Description

What is Sygnia?

Sygnia Limited (JSE:SYG) is an asset management firm focused on low-cost investment products, such as ETFs, in South Africa. For an easy reference, think of this as South Africa's local version of Vanguard (obviously on a completely different scale). Sygnia was founded in 2003 and listed on the Johannesburg Stock Exchange (JSE) in 2015.

Relevant Industry Context

Sygnia is small in a large industry. They are the 9th largest asset manager in South Africa with c. 4% market share by assets under management (AUM). Overall market AUM was R6.9 trillion (equivalent to $362 billion) in 2022, with Sygnia managing R285 billion of that. The 8 asset managers larger than Sygnia are higher-fee active asset managers, of which 3 are independent asset managers and 5 are linked to insurers/banks.

Sygnia’s low-cost and passive investment offering has been gaining share from higher-fee active asset managers in South Africa. This trend is ongoing and is still in its early stages. The trend is supported by simple economics (many customers prefer investment products with lower fees) and regulatory changes that have increased the scrutiny on (and disclosure of) fees for retirement funds in South Africa. These include the 2019 Default Regulations, ASISA Standard on Retirement Savings Cost and ASISA Retirement Fund Standard on Effective Annual Cost for Individual Fund Members.

Core Investment Thesis: Secular Winner Transitioning From A Family Business to a "Real" Public Company

Thesis Point 1: Sygnia is the market leader in providing passive and low-fee investment products to South African investors. Sygnia is levered to the secular shift from active to passive investments and the secular shift from high-fee to low-fee investment products, both of which still have a long runway in South Africa. Over the last 5 years, Sygnia has grown topline at 19% CAGR (FY2017 - FY2022). After some normalization in FY2023 (I expect flat topline in FY2023 due to cyclical normalisation in fee margin), Sygnia will resume organic topline growth in the range of 10% p.a. This will be achieved by taking share from high-fee active asset managers, whereas the overall savings and retirement industry will remain low growth.

Thesis Point 2: Sygnia has a highly attractive financial profile (low 30s net margin, low 30s FCF margin, >20% ROIC and >30% ROE). It will maintain this attractive financial profile as it grows because the company is not capital intensive and does not have significant incremental spend as it grows.

Thesis Point 3: Sygnia will continue its transition from a family business to a “real” public company. As the company grows and insider shareholding declines, institutional interest will grow and the company will re-rate to at least a low-teen P/E (c. 13x). The median trailing P/E multiples of Sygnia's two South African listed peers, Coronation Fund Managers (JSE:CML) and Ninety One (JSE:NY1), over the last 10 years have been 13.4x and 13.0x, respectively. This would represent significant multiple expansion from Sygnia's currently very cheap trading levels: 9.2x trailing P/E and, by my estimate, 9.7x forward P/E. The key barrier to such re-rating today is that Sygnia is 60% owned by its founders, husband and wife couple Magda Wierzcycka and Simon Peile. It is therefore simply too small for institutional investors and Magda is a polarizing figure among institutional investors in South Africa. However, that barrier has gradually been reduced through the founders taking steps to transform this from a family business to a "real" pubic company. In 2015, they listed Sygnia on the JSE. Since listing, non-insider ownership has increased to 34%. In 2017, Simon moved from Head of Investments to a non-executive director role. While one can’t know for sure, the fact pattern suggests that this transition is likely to continue - Magda now spends part of the year in London (Sygnia is based in Cape Town) and has started a new venture called Braavos (even changed her LinkedIn profile to Braavos).

Thesis Point 4: Sygnia shareholders will get paid while they wait for the above to play out. Sygnia is currently trading on a trailing dividend yield of 12.4% and (by my estimate) a forward dividend yield of 8.2%. The dividend is safe because Sygnia has a fortress balance sheet (net cash position represents 20% of current market cap). This cash pile also creates upside optionality for accretive buybacks and acquisitions, which management has done successfully in the past (acquired Gallet Group Employee Benefits in FY2016 to enter umbrella fund business and acquired DBX in FY2017, which they’ve built into the second-largest ETF manager in South Africa).

Key Risks

(1) Family business transition stops or affects the running of the business. David Hufton (non-family member) became co-CEO in 2020 and CEO in 2021, then Magda stepped back into the CEO role in 2022. Is Magda still engaged in Sygnia or is she focused on Braavos? How will that affect the operations and innovation engine of Sygnia?

(2) Incumbents fight back – and become fierce competitors because of their deep distribution. In other geographies, active asset managers have branched out into passive products (like Fidelity did in the US). That hasn’t happened yet in South Africa, but it likely will. In the ETF business, Sygnia’s largest competitor (Satrix) is owned by a large insurer (Sanlam) with very deep distribution. Similarly, in the umbrella fund business, Sygnia’s competitors (Sanlam, Old Mutual etc.) are tied to large insurers with very deep distribution. If they reduced their fees and improved their service, they could fight back against Sygnia’s products that have been gaining share. However, we know from the innovators dilemma that this is hard for incumbents to do.

(3) Competition from international index companies increases – either due to them setting up JSE-listed ETFs or an easing of exchange control regulations in South Africa. South Africa has an exchange control regime that makes investing in offshore funds challenging. For amounts less than R1 million p.a., it usually takes about 3 days to get money offshore and it requires completing an exchange form with your bank / broker. For amounts greater than R1 million p.a., it is a very tedious process that can take months. This benefits South African firms like Sygnia, which enable South African investors to invest in offshore companies using JSE-listed index trackers. This regulatory moat can be eroded at the stroke of a pen. Alternatively, international companies like Vanguard and Blackrock would have to setup JSE-listed index trackers for the customer experience to be comparable to Sygnia. South Africa is likely too small a market for the likes of Vanguard to bother. Overall, the likelihood of either of these eventualities within the medium-term is low.

(4) South Africa’s macroeconomic situation worsens more than expected. The Financial Action Task Force placed South Africa on its grey-list in February 2023. This increased risk premia for South African stocks. The low-growth in South Africa’s savings and retirement industry is priced in (inflationary growth in mid single digits). However, there is downside risk to that because of emigration speeding up.

(5) Greater near-term normalization than I have priced in. As an asset manager, Sygnia is cyclical. Sygnia had all-time high EBITDA margins of 50% in FY2022 due to (1) a 48% jump in Treasury Income, which has very high incremental margins; and (2) an all-time high fee margin of 21.3bps. In my base case, I have modelled EBITDA margins reverting to the mid-40s in FY2023 and beyond.

Conclusion

Buy price of R18.00 per share (current share price R17.55) implies 21% IRR over 5 years. This requires undemanding assumptions of 13x exit P/E multiple and 6% FY2022 - FY2077 CAGR for Diluted EPS (this includes the normalization in FY2023 and growth thereafter).

No-brainer price of R15 per share (reached these levels in March 2022 when markets were jittery from Russia/Ukraine war and rate hikes, so this is not an unrealistic level). At that price, highly attractive 5-year IRR (close to 30% in base case) and short-term risk/reward (4.8x).

Catalyst