Dipping my toes back into PTM

After selling out of my entire PTM holding only a month ago, based on some valuation concerns (see https://hotcopper.com.au/posts/42836673/single for the rationale behind that sale), I’ve decided to start buying back in today.

The reason is not solely the interim -30% nosedive in the share price, but also the fact that, at current levels, I see again some decent value in the stock.

My starting point, for valuation purposes, is the current “underlying” earnings yield of the business, which can be modelled as a function of the following inputs:

Funds Under Management (FUM): 23,785m$ (as of 29 Feb 2020)

Average Base Management Fee: 1.15% pa (annualised H1 2020 levels)

Cost Base: 80m$ pa (annualised H1 2020 levels)

Tax Rate: 30%

Outstanding Shares: 587m

Share Price: 3.31$

So, [Underlying Earnings Yield] = (23,785m$*1.15% - 80m$)*(1-30%)/(587m*3.31$) = 7.0%. Note that, to calculate underlying earnings, I am only counting the contribution from Base Fees on FUM, and not the mark-to-market gains/losses on seed investments (7.7m$ in H1 2020 was derived from the latter).

This 7.0% earnings yield is indeed higher than the 6.6% at which I had originally bought my shares back in July/August 2019; and that, as explained in my previous post (see link above) was a necessary condition for me to want back in. So, the question now becomes whether or not the extra yield available at today’s price is enough to compensate for the interim deterioration in the fundamentals (i.e. for the drop in FUM caused by accelerating outflows and worsening funds performance).

What I essentially require is that, even in a sharp downside scenario, the earnings yield I get from the business be still higher than what I could get today (or, within reason, over the foreseeable future) from a low-risk instrument, such as a government or investment-grade corporate bond.

As I’m hearing increasing talk of this being the beginning of a global recession, I’ve chosen to take as a benchmark scenario what actually happened to PTM’s FUM during the GFC.

Platinum Asset Management was floated on the ASX in May 2007 and, at the end of that month, its FUM was 22,385m$; that also happens to be the highest reported FUM level in PTM’s pre-GFC history. Twenty-one months later, at the end of February 2009, PTM’s FUM reached its GFC low of 13,510m$; therefore, peak to trough, the drop in FUM was by 13,510m$/22,385m$-1 = -39.6%.

Let’s now take the 24,619m$ FUM reported in January 2020 (i.e. the last end-of-month level before the current market turbulence started), and apply a -40% shock to that. The stressed level of FUM then becomes 24,619m$*(1-40%) = 14,771m$. I will also assume that, in such stressed circumstances, the Cost Base would also be reduced from its current run rate of 80m$ pa to ~60m$ pa; that does seem reasonable to me, because it is essentially equivalent to zeroing out the Variable Remuneration component of Staff Costs, which is performance-based and currently running at ~20m$ pa (inclusive of share-based payments), without touching any other expenses.

The stressed valuation parameters then become as follows:

FUM: 14,771m$

Average Base Management Fee: 1.15% pa

Cost Base: 60m$ pa

Tax Rate: 30%

Outstanding Shares: 587m

Share Price: 3.31$

Repeating the initial calculation with these parameters, the stressed underlying earnings yield becomes (14,771m$*1.15% - 60m$)*(1-30%)/(587m*3.31$) = 4.0%. That is still ~340bp above today’s 10-year Australian government bond yield, but also above what an investment-grade debt instrument of a similar maturity would have yielded for the vast majority of the past two years.

Note that the above stress scenario implies a -43.2% decline in NPAT, which is worse than the historical -37.4% peak-to-trough NPAT drop experienced between H1 2008 and H2 2009.

Based on the above, notwithstanding the accelerating net outflows and the deteriorating funds performance, I have decided that at today’s levels there is enough margin of safety to justify buying back into PTM. For, even though a financial crisis in the imminent future is a possibility, it appears to me that most of its likely impact is already in the share price.

On the other hand, if FUM and earnings do stabilise somewhere between today’s levels and the stress scenario above (i.e. at a level corresponding to an earnings yield somewhere between 7.0% and 4.0%, relative to today’s share price), and then resume growing from there, then I think this represents an attractive income and growth proposition in the current (and prospective) yield environment.

In terms of portfolio sizing: while I do very much like the scalable, capital-light, debt-free, low-cost-to-income and FCF-generative nature of this business, it is not lost on me that PTM remains a medium-sized asset manager still driven by its founder and majority shareholder; therefore, while the alignment of interests between Management and shareholders is beyond doubt, key people risk is not insignificant here. That limits my maximum portfolio allocation to 3%-4% of NAV (on a cost basis).

To conclude, PTM is back to a 1% portfolio weight for me, at this stage, with room to add according to the above guidelines if the share price drops further.

My two cents only, and all the usual disclaimers apply.