reality check - let's discuss the fundamentals

Given that we have four days away from the noise of trading, I thought it would be good to start a discussion on the fundamentals. The following are my random thoughts...please DYOR, and contribute to the discussion. I haven't gone back and checked all the points, so please highlight any ommissions as well.

In summary, HFA is a business with many challenges and is a long way from prospering. There is probably a bit too much optimism around HFA IMO at this time. Whilst they have been a strong business, there is much uncertainty. Personally, I am happy to hold at these levels, as I see them as a chance for long term success, but I certainly rate that chance at best 50/50 currently, and wouldn’t be putting cash into this that I could not afford to lose.

Anyway, starting with the positives:
- They have 2 years to address their debt
- They have developed a strong brand locally, and “open” funds appear to be holding up well in terms of redemptions
- Performance appears good (in a relative sense)
- Great transparency generally from management, although the hiccup around half yearlies was a bit strange
- Short term revenue will be helped by the redemption freeze
- They have made strong profits in the past
- Intangibles have essentially been fully written off, thus allowing the future resumption of dividends, yet a long way off
- From someone’s HC analysis the other day, effective free float is likely to be much lower than issued capital given staff holdings
- HFA are offering more transparent hedge fund investment arrangements via managed accounts
- They have not really penetrated the Australian institutional market, thus this presents an opportunity

The negatives or concerns are:
- They have a massive debt position which has ballooned in the last 9 months due to the fall in the A$ against the US$
- I can’t see any dividends over the next two years
- IMO, a funds management business should have small amounts of debt given that their assets are intangible
- They have stated that they will eliminate leverage at the product level, thus reduction in FUM of $1.7 billion and associated hit to revenue
- They have around a billion dollars of product currently frozen. When these products are re-opened, I expect that many punters will grab the cash as soon as they can, thus loss revenue on these funds
- What is the damage to their brand in Australia re the freeze...suspect it is not too bad as many other funds in the same camp
- Damage to the brand of hedge funds generally as they haven’t delivered on their perceived promise of absolute returns and preservation of capital
- Some assets are in the toxic camp, thus will be a longer term headache for the business and an ongoing negative reminder to clients
- Hedge fund margins are widely predicted to contract, with associated impact on revenue
- There are big question marks around the lack of transparency of hedge funds, and particularly fund of funds, and therefore their ongoing attraction to investors (yet see comment above re managed account programs)
- The Australian retail market looks to be heading down a path of new products being highly liquid and plain vanilla, thus the opposite of fund of hedge funds
- I have heard comments that their performance fee hurdles are too easy, yet have not reviewed myself. Whilst good for revenue whilst those products are in place, new business is likely to be written at what may be materially lower margins
- The lack of transparency around the share transfers associated with Sean McGould
- Recent resignation of the chair, and I don’t think with any statement around plans to replace etc
- I don’t think I have read that they are taking the knife to their cost base, but could be wrong. This is important as they have large fixed costs, and whilst a very healthy profit margin currently, they need to maximise the amount of debt that is paid off and also put themselves in as a strong a position as possible to weather any redemptions and reductions in leverage
- Very little flexibility in dealing with their debt – what are they going to sell?

Ultimately, the way I see it is that they need to win material new business over the next two years to replace higher margin business that they will lose from existing products via reductions in leverage and redemptions (may need a win/loss ratio of 2 to 1 to just tread water ie maintain profitability). If they do this, then they will clearly survive and likely be a great investment IMO.

However, if they do not, it is quite possible that they will not pay off enough debt and given Westpac’s aspirations in funds management via BT, I wouldn’t want to be at their mercy!

Also, given the mountain of debt they need to overcome and very little that they can sell other than say Lighthouse, it is quite possible that there is a binary outcome, that is great success (return to $1 plus) or failure (little to nothing for shareholders).

So in short, the only buy signal for me on this one is around winning material new business...fingers crossed! And let’s hope the A$ returns to parity also.

BTW, some recent buying by instos has clearly helped the share price, but I don’t put much credence into such buying. Ultimately there were large sellers supplying the volume...so which insto is smarter, the buyer or the seller.

Anyway, just my thoughts to get a discussion going on the fundamentals...please DYOR, and don’t invest unless you can afford to lose it.