fps is a good investment.

I have loaded up on this one. So it is time to share my thoughts on this incredible little company. What I wrote to a friend:

"The Business

Fiducian is a tiny asset manager listed in Australia since 2000, with 1.3 billion under management. Unlike many other asset managers, Fiducian is a one-stop shop where it starts from dealing with retail customers to managing investment. In other words, Fiducian does not rely on anyone for any of its corporate functions. For example, Fiducian has its own software developed internally to support its own salaried financial planners(FP). It costed 6 million to develop the software, yet it was carried on the book for only 200K. Despite the heavy cost incurred in the start-up stage, in the last decade, and since the first time Fiducian posted a meaningful profit of 430k, EPS has been growing at 17% compounded annually. The company was tested twice in the last 10 years, the tech bubble and the financial crisis recently. In all those years, Fiducian was profitable except for 2003.

The founders made it clear from the start that they want to be in charge of their own destiny by building Fiducian into an integrated financial service and asset management company. In the old days, Fiducian relied heavily on dealer groups to supply it with AUM. This year, 98% of the inflow was brought by its own FPs or franchised FPs, and only 15% of the AUM is from independent FPs. Adopting such a business model means the AUM will grow relatively slower than its competitors in good times, but AUM, once collected, tends to be much more stickier than the AUM from wholesale channels. Look at the charts below:

FPS AUM ASX 200 performance
2003 -12% -9.4%
2004 28% 16.7%
2005 29% 20.9%
2006 25% 20.2%
2007 29% 23.7%
2008 -6.6% -20%
2009 -21.4% -24.7%
2010 16.3% 10.7%
2011 ? 12%

As we can see, FPS generated positive net inflows even in 2008 and 2009. In fact, 2003 would also see positive inflows if a dealer group did not withdraw 100 million.

One important implication of Fiducian's business model is its high profitability. FPS can be break-even with only 550 million under management. Last year, FPS generated 23 million revenue with 1.3 billion AUM. That is 1.75% of AUM. I have looked at major public asset managers with many times more AUM, but no one can even come close to this ratio. Most of them lose money upfront on acquiring assets and make it up by charging management fees later. FPS makes a profit bringing in assets.

On the investment management side, FPS is quite special as well. Unlike many other investment management companies, it does not hire expensive 'star' managers and incur astronomical compensation expenses. Instead, FPS is functioning as 'fund of funds' and 'manager of managers'. It uses in-house software to identify outperforming long-term funds and stick with them for a long time. By its own judgement, FPS also rotate from sector to sector to reduce volatility. The compensation expense is around 60 bps of AUM at the moment, compared to 20 bps for US public traded asset managers. It will improve over time as the AUM grows. Here are the links to the funds and managed account performance. I do not really know how the MorningStar ranking works, but the long-term record sounds good.

http://www.fiducian.com.au/fundsmgmt_mpreturns.htm
http://www.fiducian.com.au/fundsmgmt_ffreturns.htm

As any other asset management business, it requires very little incremental capital to grow.

The People

Just like insurance industry, the investment management industry tends to magnify the significance of management's capability and integrity, especially the later since the operating leverage is tremendous. More often than not, the value created is distributed mostly to insiders, rather than shareholders. I still remember many years ago we were discussing BKF capital where the insiders were taking out as much as they can. FPS seems to be the case quite the opposite.

FPS has a track record to control expenses and deploy capital in a shareholder friendly way. I will let the numbers speak for themselves:

Revenue Operating Expenses NPAT
2003 7.4% 48.9% N/A Distortion due to an acquisition.
2004 9% 1% N/A
2005 26.6% 8.6% 1000%
2006 19% 7% 85%
2007 20% 9.6% 48%
2008 7.6% 3.4% 18.1%
2009 -22.9% -11.5% -47.7%
2010 6.7% -1.3% 25%
2011 ? ?

The operating leverage here is very significant. CEO Indy Singh owns around 30% of the company and he is very disciplined. In his compensation agreement, he is entitled to receive 20% of annual salary as bonus under certain conditions. Although the condition was met the majority of the time, he rejected the entitlement every time. I think over the years, he has forfeited at least 500k in cash bonus. Whatever the motive, it is very rare to be seen in today's corporate world. Another thing is that the use of options. In the early days, when FPS first went public, it used lots of options. But as the business stabilizes, the use of options has become very rational. It has to be noted that the majority of the options issued over the years did not go to top management or the CEO, but to the employees. Almost unsurprisingly, the CEO is also the company's corporate secretary. And believe it or not, the state-of-the-art software was developed by the company's FPs! No wonder the expenses was controlled so well.

Basically there are three things management does with the FCF. First, FPS pays out around 50%-60% as dividend. Second, it buys back shares every year. Finally, it uses cash to do small, but very accretive acquisition. For example, FPS did not make a single acquisition during the go-go days before the financial crisis; when it did, it paid 550k for two businesses in 2009 and it brought 400k income the next year.

The Culture

Fiducian obviously takes the pride of its culture. Normally I do not pay attention to those kind of things, but it seems management is not doing lip-service here. Management considers that employees, investors, shareholders and staff as a big family and really takes care of them. Fiducian does not lay off people because the business is bad or profit is down; but when someone leaves the business voluntarily, it trains existing staff to take over the workload instead of hiring someone new. There are more details in the ARs, so I will skip this part.

Where we go from here?

I think there is fair chance that Fiducian will grow from a business into a franchise over the next 5-10 years, if it insists on doing business this way. The company is very small with a market capital of 47 million. So whatever the growth lays ahead, this is just a start.

On the surface, Fiducian is not a screaming buy. It will have 11 million in cash by the year end, and the EV is therefore 36 million. It earns 4.1 million last year, so the P/E is just under 9 times. However, buying an exceptional business at 9 times trough earnings is a big bargin. But there is more. In Australia, small companies do not report first and third quarter earnings. Instead, they give OCF and revenue in the mandatory disclosures. In the First Q(fiscal year in AU ends in June), revenue was up 18% and OCF shot up 62%! Considering OCF always exceeds earnings somewhat, it is very possible the run-rate earnings has grown to 6 million. If this is true, we are buying a truly outstanding business at a ridiculous 6x P/E.

When we combine an outstanding business, honest and capable management, efficient capital deployment and high operating leverage together, it will surely be an explosive force. There is simply no way the market will valuate this business at 6x P/E.

The Ultimatum Bull Case

If Fiducian can earn 6 million after tax this year and assume the AU stock market performed relatively well in 2012 and 2013, it has a chance to earn 10 million 3 years from now. And this projection is not heroic considering the historical performance of Fiducian. If we slap a 25x P/E to the earnings, Fiducian is going to worth 250 million plus the earnings it generates, which is 250+11(cash on hand)+24(earnings over 3 years). This is a 600% upside from today's price. Yet this is not the end of story. Fiducian has been actively buying its own shares over the years and it pays out a large dividend. If we reinvests all the dividend and let the share buyback works its magic, we could have substantially more upside.

Fiducian is also a very good acquisition target since PE shops are making more deals in AU. It has all the infrastructure in place and lots of expenses had occurred many years ago. Once the market capital reaches a certain threshold, Fiducian is ripe to be taken over. Although I prefer Fiducian goes alone, this is a real possibility."

Fan