Asset Sale/Potential Large Capital Return – 28% Upside
This idea has been shared by a member of SSI.
Note from SSI: SSI has already seen a number of setups where a company has sold a substantial part of the business and is due to initiate a large capital return to shareholders. So far these cases have worked out consistently well. The market seems to often underestimate either the amount of capital that will be returned or the valuation of the remaining business. Some previous examples include: BCOR, LAUR, DII-B.TO, BSIG. Guardian Capital Group is the latest addition to this theme.
Summary
Guardian Capital Group is a Canadian asset manager that has recently sold two businesses and currently trades at a 7.4% discount to its net cash + portfolio of equity securities. The market is assigning zero/negative value to the GCG’s remaining profitable asset management business. Management has a strong track record of capital returns via dividends and buybacks. A large tender offer could be expected in the current situation.
Two short-term catalysts might help the stock to re-rate. With Q1’23 results the sale proceeds will be fully visible on the balance sheet, and management is likely to announce their plans for the excess cash. Valuing the operating business in line with peers at 5x-7x adj. EBITDA, results in C$51.8-C$54.3/share target or a 22%-28% potential upside from current levels. This seems attractive given the rather short timeline. While we wait for setup to play out, the downside is well protected by these liquid assets on the balance sheet.
Important – the company has two classes of shares – common voting shares GCG.TO, which are highly illiquid, and non-voting shares GCG-A.TO. The daily liquidity of the latter is around C$100k-C$300k.
Situation
Guardian Capital Group is a Canadian asset manager that has recently finalized the sale of its life insurance managing agency and mutual fund distribution businesses for net proceeds of around C$550m. On top of that, the company has a portfolio of mostly listed equity securities worth C$660m and also C$29m net debt. This sums up to total net cash + securities of C$1181m or C$45.61/share vs the current share price of C$42.23.
Aside from cash and securities, GCG also has a profitable investment management business with C$50bn AUM. This operating business generates around C$30m-C$40m (or C$1.25/share) of annual EBITDA. The profitability has remained very stable over the years. The market is currently assigning zero/negative value to this business. Worth noting that GCG’s operating businesses have never traded at a negative valuation before (note the table below also includes earnings of the discontinued businesses).
At current prices, the downside is very well protected by the company’s cash + securities balance. This gives investors a low-risk bet to see what happens next, how the management uses the sales proceeds, and if that has any effect on GCG’s share price.
Is Guardian Capital Group a value trap?
Historically, Guardian’s market cap has tracked its securities portfolio (stake in Bank of Montreal + investment in GCA’s Global Equity Strategy). The market seems to have ignored the earnings of the operating businesses, just thinking GCA.A = Securities portfolio, ignore earnings. However, the company rarely did have much actual liquid cash and when it did, it bought back a bit of stock. Hence, the management’s argument has been ”we seeded Guardian Global Equity strategies with BMO Share sale proceeds and bought back some stock, however, we never had that much actual liquid cash”.
With the recent business sale completed, Guardian Capital will have over ~$600m of liquid cash (Post Tax and Minority Interest payouts), not counting the securities portfolio. Speaking to them recently, management is aware of the cash surplus and has told me that any new possible investments “wouldn’t consume anywhere near the cash we have”
So why does the discount persist so far?
The sale closed only in Q1’23 and the large cash balance is not yet visible on the screeners. Q1 results, which are due to come out in May, will remedy this and might be a catalyst for the stock to re-rate.
The market might also be putting a discount on GCG’s cash as management hasn’t yet publicly commented on the intended use of proceeds. However, GCG management has a solid track record of capital returns and chances are high that a large portion of the excess cash will be returned to shareholders. Given relatively low trading liquidity, tender offer would be the most likely scenario for the capital return. This would be another catalyst for the share price to re-rate.
Management owns a 6% stake and their actions over the years have been well aligned with shareholder interests – the company has bought back 30% of stock since 2008 while consistently paying a dividend. In total, over the last decade, GCG returned 60% of adjusted OCF attributable to shareholders through dividends and buybacks.
The buybacks have continued in 2023 as well, with the company having repurchased a further 1.5% of shares in March/April.
Quick Business Overview
GCG is one of the largest independent asset managers in Canada with $49.6bn AUM. The company operates 3 business segments:
- investment management – investment products and portfolio management services to institutional clients;
- wealth management – remaining operations include wealth management services for high/ultra-high net worth clients and private banking services. Previously the company also had a life insurance managing agency and mutual fund dealership businesses, which were disposed of in the recent sale;
- corporate activities & investments – management of its own portfolio of securities. The company has around C$660m in a portfolio of securities (mostly its own strategies and shares of Bank of Montreal). This segment also includes corporate overheads.
Revenue is generated primarily through various management and advisory fees on assets under management.
The company has been consistently growing its AUM and revenues – both organically and through non-dilutive acquisitions (1 per year over the last 5 years). The business had a strong boost during the post-COVID market boom in 2020 and 2021. The drop in AUM last year mostly reflects the broad sell-off in the stock market, whereas the outflow from clients was relatively small at C$1.5bn.
Remaining business and relative valuation
The remaining business – mostly the investment management segment – has been consistently profitable over the years. Historical financials can be seen in the table below. Given considerable recent noise in the company’s financial statements (discontinued operations, non-controlling interests, security portfolio income, etc.) I think using adjusted EBITDA as a proxy for profitability makes sense. I calculate it by taking the reported EBITDA attributable to shareholders and deducing security portfolio income (dividend and interest), stock-based compensation, and lease expenses.
What could be an appropriate valuation for the operating business in case the market does re-rate it? Historically, the market used to value GCG’s operating businesses at around 3-5x reported EBITDA. Given the above adjustment to the calculations as well as materially improved cash position of the whole company, I think GCG’s operating business could re-rate even higher and settle closer to peer multiples.
Most Canadian asset managers are either much larger or extremely levered. FSZ and CIX (both quite levered) trade at 7-8x adj. EBITDA (also adjusted for stock-based comp, leases, and financial investments income). Another peer AGF-B trades at just 2.4x as the market is probably putting a significant discount on the value of its long-term investments (C$224m), which is mostly private equity holdings through AFG’s own strategies and also other third-party funds.
Putting a 7x adj. EBITDA multiple on GCG’s remaining operating business on top of the current net cash would result in a 28% upside. At 5x, the upside would still be 23%.
More details on pro-forma balance sheet calculations
On November 30, the company sold pretty much the whole wealth management segment for C$750m. C$600m was attributable to the life insurance managing general agency (IDC WIN) and C$150m to the mutual fund and securities dealers (Dealers). C$104m went to minority shareholders of IDC WIN and around C$20m was put into escrow to be held for 18 months for potential indemnity claims. The actual proceeds to GCG shareholders from this sale were around C$627m (page 15).
According to the recent annual report, the book value of the sold businesses was around C$155m – as of December’22 assets of discontinued operations were C$297m and liabilities of discontinued operations were $142m (page 66). Capital gain tax is 13%. With this, I calculate the net sale proceeds attributable to GCG to be C$550m.
Besides that, GCG also received around C$39m from the release of excess cash of IDC WIN and Dealers just before the transaction was closed. This cash release has lowered GCG’s net debt position from C$63m as of Q4’22 to C$29m.
As of Q4, the company also had a securities portfolio of C$660m, with a large stake in Bank of Montreal and investment into GCG’s own Global Equities strategy. The change in securities portfolio value since the year-end is likely minimal as the overall stock market is up, while the shares of Bank of Montreal are slightly down due to the bank market sell-off. Most of the securities portfolio seems to be fairly liquid. BMO is a $62bn stock, whereas Global Equity and Canadian Equity strategies invest in large/mega caps too. That’s already about 90% of GCG’s security portfolio. Information on the remaining investments is a bit limited, but it’s likely that a large part of it is liquid as well.
The company received about 5m shares of Bank of Montreal in 2001, when GCG sold one of its businesses to the bank. Over the years, GCG has been slowly selling BoM shares and reinvesting the proceeds mostly into its Global Equities strategy. According to this 13F filing here the company still holds around 2.5m Bank of Montreal shares.
Just confirming the $32M Adj. EBITDA number is PF for the recently sold operations (Wealth Management), were there any other discontinued businesses it accounts for.
Yes, you are correct. It has been adjusted for the discontinued operations already.
May not be material but when relying on the look through value of the securities portfolio and including that in the value ($660m) shouldn’t you be
1. accounting for any tax liabilities on gains
2. accounting for any YTD unrealized losses – i think the $660m number is as of 12/31/22. I’d assume there are some losses given the weight of the BMO, RBC and TD positions.
Regarding (2) YTD unrealized losses on the GCA’s securities portfolio, BMO is pretty much at the same level as at the start of the year. And then RBC/TD positions – have there been any disclosures indicating the size of these?
And your (1) part of the question is a bit more difficult. You’re correct and it definitely would be more conservative to account for the potential capital gains taxes on existing securities portfolio in the SOTP framework. However, aside from the BMO stake, I do not know how to assess the cost basis of the remaining securities. And then regarding BMO’s position, the cost basis appears to be c. C$36/share vs the current price of C$121/share, meaning that C$190m of profits (total BMO position at C$273m in Dec’22) would be subject to capital gains tax. If I understand correctly, corporation in Canada have to pay taxes on 50% of the capital gains. The effective tax rate for GCA so far seems to be c. 15% (average over the last decade from the income statement), which would result in capital gains tax charge of C$15m. So if my calculations are correct that does not change the equation materially. Also, this tax would likely be recognized over a number of years when/if the BMO position is sold-down.
So I do not think that tax issues will have a meaningful effect on this thesis. It will mostly be driven by management’s decision on how to allocate the excess cash.
thanks for the response and additional info re taxes.
I got the holdings from tikr. It is possible that the list there is incorrect and/or includes client capital.
https://app.tikr.com/investor?id=5000021454&ref=ndpmd6
Does BMO have much interaction with the US banking system? I.e. if further issues are uncovered in the US, it is likely to impact BMO, either operationally or it’s share price?
At the peak of the sell-off in US banking stocks, BMO shares were only 5% below the current levels and down 20% from the February peak. So I am guessing that any potential spill-over effects are already accounted for. This is a large-cap bank (C$86m market cap) and the market should be pricing it quite efficiently. However, anything can happen and there is definitely a risk that BMO sells-off further driven by events in the US banking system or something entirely different.
The net cash per share calculation of $45.61 implies that there are 25.89m shares outstanding (1181/45.61); can you please tell me where you got that number from?
Per the notice of the AGM filed on 17-April-2023:
“As of March 31, 2023, the authorized capital of the Corporation consists of an unlimited number of preferred shares, an unlimited number of Common Shares and an unlimited number of non-voting class A shares (“Class A Shares”), of which 2,743,379 Common Shares and 23,369,673 Class A Shares are issued and outstanding.”
That is a total of 26,113,052.
Since 17-April-2023 I couldn’t find any further information that suggested shares outstanding of 25.89m.
From March 31 until the time the write-up was posted, the company had repurchased 224k shares in the open market. That is the difference in the share count you’re getting.
By the way, at the end of last week, another 106k shares were repurchased, so the current share count is even lower.
Buybacks and insider transactions of the Canadian companies can be found here https://www.sedi.ca
To be fully accurate, the calculations should also account for the cash spent on these buybacks. Since March-end a total of C$14m has been spent on repurchases (0.33m shares repurchased). These have only a minor 1% impact on the net cash and value/share estimates.
Accounting for the buybacks till today, the share count stands at 25.77m whereas adjusted pro-forma net and securities are at C$1166m and SOTP is at C$53.94/share.
Q1 Results posted: https://www.guardiancapital.com/media/62339/gcgl-announces-2023-q1-operating-results.pdf
From the SEDAR-filed MD&A:
“The completion of the transaction returns Guardian’s strategic focus to its roots and core competency of an investment management business. Over the coming quarters, Guardian will review and update its strategic plan, which will explore the various options to deploy the additional liquid capital received upon the dispositions.
Subsequent to the quarter end, as part of a renewed focus on expanding its presence in the United States, Guardian is exercising a portion of its call option to acquire an additional 24% interest in Alta from the minority shareholders. The transaction is expected to close in the second quarter of 2023 and will result in Guardian owning 94% of Alta.”
So the capital isn’t coming back too shareholders but rather used for acquisition and expansion?
@G98
I think the Alta purchase is only like 20-30mm USD. Not 100% sure though, as I can only find info on options that the non-controlling interests have to sell their Alta stakes to GCG (worth ~26mm USD as of the last annual report). So what management says seems true: “wouldn’t consume anywhere near the cash we have”
@jwestern
Thanks for that insight, much appreciated.
I posted my comment too hastily without having read any source material and was basically just pissed off at another special sits not ‘working out’ as I thought. I have now read the 10Q quickly but need to read it again. On the whole my impression is it is a (bad) joke that they don’t know what they’re going to do with the capital by now. Surely several months to decide on a tender offer, special dividend etc. was more than enough. All this faffing around is vexing to say the least and a killer for the CAGR/IRR of the investment.
In general, I’m increasingly of the view that the vast majority of management teams of public firms are simply so personally wealthy that empire building, power and prestige are nearly always preferred to running a smaller more efficient, shareholder centric organization.
IBS, another potential large capital return play, while better than this has been disappointing. And for ‘bad management’, NANO has to take the cake (in my portfolio); I can’t believe the communications they put out in the lead up to the settlement announcement was legally acceptable!
*end rant (for now)*
As it stands GCG is still trading a negative EV (price ~44/share) and below its Tangible BV which is also unusual historically speaking.
A few pertinent extracts, mainly from the Q1 report along with some inane commentary is found below:
The sale was not expected:
“We were not planning on the sale of the Worldsource businesses and, as such, there were no strategic plans that required us to monetize the business to fund targeted objectives in other areas. The sale of Worldsource ultimately came down to a very persistent and compelling case made by the acquirer at a price that we thought was more than fair relative to the on-going execution risk we had in running these businesses.”
“Immediately after closing of the transaction [1-Mar-23] we committed to take the next six months [ends 31-Aug-23] to undertake a full strategic review which will include engagement with various stakeholders of including Board of Directors, Shareholders, and third-party advisors. Our review will focus on the strategic opportunities to support and grow our core business as an asset manager.”
In another part of the report they referenced a non-specific timeframe (“coming quarters”):
“The completion of the transaction returns Guardian’s strategic focus to its roots and core competency of an investment management business. Over the coming quarters, Guardian will review and update its strategic plan, which will explore the various options to deploy the additional liquid capital received upon the dispositions.
I want to believe the “six months”/31-Aug-23 but not sure which piece of information is more reliable etc.
“Overall, we believe that we have ample capacity to fund any future demand for seeding of proprietary strategies and their respective investment vehicles, corporate acquisitions or buybacks of Guardian stock under our normal course issuer bid.”*
* Normal Course Issuer Bid, pursuant to which it intends to purchase, during the period from December 19, 2022 to December 18, 2023, up to 137,468 or 5% of its outstanding Common Shares, entitled to one vote per share, and up to 1,623,612 or 10% of its public float of Non-Voting Class A Shares (“Class A Shares”) as at December 5, 2022
If they just buyback under their current NCIB I think it is lame – a large scale tender is surely the way to go given the massive excess cash they now have.
“With strong, continuing cash flow and an even greater fortress balance sheet, we are in the enviable position of being able to balance the needs of all stakeholders, including our clients, associates and shareholders. Given the sale of the Worldsource businesses nearly doubling our liquidity, Guardian has concluded that we have the flexibility to substantially increase the allocation of our cash flow to dividend payout, compared to prior years. As a result, the Board is pleased to report that we have declared another quarterly dividend of $0.34 per share, payable on July 18, 2023 to the shareholders of record on July 11, 2023. ”
Annualizing 0.34 results in a projected dividend yield of about 3%. Pretty weak (thus far).
On the whole, market volatility aside, there doesn’t seem to be much downside to this situation. That said, my guess it they are looking for acquisitions targets, and once the funds required to make those acquisitions are known they are likely to return a portion of the residual cash to shareholders.
Empirically, acquiring firms as a group underperform to such an extent that is has given rise to the confusingly named (because it includes liabilities too) “Asset Growth Anomaly”. So (bad) acquisitions seem to be a potential risk.
From my simplistic standpoint I would have thought which ever way you cut it, GCG is trading below its ‘intrinsic value’. Furthermore, as ‘professional capital allocators’ surely the current circumstance provides a near perfect opportunity to buyback their own shares post-haste. As a glance at the balance sheet again, the company seems to be trading below Net ‘Current Asset’ Value… if that ain’t below ‘intrinsic value’ for a profitable business with ‘reasonable’ ROE/ROA/ROIC I don’t know what is (though not knowing the intrinsic value of a business isn’t something new for me).
It would be great to hear the thoughts of others and find out what I am missing/misinterpreting etc.
This is what I infer as the “main points” of your summary; We have a Co that
– Is super cheap (negative EV)
– Is profitable
– Fairly recently received a huge amount of “suprise cash”
– Publicly stated its intent of looking for reasonable ways of allocating excess capital (be it buy backs, dividends, tenders, and even acquisitions) in the reasonable future
– Has a long term history of reducing sharecount
– Don’t have the overhang of “never fully priced” such as Chinese ADRs, etc.
If you focus on these points, and remove the company name and emotions about having a position, I think most reasonable investors would agree that this seems like a very low risk / medium-high expected IRR type of case. Will this one work out? Who knows, as for now I think we just have to sit back and wait. It seems fair to me to at least give the Co until end of the year before closing out the idea…
As for the asset growth anomaly more than bad M&A is included here (cos ramping up debt financed inventories in hope of sales booms that never happens, etc.)
Thanks for the reflection, much appreciated.
So this is actually my idea and I suggest closing it.
From when the deal occurred there was (kind of for the first time) actually meaningful cash with which to do stuff.
Managements commentary was that “we want to grow the business” but (still) have enormous cash balances which we see as surplus.
However as time goes on I’ve started to see a change in their commentary towards wanting to use $1-300m to seed new strategies, continue to buy more businesses. All of this the market is clearly unwilling the ascribe any value to.
Since the company is controlled by them and they state they’re “conservative” i.e. happy to sit there and let inflation eat the cashes value, grow the business and not run it efficiently.
I think there might be a token tender offer, but anyone who expects them to all of a sudden sell BMO and send all the cash back to us via tender is dreaming I think.
I also don’t think they’ll come out with an explicit “result” of the Strategic Review, as it seems like they are assessing a bunch of new strategies, how to seed them and potentially do team lifts which can often take months if not years.
The company hasn’t really shown a willingness to do big buybacks and run it efficiently before, the fact they are talking about “raising their dividend payout” to a shitty 3% sort of says it all. I doubt they’ll change much now.
Management seems to have done a solid job overall for shareholders. They’ve paid lots of dividends and grown the intrinsic value (and the stock price) of the business 3-4X over the last 10-15 years. Therefore, shouldn’t we trust they will do good moves with all that surplus capital?
Don’t you think there is still a chance they will make some decisions in the next months? This is a lot of money… quite an unusual situation and interest rates being higher I think gives them more time to think about it.
If there is $46 per share in net cash and securities after debt, at 11X free cash flow, I think the asset management business may be worth $400M-$500M on its own. Or 2% of AUM would give $1B. At $500M, you’re still looking at an intrinsic value per share of almost $70. It seems really interesting and simple…
I think business wise they’ve done well, sold stuff for great prices and grown the business well.
However there’s a reason this traded as a tracker to BMO + Equities, and that’s because they control it and have no incentive to actually drive shareholder value by a higher stock price.
They’ll just run it super conservatively and DGAF about minority shareholders since they control it.
There might still be a token buyback but tbh I imagine itll just be more of the same.
I think risk is low (asset backed), but also I dont think return will be great due to them just hoarding capital and trying to grow the AM business which the market clearly doesn’t value.
… and most importantly, based on management’s performance in the past, I would expect that $70 to grow over time.
Some price movement in this recently. Any news I have missed, or anyone with any takes on as to why?
This one, I guess https://www.prnewswire.com/news-releases/sterling-capital-management-llc-to-be-acquired-by-guardian-capital-group-limited-302051440.html