David Abrams (Trades, Portfolio) showed up in Gurufocus real-time picks buying shares of Och-Ziff Capital Management. As I wrote in my last article covering Abrams buys; he is a true value investor, managing several billions of dollars and typically takes concentrated positions. He is very secretive but is known to be very patient and look for companies where the CEO has a significant stake, or where his salary is stock-based.
Och-Ziff Capital is an asset manager in the alternative space aka a hedge fund manager. The firm was founded in 1994 by Daniel S. Och and currently it has $39.2 billion of AUM. The chart below pulled from the company’s website shows the firm hit a bump in the road:
Actually, it hit several bumps at the same time and the car is spinning out of control. The market is trying to determine whether the driver will regain control of the car or it will fly of the road.
Bump 1
There is a major migration from active management towards passive management going on. This can be observed by the growth of products and asset managers like Blackrock with iShares and Vanguard. This migration has two implications. There is pressure on the funds allocated towards active strategies. That means there is a headwind for hedge funds managers like Och-Ziff to gather and retain assets. At the same time passive strategies show great performance at lower fees and this is putting pressure on the fees charged on said AUM as well. It’s a double whammy. I’ve written more extensively on this subject and why it isn’t necessarily a sustainable trend in Exchange Traded Farce. This isn’t an exclusive problem to Och-Ziff ofcourse and many of its peers suffer for this headwind. Multiples in asset management tend to be low (unless the firm specializes in passive strategies). I’ve written about this trend on Gurufocus quite a few times in the past year or so, including in this recent article on Morgan Stanley:
Wealth management firms are kind of hated at this time, but the business model is sound. Collect a nice fee on assets under management and depending on the type of investment management offered (alternatives for example) a performance fee. Its an incredible asset light business and if you can gather AUM at reasonable cost or have particularly sticky clients, it is a terrific business.
Bump 2
Specific to Och-Ziff and the larger problem is that it’s on the brink of settling with the government for violating the Foreign Corrupt Practices Act. The firm has reserved $414 million to put an end to the dispute. In addition to being on the hook for a sizeable settlement the firm also spent a small fortune while defending itself from the government, depressing earnings since it all started in 2014. On its last earnings call the firm stated:
Since our last call, we have entered into advance settlement negotiations with the government, pinpointing the exact timing of the settlement remains difficult but we are hopeful that we will be able to resolve this matter in the near term. I want to emphasize that we are doing everything we can to bring this process to closure in the best way we can for the business, our shareholders, our LPs and our employee.
Previously the firm only reserved $200 million while guiding for more damages. If these reservations are a decent indication that should indicate a
Final amount between $200 and $400 million.
The FCPA Professor on the height of corporate fines:
Under the Alternative Fines Act, an FCPA criminal violation can result in a fine up to twice the benefit the payor sought to obtain through the improper payment. Moreover, the advisory U.S. Sentencing Guidelines are used to calculate an advisory penalty range. (See here for the provisions applicable to corporate conduct). Factors under the Guidelines that can affect a criminal fine include: the number of employees in the organization; whether high-level personnel were involved in or condoned the conduct; prior criminal history; whether the organization had a pre-existing compliance and ethics program; voluntary disclosure; cooperation; and acceptance of responsibility.
To put it in perspective here’s the table (from the FCPA Professor) with the top 10 HIGHEST corporate fines:
Note that most of these companies are much larger in market cap and enterprise value, have much more employees and in several cases the potential for gain seems greater as compared to how much bribery can help an asset manager. I could be wrong about that.
I have little doubt this FCPA investigation has accelerated AUM outflows in addition to the direct monetary damages it will cause. To deal with the fine partners of Och-Ziff, who are incentivized to keep the shop going, are talking about putting up $500 million in perpetuals, non-convertible with 0% interest rates for 3 years:
As you saw in our press release, certain of our partners are discussing a potential financing transaction with a special committee of the firm’s board in which these partners would purchase up to 500 million of perpetual preferred unit. These units are initially expected to have a dividend rate of 0% for three years which would increase overtime and they would not be convertible into Class A shares. Execution of this financing is dependent on customary conditions including satisfactory resolution of the investigation.
What it all comes down to; Joel Frank on the last earnings call about average management fees:
Well, you know the average rate is about 1.28%, you know, if assets come down and our multi-strat funds which are the higher fee-paying assets that may reduce a little bit, but it all depends on the mix, because obviously there – as Dan had mentioned there are not a lot of inflows at this point, but once those things is over I'm not saying it’s going to be the immediately inflow, there will be some overhang, but the mix of assets may change and some of the assets may grow. So it’s – we can't predict what flows are going to be. But at this point, it looks we're at 1.28%. It looks like the multi-strat is the one that's being more affected, so you can kind of make your projections from there.
In addition there are performance fees and sometimes carried interests fees that will add to future cash flows.
With Och-Ziff trading at $4 we have the firm at a valuation by market cap of $700 million vs $40 billion in AUM collected under one of the most lucrative type of fee structure possible. That means the asset manager trades at a ratio of market cap to AUM of under 2%.
With this type of fee level Och-Ziff should be comparable to names like KKR & Co, Oaktree Capital Group, Pzena Investment Management Group, Blackstone Group and Fortress Investment Group.
KKR & Co trades more closely to 9% of AUM, Oaktree Capital trades more closely to 7% of AUM, Pzena Investment Management 1.8% of AUM, Blackstone Group trades around 10% of AUM and Fortress Investment Group trades around 2.8% of AUM.
Och-Ziff trades at a very attractive relative valuation and I believe it could be a compelling opportunity if you think it succesfully settle with the government somewhere in the $200 - $400 million range.
Disclosure: long FIG
