Current Price: $2.56
Target Price: $3.7 (update: now materially higher)
Expiration Date: Q4 2020/Q1 2021
Update: The situation has improved since the write-up. See discussion below.
US Global Investors manages a number of mutual funds and two ETFs (gold and airlines). Earlier this year, the COVID-19 triggered the airline industry crash, which has subsequently attracted a lot of investors/speculators betting on a swift recovery. As a result, GROW managed airline ETF JETS saw its AUM increasing from less than $100m to $1.7bn. Investors likely expected that this increase in the AUM would be instantly reflected in the upcoming GROW financial results finally turning the company profitable. However, the recently released annual report (FY20, ending in June) left the market disappointed as it appeared that operating expenses were higher than anticipated, and operating profitability wasn’t reached. As a result, GROW fell by 40%.
I believe the market overreacted and is overly pessimistic:
- Fee revenues from ETF during the reported quarter (Mar-Jun 2020) reflect an average AUM of only $858m whereas for the quarters going forward this figure will be closer to $1.8bn, resulting in 2x higher fee revenues.
- It is likely that at least some of the expenses were one-off driven by net capital inflows into the fund and new EFT unit creation. 80% operating margin for incremental revenues seems to be justified going forward.
- The latest quarter also saw a drop in net revenues from the mutual fund segment (USGIF). This drop partially overshadowed the positive impact from the growth in the ETF segment. However, mutual funds AUM has recovered from the March lows and fee revenues are likely to follow turn. Also, USGIF segment revenues appear to fluctuate on a quarterly basis and had a similar decline during the previous fiscal Q4 only to recover during the subsequent quarters.
By my count, with stabilized AUM and Opex, GROW operating income for FY21 will be around $4.0m-$4.5m which compares to a loss of $2.4m during FY20. At 10x multiple and a further $12m of non-operating assets on the balance sheet, I arrive at a value of $55m vs $38m market cap currently, indicating 45% upside to the current market cap.
Moreover, a substantial further upside is likely to be achieved when the airline industry starts recovering. Airline stock prices are still c. 40%-50% below their pre-covid levels and not too far from the March lows. AUM would increase together with the improvement in the airline share prices driving additional fee revenues. It is not too difficult to envisage an optimistic scenario where AUM would double from the current levels if we see a full recovery of the industry. A free option on top of already discounted valuation.
There are 3 main risks here:
- Operating expenses still turning out higher than expected. This is definitely the biggest caveat, however, the comments from the management and the OPEX dynamics in fiscal Q4 (a relatively low increase compared with advisory fee growth) give some assurance;
- Significant deterioration of the investment portfolio ($10m of non-operating assets). The majority of it is placed in a safe fixed-income fund, which mitigates this risk;
- The second wave of COVID/travel restrictions decimating the airline industry one more time, which would induce investors to withdraw funds from JETS. Nothing much to say here, however, I don’t think the chances of this becoming a reality are significant.
For more details and further background, you can also refer to this VIC article written in June – currently GROW trades just slightly above the levels at the time of that write-up.
US Global Investors provides investment management services to 9 small mutual funds, together called USGIF (natural resources, precious metals, minerals, China region, emerging European markets, etc.). Until recently, this was their main revenue source. Primarily due to shareholder redemptions, in 2016/2017/2018 USGIF faced significant AUM deterioration ($700m to $450), however, during the last 2 years the company has managed to stay consistently above the $400m mark. GROW charges a base management fee of 0.76% – 0.97% for its mutual funds and a performance fee (only for equity funds).
GROW also manages 2 ETFs: US Global Go GOLD (GOAU), which focuses on precious metals, and US Global JETS (JETS) – with portfolio. The expense ratio for both ETFs is 0.60%.
Comments from Management
During the fiscal Q3’20 conference call (in May, when JETS AUM was expanding) management clarified on the delay between AUM growth and the effect on the financial results and hinted on the supposedly positive quarter ending Sep’20 (results have not been reported yet):
But since revenue is based on assets under management, operating revenues will increase. But these will be offset by increased business development costs related to the ETF creation. Consequently, there is a delay in when the increase in AUM is notable in net income. And this delay can be a few months. Therefore, we would expect that the net positive result of the recent increases in JETS will probably fully be represented in net income after a few months, which is going to most likely be in a quarter ending September 2020.
But the – as far as where JETS AUM comes in, that really hit our revenue line item. And so we saw a significant increase in our revenue in the quarter ending June 30. Now, how it works for us is that, we do get those 60 bps that Frank had talked about earlier, but we also pay all of the expenses related to the ETF.
So with that, some of the expenses are based on AUM and will increase as AUM increases, plus we have some distribution costs that are related to inflows. And as you know, we had significant inflows during that quarter. So that did increase our expenses. But some of those distribution costs are like one-time costs, so we were seeing that.
The table below shows the projected financial performance for the next fiscal year (ending Jun’21) assuming the current level of ETF AUM remains unchanged. The key points:
- Fiscal Q1’21 (Sep’20) ended with ETF AUM of almost $1.8bn. So since the last results (June), the average ETF AUM will be almost 2x higher, which should elevate the Q1’21 revenues.
- The company doesn’t provide many details regarding its operating expenses, so it is not always clear why the expenses are going up or down. However, it is visible (table below) that the main increase in OPEX took place in fiscal Q3. Management confirmed that most of this was due to the increase in ETF AUM: “And it was primarily due to an increase in general and administrative expenses of $338,000 or 45%, primarily due to business development costs related to increase in ETF assets”. Some part of that was likely the result of various one-off costs (as mentioned in quotes above). So although AUM growth in fiscal Q4 was even more intense, the OPEX increase was way more moderate and I would expect opex to stabilize in the upcoming quarters.
- I have attempted to model the split between overhead costs, variable ETF expenses (taking 20% of AUM, or in other words 80% profit margin on incremental revenues) and one-off costs related to ETF unit growth (0.03% of AUM delta between quarter ends). The model is far from perfect and as you can see does not really explain the sharp Opex jump in fiscal Q3’20, however, I think it points in the correct direction, i.e. costs will remain elevated slightly above current levels.
- USGIF AUM is likely to stay around the $425m mark going forwards, where it has remained during the last two years except for the covid driven March sell-off. However, to stay conservative I have modeled $30k decline in quarterly USGIF net revenues relative to FY’20 (a similar drop was in the previous year).
With 15.1m outstanding shares and 10x multiple, the operating business should be worth between $40.3m and $44.7m.
Aside from the operating business, GROW also has on the balance sheet:
- $2.2m net working capital (mostly cash).
- $7m invested in their own USGIF funds (mostly fixed income).
- $5.6m in public listed Canadian equities including $2.6m in HIVE Blockchain, $1.85m in Thunderbird (content production studio) and $1.13m in Goldspot (gold exploration). Due to lower liquidity (and being listed on Venture exchange) I am marking these at 50% discount to their market for the SoTP valuation.
The company also has about $9m of NOLs. These undoubtedly are worth something, especially when the company is going to turn profitable, however, I haven’t included in the SoTP valuation.
The combined valuation of operating businesses (at status quo, without further AUM growth) and non-operating assets results in GROW value of $3.5 – $3.8/per share.