Cohen & Steers is an asset management company that is mainly focused on real estate - the asset class that was perhaps under the most pressure during the collapse of 2008 and early 2009. Therefore, it is not at all surprising to discover that real estate related equities have been recovering more rapidly than others as the crisis subsides. As a result, during the second and third quarters combined, Cohen & Steers's assets under management (AUM) almost doubled, and it was not merely the result of appreciation. Of the increase, 71% came from appreciation and 29% from net inflows. Moreover, Cohen & Steers was able to raise $1.4 billion of new AUM in the second quarter and $1.8 billion in the third quarter. Given the continued positive performance of real estate stocks in the fourth quarter, it is reasonable to expect another improvement occurred n the fourth quarter. One can reasonably conjecture that AUM probably rose by a further 10% in the fourth quarter vis-à-vis the $22.5 billion as of September 30th to somewhere about $25 billion.
One of the interesting things about of Cohen & Steers is that it operates many leveraged closed-end funds. When the AUM increases in a leveraged closed-end fund due to market appreciation, it is possible for that fund to employ additional leverage. It is important to note that in a leveraged closed-end fund the manager bills on total assets being managed, not the equity assets managed. The result is that an increase in the net asset value of a closed-end real estate fund, which permits further leverage and, therefore, the employment of yet additional funds, has the same arithmetical impact on the managers' cash flow as increasing AUM through new inflows. As a result, positive fund performance will boost fee income at a higher rate. Regardless of whether AUM rise because of market appreciation, leverage or net inflows, or a combination thereof, an asset manager such as Cohen & Steers has almost no incremental costs offsetting an incremental dollar of fee income. In other words, the company's profitability increases with rising AUM. During the 2006-2007 period of rising AUM, the company earned approximately 20-25 basis points on its AUM, but because of the decline of 2008, coupled with Cohen & Steers's relatively fixed cost structure, its earnings declined to just 8 basis points in 2008. The company has also improved its infrastructure, product development and distribution during the downturn so its margins will likely expand meaningfully in 2010 as a result of the higher AUM.
Cohen & Steers's management has indicated that, while the company has tried to identify acquisition candidates, it has so far been unable to find attractive deals that would have a meaningful impact on the company's business. This, coupled with its strong generation of free cash flow, which adds to its already significant cash balance of approximately $210 million, makes it likely that the company shortly will decide to raise its dividend, perhaps back to $0.80 per share, which represents the annual level in 2007. The company has indicated that it will review its dividend in March. On the other hand, if the company decides to keep the excess capital and invests it in its own funds in a recovering economy and real estate market it would likely generate a substantial return on this capital.
Cohen & Steers currently has a market capitalization of $988 million. Assuming a normalization of stock markets in general and real estate prices in particular, the company will likely continue to grow its AUM significantly over the next two years. Consequently, its AUM may shortly surpass the prior record of $35 billion. At such an AUM level, Cohen & Steers will likely reach approximately $100 million in annual earnings. If that can be accepted, then the company, having no debt and $210 million of net cash would, on a net enterprise value basis, be trading at 6.6x earnings. This is achievable over the next two years. The earnings estimates that are prevalent for Cohen & Steers do not reflect that scenario; rather they reflect the presumption that much lower AUM are likely to be achieved. In a more positive market environment, the shares can trade at 20-25x earnings .As the shares are unchanged in the past four months, the market clearly has yet to respond to the elevated asset levels of the company.
1 Market appreciaition of AUM. 2 Additional AUM growth from net cash inflows 3 New products increasing AUM 4 Acquisitions possible 5 Significant dividend increase 6 Earnings increase, particularly next year, that will be shockingly surprising