UK AIM-Listed Charlemagne Capital Limited (CCAP) – Still No Margin of Safety
The company has been trading near its three-year lows (although current price is near 52-week high), so was worth a bit of further analysis. The current price (Oct. 17, 2013 – 14.10p) equates to about £40 million in market cap, i.e. around $56 million (accounts are all in USD so need to look at market cap in USD).
The company has a cash balance ($22 million – 39% of market cap) and no debt. This is a big plus.
The directors hold 31% of share capital. Founder CEO, Jayne Sutcliffe, holds 11% and non-executive director, James Mellon, holds around 19% (he set up Regent Pacific along with Jayne Sutcliffe – CCAP was formed out of this entity). This is another positive sign.
The company has paid dividends each year since 2004. Its policy is to pay out regular dividend to reflect the earnings and cash flow of the Group. A point to note is that in the last couple of years dividend level as been maintained even though profitability has reduced. Most of the earnings have been paid as dividends over the last five years.
The capital allocation record of management is decent – most of the earnings have been used for dividends and buybacks. Although there has been no buyback in the last three years, there was a big amount of buybacks in the previous years. Overall share numbers have remained stable since 2006 when the company started trading on AIM. Over the last five years shares have increased marginally.
At the end of 2012, outstanding options were around 20 million with average exercise price of GBP 0.007 – so option overhang was around 7% of share capital. That is quite a lot. Apart from the CEO, other executive directors can receive share based incentives. During 2012, employees were given 16 million share options at a zero exercise price based on continuing service – thus no performance condition was involved. Granting non-performance related options is not a good sign.
The company gets its revenues from two types of fees: management fees which are linked to the assets under management (AUM) and performance fees which can be quite volatile. Over the last five years AUM have increased by around 4% per annum from the low at the end of 2008. However, revenues have decreased by around 7% per annum. Performance fees have held up okay since 2008, but management fees have taken a big hit. Since revenues are dependent on the average AUM over the whole year, let’s look at revenues from 2009 – they have grown by around 6.5% per annum in this case. Institutional clients are more sticky and stable compared to retail, but the company has not managed to increase AUM from this source substantially over the last five years.
In terms of profitability, operating income has reduced by around 3% per annum from 2009 to 2012. Operating margins have decreased from around 24% in 2009 to 16.5% in 2012. The interim results for 2013 highlight further drop in operating margin to 10%.
Personnel expenses make up most of the chunk of the operating expenses as can be expected in this industry. Moreover one would expect variable bonuses linked to performance to be a significant part of remuneration. The Annual Report mentions that bonus pools will be predominantly proportionate to profits. So it is a concern that personnel expenses have increased by around 11.5% per annum even though revenue levels have decreased. This is the primary reason for the drop in operating income.
Operating cash flow has been quite volatile over the last five years. All of this cash flow does not come to the company’s shareholders though. The reason is an employee of the Group holds a 49.9% minority interest in the shares of a group entity and has an option to acquire a further 12.6% of the shares. Major portion of the profit/operating cash flow seems to go out to minority interest holders. In 2010, 15% of net income went to minority interest – this has increased to more than 60% in 2012. After deducting this, the free cash flow (FCF) coming to company shareholders has reduced to $3.5 million in 2012.
Based on a FCF of $3.5 million, FCF yield to company equity holders is less than 7% per annum. The share option overhang has not been taken into account here. The FCF after minority interest needs to increase by at least 60% to justify the current market capitalization of $56 million to provide a FCF yield of 10%. AUM have further decreased as per the interim results of 2013, so there is no margin of safety.
Disclosure: As of this writing, I do not have any positions in Charlemagne Capital Limited (CCAP).
This research was produced by M. Joshi (the “Author”). Information and opinions presented in this research have been obtained or derived from sources believed to be reliable, but the Author makes no representation as to their accuracy or completeness. The Author accepts no liability for loss arising from the use of the material presented in this report. The Author may have long or short positions in (please refer to the Disclosure above), or may buy or sell any of the securities, derivative instruments or other investments mentioned or described in this research, either as agent or as principal for their own account. This research is prepared solely for information purposes and it does not constitute an advertisement. This document is not, and must not be construed as, a solicitation or an offer to buy or sell any securities or other financial instruments in any jurisdiction. By writing this research, the Author neither provides personal recommendations to, nor receives and transmits orders from, nor executes orders for, recipients of this research. This research should neither be passed on, nor reproduced in whole or in part under any circumstances without the Author’s express consent. This report is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation which would subject the Author to any registration or licensing requirement within such jurisdiction. The financial instruments described in this research may not be eligible for sale in all jurisdictions or to certain categories of investors.