Westwood Holdings Group (NYSE:WHG) is an funding supervisor with $14 billion in AUM.
The corporate’s merchandise consist principally of mutual funds and energetic methods supplied to establishments and high-net-worth people. Lively cash managers have suffered web outflows for many years, and WHG isn’t any completely different, with natural web outflows in 11 out of the previous 15 years (and 9 of the previous 9).
Including to the issue, WHG has been unable to regulate its value construction, principally composed of worker compensation, to guard profitability. The corporate’s prices have been decreased, however nonetheless, the corporate’s margins have collapsed.
WHG’s long-term headwinds should not anticipated to vanish, and the corporate has been unable to adapt. WHG’s dividends are poorly coated, and most share buybacks are re-issued as share-based compensation.
The corporate isn’t a chance at these costs.
Notice: Until in any other case said, all data has been obtained from WHG’s filings with the SEC.
Business headwinds: As talked about in my article about Hennessy Advisors (HNNA), the energetic public funding administration trade has been severely broken by the proliferation of passive autos.
These autos don’t cowl solely easy methods like lengthy the S&P 500 or quick Treasury bonds. They permit establishments and retail buyers to allocate extra complicated mixtures, selecting sectors, market caps, geographies, kinds, and so on. Additional, at a fraction of the associated fee and considerably related returns because the mutual fund or energetic technique counterparts.
WHG has not been proof against this pattern, with natural web outflows in 11 out of the previous 15 years and yearly since 2014. The corporate has counteracted this by buying different funds, however the natural pattern is just too sturdy.
Self-inflicted wounds: The income fall is a actuality, though the corporate might have perceived that pattern earlier and moved in the direction of extra protected realms (like actual belongings or personal fairness), solely doing so in 2022 with the acquisition of Salient Companions.
Nonetheless, the corporate might have decreased its workforce or the compensation that it pays to that workforce to guard profitability. I perceive that is simpler mentioned than performed as a result of funding managers typically have important operational leverage (on the upside and the draw back).
Robust steadiness sheet: The corporate amassed important money and funding reserves when it was a really worthwhile (30% working margin) enterprise. A part of these reserves continues to be with the corporate.
Paying dividends out of capital: The corporate has paid extraordinary dividends to shareholders that aren’t coated by earnings and due to this fact are a return of capital. These dividends shouldn’t be thought-about recurrent. As of FY22, the corporate isn’t overlaying its dividend with working earnings.
Money flows are not any higher: The corporate boasts a lot better FCF than web earnings. Nonetheless, the distinction is generally defined by stock-based compensation and the incorporation of modifications in securities as a part of the CFO (normally goes in money from investing).
Additional, the corporate’s share repurchases are solely helpful to cowl the stock-based compensation, with the general share rely remaining stagnant. Even the massive buy of 2020 solely decreased the share rely by 8%.
Shifting to alternate options: The declining public enterprise is a actuality. The corporate has now entered the realm of different investments and actual belongings by buying Salient Companions, with an AUM of $2.7 billion, for $33 million.
Salient has choices in personal fairness, actual belongings like wind farms, and a commodities buying and selling arm. This variation is wholesome, on condition that the headwinds towards energetic managers haven’t disappeared, however doesn’t assure profitability development.
The choice investments trade can be aggressive and should have grown quick solely beneath the safety of QE and low charges for the previous 15 years. For instance, Salient managed $27 billion as shut as 2015 however was offered whereas managing solely $2.7 billion.
Multiples: WHG generated web losses in 2020 and 2022, partly fueled by losses on their investments and the sale of their European subsidiaries.
However additionally they generated working losses in these two years. Suppose we take away acquisition prices from the Salient deal ($7 million over a $33 million deal, excessive) and impairment bills in 2020 ($3.5 million). In that case, we arrive at $1 million in working revenue for 2020, $6 million for 2021, and $2 million for 2022.
The typical of $3 million could possibly be thought-about a measure of profitability. In fact, ignoring the bills we now have not added and the funding losses.
Westwood trades at a market cap of $95 million, or a 32x a number of of adjusted common working earnings. For a corporation struggling persistently from sturdy trade headwinds, it appears extreme.
In fact, WHG’s fastened value construction can considerably improve working earnings by a comparatively small improve in income. The issue, for my part, is that development must be substantial to return even a ten% earnings yield (contemplating taxes, which we keep away from when utilizing the a number of on working earnings) and that these earnings must be sustainable, which isn’t assured given the trade backdrop.
WHG has suffered from its trade’s ailment, unable to develop organically for a lot of the previous 15 years.
The corporate grew via acquisitions however couldn’t act towards the larger pattern and transfer earlier into alternate options. Final yr’s acquisition of Salient is probably not sufficient to revitalize the corporate, notably if the choice funding trade suffers from excessive rates of interest.
The issue isn’t the context or the corporate however the inventory’s value. At present costs, the corporate trades at an unlimited a number of of adjusted working earnings.
That value incorporates a major enchancment in profitability (a minimum of quadrupling working earnings or rising revenues by 10% given the working leverage), but in addition sustainability on these earnings, one thing that the context doesn’t assure in any respect.
Due to this fact, I consider WHG isn’t a chance at these costs.
Editor’s Notice: This text covers a number of microcap shares. Please concentrate on the dangers related to these shares.