Is PAC a Buy or Short?

Hi Everyone
Have spent some time reviewing Pacific Current (PAC) and benchmarked PAC shares against peers with an evaluation matrix I had recently read about.
Over the years, PAC has changed from a Cash Generation Machine to a Cash Sinkhole. Here is the history since 2004:

	Column 1	Column 2	Column 3	Column 4	Column 5	Column 6
0	Year	Net Assets	Goodwill / Intangible Assets	NC	% Return on Net Assets	% Return minus Intangibles
1	2016	$322,802,109	$390,206,000	$15,305,374	4.74%	n/a
2	2015	$454,028,494	$555,000,000	-$18,529,296	-4.08%	n/a
3	2014	$63,774,670	$40,250,000	$12,160,077	19.07%	52%
4	2013	$61,077,425	$40,500,000	$10,909,820	17.86%	53%
5	2012	$57,916,381	$40,200,000	$6,730,878	11.62%	38%
6	2011	$59,185,290	$38,200,000	$7,802,946	13.18%	37%
7	2010	$56,127,262	$32,900,000	$6,766,922	12.06%	29%
8	2009	$50,095,988	$23,500,000	$6,516,000	13.01%	24%
9	2008	$57,282,206	$30,388,000	$13,976,403	24.40%	52%
10	2007	$54,453,600	$13,200,000	$27,317,132	50.17%	66%
11	2006	$46,771,310	$10,700,000	$23,488,885	50.22%	65%
12	2005	$34,572,314	$3,981,000	$20,340,600	58.83%	66%
13	2004	$22,383,516	$2,789,000	$12,458,997	55.66%	64%

Table 1
To begin with, believe it is important to be clear what lines from the Financial Report’s I have used and why. To compare peers and history have used the Net Cashflow Generated By/(Used In) Operating Activities (NC), the reason for this is that it can’t be manipulated through the purchase and sale of investments (PAC’s 2016 Annual Report gets close to being manipulated and needs to be normalised). The % of NC against Net Assets shows how much the business can generate from investing further in Assets versus liquidating business to realise a return to shareholders.
Given PAC’s level of debt compared to peers you would expect a higher return. Here is a comparison to PAC’s peers today:

	Column 1	Column 2	Column 3	Column 4	Column 5	Column 6	Column 7	Column 8	Column 9	Column 10
0	Company	Net Assets	Goodwill / Intangible Assets	NC	% Return on Net Assets	% Return minus Intangibles	FUM	Shares on Issue	Share Price	Mkt Cap
1	BTT	$743,839,000	$541,503,000	$174,163,000	23.41%	86%	$91,200,000,000	307,430,721	$12.20	$3,750,654,796
2	MFG	$355,369,000	$242,470,000	$181,545,000	51.09%	161%	$47,709,000,000	172,076,468	$23.56	$4,054,121,586
3	PAC	$322,802,109	$390,206,000	$15,305,374	4.74%	-23%	$14,099,677,478	41,801,622	$5.68	$237,433,213
4	PTM	$364,211,000	$-	$202,461,000	55.59%	56%	$23,168,000,000	587,030,048	$4.34	$2,547,710,408
5	LM:NYS	$4,411,550,000	$4,626,001,000	$89,177,000	2.02%	-42%	$669,600,000,000	97,400,000	$36.74	$3,578,476,000

Table 2
Note: For PAC’s NC I have used PAC reported cashflow only. If you combine PAC and Aurora Trust NC together you get $20 Million, however wasn’t sure if there would be duplication if I did this and kept it with PAC only.
With the peer analysis and historical look at PAC, there are two outcomes we want to investigate:

1. Can PAC return to the halcyon days of the Cash Generation Machine it was pre-2007?
2. What should we value PAC at compared to peers?
3. What is the possibility of a takeover?

What does PAC need to achieve to return to the halcyon days?
Scenario 1: To generate returns of 50% against Net Assets versus NC, NC would need to increase to $160 Million and costs would need to stay the same. This is an NC increase by $135 Million more than today, highly improbable given Revenue is just under $60 Million.
Scenario 2: To generate returns of 25% against Net Assets versus NC, NC would need to increase to $80 Million and costs would need to stay the same. This is an NC increase by $65 Million more than today. This would return PAC to a level compared to the average of peers (not MFG, but will be greater than others)
Scenario 3: To generate returns of 15% against Net Assets versus NC, NC would need to increase to $48 Million and costs would need to stay the same. This is an NC increase by $30 Million which is the most probable outcome, given that we are looking at significant costs savings coming in this year’s reporting.
Scenario 4: To generate returns of 15% against Net Assets versus NC, with no NC increase, Net Assets would need to fall to $100 Million or a Write-off of assets to the tune of $222 Million.
Scenario 5: To generate returns of 25% against Net Assets versus NC, with no NC increase, Net Assets would need to fall to $60 Million or a Write-off of assets to the tune of $262 Million.
Risks to the scenarios are:

• Revenue may decrease due to overall market conditions. In the first-half financial report for 2017 page 32, Receipts from Customers were down from 31/12/2015’s $32 Million to 31/12/2016’s $19 Million.
• Debt is not settled within a timely manner. While Interest Expense is reported at around the $1 Million mark, with current debt PAC have a true liability of $4.5 Million Interest Expense per annum (Seizert Capital Interest is capitalised into the notes and not reported as an Interest Expense and XRPU’s have a delay on the Interest Expense until March 2018)

Positive factors contributing to the likelihood that PAC can return to the Cash Generation Machine that it was:

• US market FUM is growing strongly, as mentioned in another post 22% in the last two quarters (no extrapolation, just excitement)
• The AUD/USD is on a downward trajectory, but this has a trade off with debt increasing. We have a net benefit from a falling AUD/USD, but cashflow gets impacted with having to pay higher debt as most is USD denominated debt.
• Costs are being reduced and there are some minor cost improvements in future years. Current year will show the most cost savings able to be achieved.

What should we value PAC compared to peers?
Valuation is always a tricky and subjective topic. I think with potential growth of PAC in NC we will see a revaluation of where we can possibly go share price wise. What I think is always a bit on the optimistic side, however should be achievable with current growth being experienced in the next two to three years.
From table 2 above the NC generated isn’t as high as others from a percentage perspective against assets. Here are metrics for 18x (which is the peer group average):

	Column 1	Column 2	Column 3	Column 4	Column 5	Column 6
0	Company	NC	18 x NC	share price on 18 x	20 x NC	share price on 20 x NC
1	BTT	$174,163,000	$3,134,934,000	$10.20	$3,483,260,000	$11.33
2	MFG	$181,545,000	$3,267,810,000	$18.99	$3,630,900,000	$21.10
3	PAC	$15,305,374	$275,496,732	$6.59	$306,107,480	$7.32
4	PTM	$202,461,000	$3,644,298,000	$6.21	$4,049,220,000	$6.90
5	LM:NYS	$89,177,000	$1,605,186,000	$16.48	$1,783,540,000	$18.31

Table 3 – valuation based on current industry average of 18 times NC (if PAC are re-rated the industry average will increase to about 20)

	Column 1	Column 2	Column 3	Column 4	Column 5	Column 6
0	Company	NC	18 x NC	share price on 18 x	20 x NC	share price on 20 x NC
1	BTT	$174,163,000	$3,134,934,000	$10.20	$3,483,260,000	$11.33
2	MFG	$181,545,000	$3,267,810,000	$18.99	$3,630,900,000	$21.10
3	PAC	$30,610,748	$550,993,464	$13.18	$612,214,960	$14.65
4	PTM	$202,461,000	$3,644,298,000	$6.21	$4,049,220,000	$6.90
5	LM:NYS	$89,177,000	$1,605,186,000	$16.48	$1,783,540,000	$18.31

Table 4 – valuation based on future state where PAC saves $15 Million in costs this year and generates an improvement in NC
Valuation based on industry averages, if you believe in mean reversion over time (as I do) believe we will see an increase in PTM plus PAC and BTT plus MFG will decrease. This will be over at least a three to five-year period. It assumes an increase in PAC NC and others NC being constant.
To answer the question of what should we value PAC at, short-term between $6.59 and $7.32 given that NC will return to 10% of Net Assets and improve over a five-year period.
Given the NC potential increase to $30 Million either this financial year end or next, the price range should increase to between $13.18 and $14.65. Given the current growth in FUM being experienced it is likely to go beyond this value.
What is the possibility of a Takeover?
For PAC to be taken over they would need to demonstrate good consistent growth over a period of years to justify multiples comparable to industry. Going by Table 2 above you can see PAC is underperforming compared to peers, however if we generate further NC in Operating Activities we will begin to see share price rise and interest should be piqued by peers.
There will be a disparity in time where we as investors won’t believe that improved numbers are possible due to historical issues with the company management. Company management has a lot to answer for by getting investors in the current pickle we are in. Industry peers are likely to see this as a period of advantage and will pounce on PAC if they are truly interested.
So, possibility of takeover is currently high given that the restructure of PAC is nearing its end. Short term takeover price would have to be about the $7.32 mark. If a peer wants to takeover PAC in the next two years they will need to be prepared to pay double this figure or an additional $300 Million.
What to conclude?
Currently, we as investors are unsure whether the halcyon days can return and the share price is languishing. It may be a couple of years, but we will see a return to industry averages. With many US investors on the share register now, you are likely to see an improvement in share price. PAC is cheap and US investors are typically overly optimistic when it comes to smaller companies. Short term share price improvement has seen this occur (also PPT buying shares on market to maintain level of ownership in PAC).
Can PAC return to the halcyon days? There would need to be a restructure of the business again which may see short term headwinds, PAC management would need to invest in more businesses like Aperio, GQG, Investors Mutual, etc. Investing early in growing Fund businesses has been a significant contributor to generating high returns on Net Assets. If other opportunities like GQG and Aperio come along is PAC able to invest to grow, yes, we have been by raising debt and paying the debt off over time. Aperio and GQG was a very modest amount to invest with PAC management finding a different way to generate funds other than through ownership.
Still believe overall cashflow is an issue due to debt repayments approximately $30 Million per annum over two years. With growth and cost savings measures in place PAC will have just enough money to pay these back this financial year and next. In the 2018 financial year there should be a small amount of cash for a dividend or part contribute cash to purchase another small Fund in the US with debt. Question is, what is the appetite of investors, growth or dividends?

As always interested in feedback on above. What are your thoughts?

Best of Luck
Lost