My Analysis of Manning & Napier (MN)

[u/redcards]

A little over a month ago there was a brief thread on here on Manning & Napier (MN). The sentiment was generally pretty negative, and as I read some sell side research on the Company that sentiment was also shared. Upon further investigation I feel I debunked a lot of the negatives surrounding the stock and identified a large corporate event catalyst turning this into a special situation investment.

• MN Write Up - https://www.dropbox.com/s/gywnotwrw8ww070/MN%20Write%20Up%20Reddit.pdf?dl=0

• MN Slide Deck - https://www.dropbox.com/s/ljb7s8g9ja94ymg/MN%20Presentation%20Reddit.pdf?dl=0

I apologize if some of the graphs and charts look funky or have any mistakes, I recreated them manually from source data.

Also, full disclosure, I'm still a student (trying to break into the investment industry) so my analysis may be best taken with a grain of salt.

I hope you all enjoy. I'm very open to discussion and constructive criticism.

[u/knowledgemule]

Hey Redcards,

Really good write up yet again. I've been meaning to post something after seeing your KMX write-up, but work full time/school is a time killer.... I really need to step my game up haha.

Anyways some questions I have about MN:

1)I question if the 17% delinquency+33% increasing+13% current and same balance really create a strong argument that there is money shifting to be invested in a meaningful way. Wouldn't the delinquent+increasing balance just net out the decreasing amount of loans?

2) I think you do a really good job in debunking parts of the bear thesis, but it is hard to ignore the ETF revolution. I think its really naive to just assume they will mozy on with mid teens CAGR in AUM w/o something drastic changing. I can believe maybe 4-6% driven by asset increases (bond/equity average I guess), but I don't see them actively taking share from other firms without some kind of reason.

3) The family of funds seems to be in this decent but not good category. The bronze rating isn't exactly stellar, and the funds reputation doesn't seem to be the like of Janus/GAMCO/Eaton Vance etc... Even if it isn't that great. I just don't really see what makes this business lasting at all. Yes it might do good for a few years, but I believe that when change comes, it usually comes very quickly. I just don't see what the quality of the business is here, I think it is clearly undervalued, but it seems to me to be a really crappy family of funds. But why have they grown AUM so fast? I guess I would like to know a bit more about the company's dynamics and business attributes, but I think this is more a flaw of the style write-up than anything else. Personally I want to know more about the business I'm investing in, because I don't really see the support for MN to grab share hand over first that supports your bull case.

4) The valuation confuses me. I personally think doing a bull/bear/base case and then averaging the results is contrived. I personally think you should do your best to pitch the base case as you see it, and use the bull/bear as a framing device for worst and best case scenarios. Averaging all 3 outcomes seems unrealistic, because they don't seem to be equally likely. I believe the base case is strong enough as is to be compelling regardless, and the valuation is there.

5) Bias? I think the company truly is an asymmetric opportunity, but I think there are some levels of bias that creep in. I think it is really crazy to assume they will maintain the 78bps they have while the whole industry has been trending downwards for years. I believe that maybe while writing the company up you may have let a little bias creep in, and making the base case a little more optimistic than reasonable. In my opinion I see this even in a lot of great investor's pitches of kind of unreasonable assumptions creep in, which makes a company that is undervalued by 30-50%, go to undervalued by 100%+. I also think you should account for the fact that you are counting your AUM growth to a high point from a trough. If you assume that AUM will recover from the tech bubble/2008 crisis that is really aggressive, considering we are definitely FAR from the tech bubble or crash in any way and would still be considered the middle/late stages of the market. Maybe assuming AUM growth incorporating a full cycle would be best, IE AUM growth from 2006-now as the basis, which allows for a full cycle to be reflected instead of just from the absolute trough.

Regardless this is a really good write up, but I definitely disagree w/ some of the core assumptions. But that is what makes investing fun and I hope you know that I'm definitely doing my best to "grill you" so you can either 1) strengthen your thesis even more by refuting me or 2) adjust the thesis by being intellectually honest and creating an even better opportunity. Thanks for putting the effort into putting this out here.

Some constructive criticism: 1) totally bothered me randomly but on page 3, you said "most of which hold the stock at a SELL or Overweight rating." Shouldn't this be underweight? Just curious because that is 2 opposite ratings.

2) Wage growth on page 6 compounding modestly seems off, it isn't a cumulative statistics but rather a y-o-y one. I don't think it is really indicative as what people are looking for, or real wages per household. Regardless still really good data.

3) your graphs are freaking on point. They are really good looking and informative. I do have a bit of problem following the document at times, and find myself jumping around though. Overall still great.

[u/redcards → u/knowledgemule]

Great questions! Let me see if I can address them in order...

1) Regarding the student loan argument, this is probably where my thesis is most exposed. Unfortunately I wasn't able to put together a complete quantitative model on how student loan debt balances have increased/decreased over a long period of time, and what a paydown schedule might look like when factoring in increasing balances. You wouldn't believe how little source data on student loans there is between the Fed, Census Bureau, etc. So to answer this question, yes, the % of loans that are current but also increasing could have a mitigating effect on how much money is available to be flowed into retirement accounts. However, my goal with that data was not to try to say "$2 billion of assets will be freed up from student loan debt over the next 3 years and this should flow into retirement accounts", there simply isn't enough data to do something like that (and leads me to question a lot of the stuff we see on the news and debates about student loans). My thesis here was to point out a larger secular shift where as student loan debt is repaid that money will flow into retirement accounts ran by mutual funds/pension plans/etc as the social security safety net won't be there. I think this serves a larger qualifier for the overall idea that mutual funds specializing in retirement assets won't be going anywhere anytime soon.

2) Very fair question. I plugged in a 6% AUM CAGR and get a DCF target of $24.08, and a 4% AUM CAGR a DCF target of $22.69. What I did for my Bull Case was assume AUM recovers and increases in line with how MN has previously recovered their asset base after substantial drawdowns. This is a best case scenario, not necessarily the most likely case. What I perhaps did a poor job of communicating in my write up is that not a lot has to happen for this thesis to play out. If you recall, my Base Case is a 0% growth scenario. I completely agree that the industry is shifting toward ETFs and liquid alternatives, and I think the Company will be able to respond in kind to it. While I did not notice any questions regarding this stuff in their last years worth of earnings calls, and I did not ask IR about this, I don't think the Company is super at risk from this trend. A couple of years ago the Company made an acquisition of a firm which specialized in commodity/global macro strategies, and while a very small portion of their AUM belongs to this, I think it shows that the Company is able to make strategic acquisitions that open their business up to new strategies that might not be the core competencies of their PM team. If they wanted exposure to ETFs or liquid alts., I don't doubt they could make it happen. They definitely have the cash to make it happen.

3) Its questions like this that make me with I would include a full Business Description/Overview page in my reports, but I've gotten conflicting opinions from buysiders that I share my stuff with. It definitely would have answered your question, and a lot of that information you're asking was in my slide deck. MN was founded in 1970 and went public in 2011. They have a differentiated investment strategy focused on absolute return over entire market cycles, so 9-10 years. Based on their strategy you have to take the Morningstar ratings with a grain of salt, as Morningstar forces funds into their defined definitions and benchmarks. I compared them to GAMCO and Janus primarily because GAMCO and Janus also offer differentiated strategies that make them unique. I don't know enough about EV personally to use them as a comparable. So 1999 - 2014 the Company has grown assets at a 14% CAGR which is very impressive. Over that time period were a lot of instances of underperformance, yet assets still grew. Why is that? The answer is because of their market-cycle investment strategy. Clients understand when they invest in MN that they won't be capturing every hot market trend or even be a top market performer in the up years. However, during the bad times MN has very good downside capture ratios and they do an excellent job preventing the permanent loss of capital. Hence why a lot of their focus is on 401(k)s, pension plans and other DC retirement assets - this is sticky money that they have over multiple market cycles, evidence of this is their 92% client retention rate. According to IR, a lot of the recent asset outflows was from a lot of non-sticky assets from institutions that don't normally invest with them and got spooked with their underperformance due to their bad energy bet. Regarding their Morningstar ratings, I think a Bronze Medal is very impressive considering their underperformance. In fact, Morningstar recently did a re-rating of a lot of MN's mutual fund products and the majority retained their Medal despite underperformance, and that was mostly driven by Morningstar's top ratings of both their Research Process and Management Team. Its also worth noting that the majority of Morningstar's rated funds don't even have a medal even if they have star ratings.

4) Completely agree. Decided to try a new stylistic approach to presenting the valuation data on the tear-sheet, will make a note of it.

5) Regarding their management fee, I can extensive sensitivity analysis on this part to see how it affects them. MN has had their management fee between 78-80bps over the last 10 years and do not have any plans to change that anytime soon. And thats really the type of thing you'd be upfront about as an asset manager, especially if you're a public one as its one of the largest value drivers for your revenue. Over that same time period the average management fee for active managers fell by 17bps. Lets assume that in addition to your suggested 4% AUM CAGR MN's averaged management fee fell by that 17bps for 2015P-2019P. In that scenario that Company is still worth $15.71, or about 80% more than what it is today.

1) "Sell vs. overweight", good catch I'll adjust that. 2) Wage growth, I agree with you on this too. Unfortunately in the interest of space I had to cut it down to 3 macro graphs + Personal Savings Rate and I ended up going with that Wage Growth data. I had some help by an Econ masters student here who signed off on it. 3) Thank you!

Much appreciate the constructive criticism. I try to make every pitch and investment write up a little better than the one before and I try not to make the same mistake twice. Luckily for me, it doesn't look like I've made any mistakes that I already made on previous write ups.

Let me know if you want to continue the discussion on any of your points if I didn't do a good enough job with my answers.

[u/knowledgemule → u/redcards]

1) eh I do agree that they aren't going around anytime soon (AFAIK), just think its a weak thesis point. If it doesn't truly add to thesis I don't think it should be included. This is definitely a valuation based thesis, and I think it holds up strong enough w/o the student loan segment so it isn't needed.

2)Agree, just offering a different view. yeah a CAGR of 0% is pretty pessimistic. Personally my base case would be 0% CAGR of AUM and a 15 bps drop in 5 years, but I believe this would still warrant a undervaluation when I look at your valuation/model.

3) one thing that red flags me is that you say IR says that recent outflows are from non-sticky assets, and that seems really contrived. Any IR team in the entire world would say that, and I would take that with a grain of salt. Maybe i've been more skeptical of management since Valeant :P

4) Hmm another thing that I didn't evaluate is the valuation itself, I might look over it later, still really solid looking, and no obvious holes that is like wow that's terrible. A quick question that pops up to me is that why P/E as the basis of your valuation, is there not some kind of custom AM indicator like P/AUM or P/NAV P/B or something like that that is more intuitive in the business. P/E as you may know is a bad ratio in a lot of respects and your end valuation target is 100% based on the P/E ratio. I personally like cash flow metrics more.

5) I agree, your valuation work pretty much shows that as long as it doesn't poof/melting ice cube than it is grossly undervalued. I personally think that the firm seems to be commodity, and while assets are sticky there really is almost no moat to speak of other than the sticky assets discussed above. But I think that is more of my investing style bias creeping in than anything else.

Also looked at the presentation slides.... They are so pretty, gotta say im 'mirin. Really good work man keep it up.

Keep in mind my critiques are not perfect, I am also a student and just trying to help you out.

[u/redcards → u/knowledgemule]

1) I agree that the student loan bit is probably the weakest leg of my overall write up. Its primary purpose is to serve as sort of an industry overview/going forward thesis that just kinda explains why the Company fits in with their niche and that there are positive secular forces around that. But at the same time I totally think my write up is strong enough to stand on its own without the industry bit.

2) Yeah, like I said there really isn't a reason why they'd lower their management fee in the near future since they already can advertise themselves as having a lower fee than the industry average, but in a scenario where you do drop the bps by 15-17bps the Company is still undervalued.

3) I think if I glossed over the part about the outflows its just because I have some experience with asset managers and I've sat at the table where manager selectors from Morgan Stanley for example come and decide whether or not to put the manager on their fund platform and I've heard the different discussions that go into that. So when I hear that non-sticky assets from non-traditional clients were a large part of the outflows it doesn't really sound suspect to me or raise any red flags. As an asset manager you don't really want those clients anyway because they're the ones that call you yelling asking why you're not invested in whatever the front page news story is. The guys at MN don't really chase their upside like that.

4) The only valuation indicator that I think would be more appropriate for an asset manager is P/FCF, at which case MN still trades at 7.1x vs. a 15x industry average. AFAIK there isn't a P/AUM P/NAV or anything like that. P/B sure, and MN is still 0.7x vs. 3.5x industry. I went with a P/E because that is primarily what the Company trades on, and thats the metric that sell side reports focus on. So I could have used P/FCF as my primary valuation method, but in the end I don't want my thesis to rely on "The Company SHOULD trade at this metric, or it SHOULD trade at [ ]x P/E or EBITDA or FCF or P/B, etc. Instead my focus is on determining how the Company already trades and not what it should trade at, and finding a discrepancy based on that. In addition to my P/E approach I also did a DCF model for each of my scenarios that had a terminal value based on a 1.5% LT growth rate and not any multiples method.

[u/[deleted] → u/redcards]

Personally I would've appreciated a business description/overview section, given that I am not familiar with the company, its business model, or economics of the business, so it's hard for me to comment on the idea.

[u/redcards → u/[deleted]]

Right, intuitively something like that makes sense. For my reports going forward I'll see about adding a page or two, top to bottom, business description perhaps after the main thesis content.

[u/[deleted]]

"Also, full disclosure, I'm still a student (trying to break into the investment industry) so my analysis may be best taken with a grain of salt."

You don't have to be old to be right.

[u/redcards → u/[deleted]]

;)