rab smart move

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RAB CAPITAL - smart movers.
ASK YOURSELF , WOULD YOU INVEST 1.5 MILLION DOLLARS ON PUNTLAND
after you have seen the video, RAB have done their homework .
JV i would say a certainty.


Momentum behind RAB
18.08.06
Edmond Jackson

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors and if in doubt an investor should seek advice from a qualified investment adviser.

I have previously explained how the economics of fund management groups can mean a purple patch for shareholder return, so long as financial markets are reasonably benign. Once a small to medium-sized group establishes its operating base, profits kick in as assets under management expand. This is currently happening at AIM-listed RAB Capital (RAB), the hedge fund management group whose late July interims showed a like-for-like 77% rise in assets under management to just over £2 billion equivalent.

The shares meet my current criteria for genuine momentum plays where the underlying dynamics have scope to keep beating expectations, and prospective earnings are not too highly rated. There are risks with a 'momentum' approach to share selection but it currently works - perhaps because investors now favour better quality earnings.

It is worth visiting www.rabcap.com to understand the business and its underlying momentum, which for the first six months of 2006 meant a like-for-like 193% rise in pre-tax profit to £14.2 million on turnover up 190% to £27.3 million. Such a rich margin results from the performance fees charged by hedge fund managers (in addition to basic management fees), and it is shifting expectations about the trend in performance fees that explains the volatility in RAB shares since flotation in April 2004. The price soon doubled to 50p then slumped back to 25p and more recently has explored a range well above 100p. Currently 98p and re-testing 100p, this capitalises the group at about £435 million.

RAB prefers to call itself an absolute return rather than hedge fund manager, perhaps due to the hairy reputation these funds tend to have. But although its funds retain the usual 20% performance fee and flexibility to go short (sell shares they do not own), my impression since spotting RAB before it floated is more a culture of bold thinking and vigorous innovation. You can see this in the way its flagship special situations fund achieved a 1,475% annual return - even after fees - in 2003. It largely resulted from exploiting low valuations before the commodities' bull market took off, negotiating development capital positions in companies ahead of flotation.

Believing in a long-term commodities super-cycle, RAB established an energy fund in 2004. Resources shares represent under just half of the various group funds' asset exposure, so there is prudent diversification too. Warrant deals besides shares are another classic RAB tactic.

It is interesting how this company has shrugged off the early summer market correction, perhaps indicating that RAB has now established its reputation so that its funds are less susceptible to redemptions among edgy private investors. Pension funds continue to find they need specialist investment managers and RAB is marketing in the US as well as UK.

One litmus test of a growth business is balance sheet cash and RAB's has soared from £33.2 million to £87.5 million between the end-June interim dates. This has created quite a dilemma: should more cash be distributed to shareholders than a likely 1.1p per share dividend this year, although RAB has stated that acquisitions are part of its strategy and buying Cross Asset Management is illustrative. In the year since acquiring Cross Asset Management, RAB has boosted the manager's funds by a third, hence reducing the effective purchase price. Group shareholders' funds jumped 57% to £77.6 million, June to June, and there were £11.7 million of unrealised investment gains.

Can such remarkable growth rates continue? Probably not, but the shares' price-earnings ratio in the mid-teens already anticipates that. Company REFS shows the consensus City expectation being normalised pre-tax profit of £39.2 million this year and £44.6 million in 2007, for earnings per share of 5.6p and 6.7p respectively. If the prospective p/e was well in the twenties then caution might indeed be prudent.

Despite the May shakeout in resources shares and the plunge in the share price of Oxus Gold, a key holding for the special situations master fund (which includes an AIM-listed fund), this key fund is up 32.5% so far this year. With assets now near £700 million equivalent, that is a highly respectable rate of return.

Playing expectations in a share like this is quite tricky as in principle you would wait until the autumn to get a decent sense of how markets are trading in the second half. RAB shares have risen about 10p since the end-July interims with investors taking their cue from a five-fold (like-for-like) increase in performance fees in the first half as funds expanded. If markets had an awkward few weeks in the autumn you could easily see the price fall amid uncertainty about performance fees for 2006. Yet worrying about short-term volatility misses a key point in the investment rationale: that the economics of successful fund management firms make for excellent long-term growth shares. In the 1980s to 1990s, Perpetual and Mercury Asset Management showed how it is possible to weather market volatility as the fund manager's reputation grows and operational gearing enhances profits. You need to be aware, however, that the performance fee element of hedge funds makes RAB a higher risk/reward investment in relation to market cycles.

Another classic risk for any 'people business' is key individuals departing. RAB has been proving successful at creating an attractive environment for talented fund managers even if a few investors grumble at the near £16 million cost for staff and bonuses in the first half of 2006 alone. It will be interesting to see if, like the Cross Asset Management founders, more hedge fund managers opt to sell their businesses for a mix of shares and cash. This has so far worked brilliantly for both sides making RAB a more likely place for talent to join than depart.

So long as you recognise the higher risk/reward profile on RAB shares it looks possible to target a trading range well above 100p for 2007 onwards - based on earnings growth and a steady rise in the rating. In its fairly short history, RAB has already established itself as one of the prime UK fund management companies and it is hard to bet against this success story