THE HEDGEYE EDGE
The combination of a slow start to 2014 performance and a renewed focus on a pending legal issue has knocked Och Ziff (OZM) shares to an attractive level for new long positions and we are adding the stock to our Best Ideas list.
- OZM is exhibiting the fastest organic growth (flows) in the asset management industry YTD.
- OZM shares are trading at a valuation level that has historically been a great entry point for intermediate to longer-term investors, as it is being assigned almost no value whatsoever for any potential incentive fees.
- Current concerns over an SEC subpoena seem significantly discounted in shares, though this clearly remains the one risk that is difficult to handicap.
- Investors get paid to wait for the valuation to mean revert higher back to normal levels. OZM should pay a dividend equivalent to a yield of ~5% even with no incentive fees. Should incentive fees meet expectations for the year, the yield would be closer to ~10% at the current valuation.
INTERMEDIATE TERM (TREND) (the next 3 months or more)
We are taking the view that the intermediate to long term duration is positive for OZM shares and that outside of some negative short term issues the company is displaying good, solid fundamentals including an industry-leading organic growth rate and a valuation reflecting only its base management fees (with no multiple on its highly-accretive incentive fees). Historically, when shares have traded with no multiple on incentive fees it has been a good time to buy the stock. We calculate that the stock has over 30% upside just from mean reversion to its historical multiple versus the traditional asset managers and just 13% downside should the stock fall back to its all time lows on this metric. This creates a favorable upside/downside ratio of 2.5-to-1 which does not include the firm's estimated forward dividend yield of 9.9% (although we acknowledge roughly 4.4% of this forward yield is dependent on the firm earning incentive fees this year).
LONG-TERM (TAIL) (the next 3 years or less)
The $18.8 trillion U.S. pension fund market is continuing to incrementally allocate additional funds to the alternative asset allocation which would primarily benefit the biggest hedge funds, private equity, and real estate firms that have leading scale and performance. Potential net inflows of $180 billion per year on the current $3 trillion in U.S. alternative assets would produce an organic growth rate of ~6%, well in excess of the 2% rate of growth within the nascent return of equity fund flow in the mutual fund industry. As a top five hedge fund by assets-under-management with industry leading historical performance, OZM stands to benefit from this trend.
We estimate that the pension fund opportunity is already showing up in Och Ziff results. Year-to-date, OZM has put up an industry-leading 24% organic growth rate (annualized net new asset growth as a percentage of beginning assets) thus far in 2014. By comparison, Och Ziff's YTD growth rate compares to much more modest growth rates at T Rowe Price, which has generated just 5% annualized growth, BlackRock which is annualizing at just 2.4% growth, and Franklin Resources which actually has a negative decay rate in its client assets currently.
Currently, the confluence of a slow start to 2014 performance for the company and ongoing legal headlines have knocked OZM shares to levels solely on base management fees that historically have been near trough levels. Och Ziff shares are currently trading at just 16.6x base management fee earnings, a 23% discount to the long term average of 21.7x. Furthermore current valuation levels are approaching a range where the stock bottomed on this metric in the middle of 2011 and at the end of 2008 at just over 12.0x management fees.
OZM shares are in a growth category in the alternative investment management industry and the firm is putting up industry-leading organic growth in client assets on new, record AUM. The recent slow start to the year in the firm's performance and ongoing legal headlines have knocked the stock down to a range which historically has been a good entry point for intermediate to long term shareholders. Despite this slow start to 2014 investment performance, we point to a industry leading 20 year track record of strong performance that make any short term performance issue less worrisome. In addition, the Street's current assumptions around important year-end incentive fees don't seem unachievable at this point considering the ground that the firm needs to make up at this point is not outside of their historical annual compounded returns. As a result we are adding the stock to our Best Ideas list as a long position.