If you’re watching the spat over Dell Inc. (DELL) and trying to guess the best way to play the prospects that founder Michael Dell and his private equity partners will be able to push forward with their $13.65-a-share buyout of the computer company, here’s one option that you may not have considered yet.
Pzena Investment Management (PZN) is a value investment firm that has been among the leaders of the anti-LBO campaign, most recently joined by T. Rowe Price Group (TROW) and numbering several other large asset management firms. If they lose the battle, they probably won’t lose money: analysts who track public filings by asset management firms like Pzena have put the cost basis for their position in Dell at around $12.34 a share. So, even if the deal goes through, it’s unlikely to trigger a mass exodus on the part of investors in Pzena’s funds.
And if Pzena is seen as a leader in halting the transaction, that’s going to be good new in the short-term in the form of publicity for the firm’s mutual funds and Rich Pzena’s activist stance. The longer-term outlook remains uncertain, but several convincing arguments have been made that the true value of Dell’s assets and businesses probably exceeds the level ascribed to them in the buyout offer. If Pzena and the other activists succeed in extracting a significantly richer buyout offer, that’s a win on both the PR front and in terms of investment returns.
You could play this scenario directly, by buying Dell shares. But it’s hard to see why anyone who isn’t a professional trader would risk doing so as long as they are trading above the existing buyout offer price. But while Dell’s gains have been steady and significant, those at Pzena have been more volatile. True, the stock has handily outperformed the S&P 500 this year, and its percentage return so far in 2013 is nearly double that of T. Rowe Price, for instance.
But Pzena offers a purer play on what is happening in the world of asset management this year: a dramatic turnaround in sentiment with respect to actively-managed mutual funds. Last year, as chronicled by Lipper and others that monitor fund flows, it was ETFs that dominated the landscape as investors favored highly liquid and passive funds that they could exit quickly. This year, that pattern has changed, and fund flows in the first four weeks of the year hit a 12-year record.
There are myriad ways to play this trend, as the number of investment management companies that are publicly traded edges higher. But Pzena has generally managed to post higher operating margins and pretax margins than the industry as a whole, by some calculations, and it trades at a lower multiple of forward earnings than some of its larger peers, such as T. Rowe Price.
The company also is trading slightly lower than it was a few days ago, thanks to some disappointing results in its fourth-quarter earnings, including $400 million in net outflows in assets under management over the third quarter (offset by gains in its investment portfolio), and the bottom line earnings per share of 8 cents and the rate of growth in revenues fell slightly below what investors had been hoping for. Fees also have fallen off. Still, assets under management were 27.3% above where they were a year ago – and that doesn’t reflect any benefit the funds managed by Pzena will see as a result of the big inflow of assets in the first quarter.
Moreover, Rich Pzena commented during the company’s earnings conference call that the firm’s appointment to manage 28% of the Vanguard Windsor Fund last summer has triggered growing interest among other big institutions in exploring the idea of handing over some of their value investing to Pzena as a sub-advisor. “Funds flows have turned positive into our sub-advised accounts,” Pzena said of the year-to-date results, noting that the firm also is benefitting from the decision to expand its business development team. Moreover, he pointed out, 2012 proved to be a great argument in favor of owning ‘risky’ assets, including value stocks. “At the beginning of the year, conventional wisdom had Europe teetering on the verge of collapse, the financials years away from even anemic recovery and the housing sector, particularly in the U.S., hobbled by falling prices and lack of mortgage lending,” he pointed out. A year later, that consensus appears laughably wrong, and the market’s gains underscore the importance of “being positioned before the turn.”
Pzena pointed out that he can’t be sure that January’s industry-wide fund flows can be sustained throughout the year, or that the rate of interest in his firm’s asset management business on the part of prospective clients can be converted into new investment mandates, but added he sees this as “encouraging”. Overall, the picture that is taking shape is of an indirect play not only on Dell but on other undervalued technology stocks that Pzena can parlay into profits for his clients and ultimately for investors in the form of growing assets under management and a recovery in fee levels.
Suzanne McGee, a contributing editor at YCharts, spent nearly 14 years as a reporter at the Wall Street Journal, in Toronto, New York and London. She is also a columnist for The Fiscal Times, and author of "Chasing Goldman Sachs", named one of the best non-fiction books of 2010 by the Washington Post. She can be reached at firstname.lastname@example.org.
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