up the following figures you well get a current book value of nearly $450 million or $24 dollars a share, if everything were liquidated today. It is important to note that this assigns zero value to Resource America’s financial funds & real estate management segments. It also does not included is the company’s plan to repurchase $50 million worth of its own shares, representing an impressive 35% of the total company.
Valuing the Company’s Cash Flow
Another important aspect of the Resource America story is the large level of free cash flow that it spins off. The company generated $35.15 million in adjusted cash flow from operations in the last two quarters and had capital expenditures of $5.5 million for the last two quarters. If you expand these figures, Resource America will be generating about $59 million in free cash flow for the year, a rate that is likely to only increase.
In valuing Resource America’s free cash flow, I believe that Brookfield Asset Management (NYSE:BAM) can be used as an example. Brookfield is generating almost $2 billion in free cash flow per year. The company’s current market capitalization is $22.4 billion giving Brookfield a multiple of 11.2 times free cash flow. If Resource America were trading at the same multiple it would be worth $660 million or $35 per share. Again, this doesn't take into account the 35% share buyback Resource America will be undertaking for the year or the fact that its growth rates are substantially higher then Brookfield.
Understanding the Current Valuation
The current market capitalization of Resource America is well below the figures I have outlined above, and this is for several reasons. First, Resource America’s management of a number of alphabet soup financial product funds has probably enticed many investors to sell first and ask questions later.
Secondly, a firm by the name of Spencer Capital Management has dumped about 600,000 shares over the last 2 months. This should not be viewed as a vote of no confidence for Resource Capital. Spencer Capital has had a poor year with large holdings in Borders Group (BGP), Sears Holdings (NASDAQ:SHLD) and TravelCenters of America (NYSEMKT:TA) all collapsing in share price. I would imagine that such poor results have resulted in large redemption requests. More importantly, Spencer Capital was purchasing Resource America shares as recently as late February so the firm clearly saw value in Resource America prior to their Q1 08 redemptions.
The CEO of Resource America has purchased over $600,000 worth of shares over the last 6 months with a purchase as recent as 3/31/08. On an interesting side note, Resource America is run by the Cohen family, which has this tendency to print money with their investments. They currently control the following:
REXI, RSO, ATLS, AHD, APL, ATN, AFN, RAS & TBBK.
One worry for Resource America is the coming restatement for its Trapeza subsidiary, which manages CDOs. Worst case, Trapeza is basically a call option on the return of the CDO market. I think CDOs, in some form, are here to stay as they have allowed for significant financial innovation, when the CDO market returns Trapeza will likely be a strong growth area for Resource America in the future.
One possible catalyst that Resource America could see over the next 12 months is the spinoff of LEAF Financial. LEAF Financial alone is probably worth 2 to 3 times Resource America’s entire market capitalization. Resource America’s last spinoff, Atlas America (NYSE:ATLS) (which I have written about here), has risen from a split adjusted $6.88 per share in 2004 to over $70 today, implying that Resource America’s management has the profound ability to create shareholder value. Atlas America’s market capitalization is currently more than 13 times Resource America’s market capitalization. I would expect LEAF Financial's future to be just as bright.
Whether Resource America should be worth $24 or $35, I cannot be certain. Regardless, Resource America is trading at a substantial discount to what it should be worth. With Resource America’s solid history of creating value and strong positioning in the low risk asset management industry, its stock is a value I find too good to pass up.
Disclosure: Long REXI, ATLS, AFN.
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