Shares of HFA offer a compelling opportunity to acquire a top tier fund-of-hedge-funds (Lighthouse Partners) at an attractive current multiple (4.5x NTM EBITDA-CapX) with a significant catalyst for growth as a result of the newly formed partnership with Apollo Global Management. In March of this year, Apollo Global Management ($70bn alternative asset manager - Leon Black's fund) and the South Carolina Retirement System (the state pension fund) purchased over 40% of the fully diluted shares through a mandatory convertible security at $1 per share. The stock currently trades at $.72/share. The investment was made by Apollo's general partnership, not as a private equity investment for one of their existing funds, and presumably will be their 4th business line (buyouts, real estate and fixed income are the other 3). HFA incurred this significant dilution anticipating that Apollo will significantly accelerate growth in assets under management as Apollo markets HFA's fund-of-funds to their own investor base. While it is difficult to handicap the success and timing of future gains in assets under management, I am encouraged by a recent $500 MM investment from a large US pension plan, bringing AUM to $6+ billion. Though I do not anticipate Lighthouse approaching Blackstone's fund-of-funds AUM of over $35bn, I certainly would be disappointed if Lighthouse's AUM didn't grow significantly. Nevertheless, at today's current enterprise value, you are getting any growth for free.
Description: HFA is an Australian listed (Bloomberg Ticker: HFA AU) global fund manager with two distinct business units: Lighthouse, a U.S. based fund-of-hedge-funds manager and Certitude, an Australian fund-of-funds which provides distribution capabilities to 3rd party investment managers. The vast majority of HFA's value is derived from Lighthouse which has approximately $5.5bn under management. Certitude is cash flow breakeven at best, but represents a free option on distribution in Australia. Roughly two thirds of AUM pay management fees only, while the remaining one third also pay performance fees of up to 10%. To our knowledge, all assets are above their high water mark.
Lighthouse was formed in 1996 and has significantly outperformed its benchmark over all relevant timeframes. In fact, from the market peak in October 2007 through August 31 of this year, most Lighthouse funds are near their peak value, unlike most relevant indexes. Besides performance, the distinguishing attraction of Lighthouse is their managed accounts platform, which is the primary vehicle they employ to invest in hedge funds. The platform consists of approximately 90 funded proprietary accounts, representing over 2/3rds of assets under management. Under the platform, Lighthouse controls and maintains full ownership of the investments while investment decisions are made by the hedge fund managers. This protects against many potential non-investment losses such as fraud and counter-party exposure. Additionally, liquidity is managed by Lighthouse, thus avoiding lock-ups, gates, holdbacks and suspensions at the underlying fund. Finally it provides daily transparency down to the individual position level for each fund, which greatly aids risk management. The platform is provided at no additional cost relative to the competition and provides in my opinion a significant strategic advantage for limited partners.
Certitude currently has over $1bn invested in several investment funds including Threadneedle Investments ($110bn European asset manager), Marshall Wace GaveKal Asia-Pacific (Hong Kong based Asian focused fund) as well as Lighthouse. Again, it doesn't produce meaningful cash flows, but has access to Australian investors, and hopefully these relationships can be further monetized in the future.
History: HFA Asset Management was founded in Australia in 1999 as a domestic distributor of investment products. A year later HFA entered into an exclusive Investment Adviser relationship with Lighthouse Partners. In 2006, HFA went public in Australia and in January 2008, acquired Lighthouse for roughly $625mm. The combined entity had over $7bn under management and a market value of roughly $775mm. In 2009, as the global financial crisis hit, assets fell to under $5bn and HFA's market value fell to as low as $25mm (enterprise value was $115mm). In 2010, Lighthouse completed the implementation of their proprietary managed account platform, the cornerstone of the business today. Since then, with the market recovery and improved performance, Lighthouse's AUM once again began to grow. The legacy Australian retail business never recovered given the levered accounts popular at that time lost much of their value during the crises and effectively wound down. Hence the Australian business today (Certitude) is break even at best. Finally, in March of 2011, the Apollo/South Carolina transaction was consummated, investing $75mm in a mandatory convertible preferred security in exchange for over 40% of the fully diluted shares.
Lighthouse has historically targeted family offices and other smaller institutions. Apollo's investor base is predominantly larger pension funds and advisors, thus there is relatively little overlap between the respective investor bases providing ample opportunity for Lighthouse to expand their AUM.
Valuation: There are approximately 200mm fully diluted shares outstanding (assuming conversion) at $.72 per share equating to a market value of approximately $144mm. HFA currently has around $20mm of net cash resulting in a $124mm enterprise value. There is also a deferred tax asset of $240mm, $200mm of which resulted from the Lighthouse acquisition. To be conservative, I've assumed HFA benefits from less than half of it which equates to a present value of $30mm. NTM EBITDA - CapX should be roughly $26.5mm, based on average AUM of ~$6 billion, and a weighted average fee of ~1.2%. This equates to a multiple of 4.5x (3.4x adj. for the deferred tax asset), a very attractive multiple for a static business.
While the valuation is quite attractive relative to the current economics of the business, I am particularly attracted to the growth potential of this business, and believe that free cash flow over the next three to four years alone will likely exceed today's $120mm market value. With the addition of Apollo's marketing rolodex, and with a top tier track record and platform, HFA hopes to grow AUM substantially in the coming years. Although they are likely to face management fee pressure as bigger institutional clients demand reduced fees, I believe this will be more than offset by the strong operating leverage inherent in an asset management model. Given the combined strength of Lighthouse's product offering and Apollo's marketing prowess, I believe they will achieve their goal of increasing AUM, and thereby cash flow and stock price, to multiples of todays levels.