Preface: In this market one finds it hard to find great businesses at great prices or even fair businesses at great prices but every now and then you spot what appears to be a great business at a fair price. I believe Cymbria fits this bill. Allow me to explain why.
CYMBRIA
Company history: Cymbria is an investment company incorporated in 2008 by 4 Trimark alumni (Tye Bousada, Geoff MacDonald, Patrick Farmer and Robert Krembil) who became disgruntled with the sales driven, asset gathering nature of the Canadian fund management space. Cymbria was created by the IPO of Class A shares and the private placement of Class J shares in 2008 for gross proceeds of $234M.The proceeds went into the holding company structure which consisted of $509,585 for a 20.7% stake in the new investment manager created, Edgepoint Wealth Management, and the balance to manage an active portfolio of global securities. Edgepoint Investment Group is the manager of Cymbria.
Business description: The holding company is simple: a portfolio of mostly public companies and the 20.7% stake in Edgepoint. The group of four (Bousada, Farmer, Krembil, MacDonald) own 100% of the voting common shares of Cymbria and 68.1% of Edgepoint Wealth Management. Cymbria shareholders own 20.7% of Edgepoint Wealth and Edgepoint Wealth’s employees own 11.2% of their firm. Furthermore, Robert Krembil entities (Krembil Foundation and Chiefswood Holdings) control 12.6% of the Class J Shares and the industrialist Robert Schad controls another 12.2% of the Class J Shares. Edgepoint Investment Group charges Cymbria a MER (management expense ratio) of 1% for the Class A shares and 0.5% for Class J shares.
Business model: At the Cymbria level, value comes from growth of the portfolio of securities and increases in the valuation of Edgepoint Wealth. Edgepoint Wealth operates mainly in the competitive Canadian retail ($13.5B AUM) and institutional ($3B AUM) spaces through four funds (Edgepoint Canadian, Edgepoint Canadian Growth & Income, Edgepoint Global and Edgepoint Global Growth and Income). Retails funds can be purchased in either Front End (FE), Low Load (LL) and Fee Based/Advisory Fee Formats. Interestingly enough, the firm does not offer any Back End (BE) funds. With BE funds the standard arrangement is that the mutual fund manager pays the financial advisor a fee upfront (usually 5%) while the manager charges the client this fee on early redemption over a declining schedule (usually seven years). LL funds have both lower upfront fees (usually 3%) and shorter schedules (usually three years). On an annual basis, Edgepoint Wealth Management charges retail clients a Management Expense Ratio (MER) which ranges from as low as 0.8% with the fee-based option, to as high as 2.42% with one of its LL options. Institutional fees are usually lower and negotiated by mandate. Out of these fees Edgepoint Wealth expenses are the annual trailer fees to the advisor, transfer agency, custody, fund accounting, filing fees, legal, audit, general and administrative, and other costs.
Canadian AUM Space: As of September 2017, Canadian mutual fund assets stood at $1.43T of which $1.2T was in equity and balanced funds. Another approximately 1T sits in segregated and pooled pension assets. In a sense this is Edgepoint’s addressable market but a large section of these assets are sticky and sit with the big banks. A retail client whose mortgage, chequing and savings, and insurance is at a big bank is very difficult to recruit back into the non-bank space. Not impossible but difficult. A more realistic addressable market are Edgepoint’s non-bank competitors. The most recent AUM reported of the major public non-bank competitors (IGM, CI, Fiera, AGF) adds up to $424B. Round that up to include much smaller shops and one can say Edgepoint is playing in a $500B pool. As imprecise as these figures probably are it is better to be roughly right than precisely wrong.
Investment Rationale
Strong Performance: Over its four portfolios Edgepoint Wealth Management has outperformed its benchmark since inception (November 2008 to September 30th 2017 CAGR) by adhering to its discipline process of buying companies with strong competitive positions, strong managements, strong barriers to entry, and long term growth prospects at discounts to intrinsic value. Their highest conviction ideas are added to the public equities section of Cymbria’s portfolio. At the Cymbria Level NAV has grown by 311% (Nov 08 to Q2 2017).
Culture/Skin in the Game: The company seems to have a strong culture at the employee level, advisor level, client level. Up until this point, the company has done no advertising and marketing, released no fancy merchandise, sponsored no major events and even uses black and white printing to save costs. Retail clients tend to pull money out at the worst time and Edgepoint has taken moves to curtail this. It has a $15,000 minimum and every financial advisor they develop a relationship with has to sit with a relationship manager who ensures the advisor is aligned with the firm. By December 2016, employees of Edgepoint had over $160m of their own money invested in their funds. They also own 11.2% of Edgepoint Wealth Management as mentioned earlier. As of the last count, all 62 employees listed on the Edgepoint website are listed as partners and this level of commitment clearly shows. Employee turnover is extremely low, outside the founding partners, of the 14 new hires I counted in their 2008 annual report, 12 are still with the firm. Edgepoint’s non-bank competitors have 4x as many employees. Even if you factor in the fact that some back-office administration is handled by CIBC Mellon as opposed to non-bank competitors like Mackenzie and CI where these activities happen in-house, the productivity per employee is impressive. The future effect of culture is hard to quantify and often poorly underwritten in public markets.
Threat of ETFs is overblown in Canada: Canadian ETF assets are now over $135B. Total Canadian AUM is probably closer to $3T so ETFs are roughly 4.5% of the market. Over time ETF market share will only increase and many active fund managers will be badly affected. To the contrary, fund managers that provide value to their clients after fees will remain valuable, maybe even more so with less active competition. Also, ETF inflows have increased in a rising market. In the next major downturn where there is forced selling of ETFs, prepared active managers will benefit greatly from the indiscriminate selling.
Disagreement with Deloitte on Edgepoint Valuation: The company works in consultation with Deloitte as the 3rd party in helping value Edgepoint. The accounting profession is conservative by nature, and rightly so, but I believe Cymbria’s stake in Edgepoint is worth considerably more than the $151M it is valued at as of Q2 2017, and will explain why in the valuation section below. Deloitte’s assumptions ranges are:
Annual market growth 4%–8% ($14.4M)–$14.6M
Annual gross sales $700M–$1.9B ($14.0M)–$12.9M
Redemption rate 8%–14% $21.7M–($22.1M)
Discount rate 10%–13% $25.4M–($7.8M)
Terminal value 7x–11x ($6.9M)–$18.0M
I am of the view that Edgepoint is likely to hit or exceed the high end of the ranges for annual market growth, annual gross sales and terminal value.
Valuation
Assets (ex Edgepoint stake): The value of Cymbria assets less its stake in Edgepoint is $816M as of Q2 2017. This consists mainly of cash $75M and public equities of $731M. The top holdings are listed below.
As of October 31st, 2017, Class A NAVPS was reported at $43.46 compared to $39.46 in Q2 2017. Adjusting for this 10.14% increase leads to an estimated increase of assets from $816M to $898M.
Edgepoint: As no public financials are available for Edgepoint Wealth Management one must infer from other publicly available data.
Assumptions
The 2 public companies used as comparables are the Mackenzie segment of IGM Financial and the Asset Management segment from CI pulled out of their 2016 Annual Reports.
Rev as % of Average AUM: 1.7%. Should be at least as high or slightly higher than CI considering the fact that Edgepoint does not offer any low margin fixed income funds, but CI does.
Commissions as % of Revenue: 7.35%. To be conservative I chose the average of CI & Mackenzie numbers and applied it to Edgepoint. I suspect it might be even lower as Edgepoint does not offer BE funds, which have the highest commission.
Trailers as % of Revenue: Again, average selected, 31.2%.
Non-Commission Expenses as % of Revenue: 10% as a percentage of revenues is applied. This is where you would find general & administrative costs, and sales & marketing. Here, Edgepoint should be best in class due to employee productivity and lack of advertising and marketing expenses. In the startup years they chose a transfer agency cost per account as opposed to % of AUM. As the business got bigger, they benefited from economies of scale. In 2015, Custodians switched from Citibank to CIBC Mellon but similar agreements are probably in effect.
P/E Multiple Applied: At the end of 2009 Edgepoint AUM was $450M and now stands at $16.5B. That’s a CAGR of approximately 60% per year! It is reasonable to assume AUM can grow at 15% per year. for the next five to ten years from a combination of inflows and performance. With staff productivity and the scalability of the investment management business it is difficult to see employee count more than doubling over the next five to ten years. The firm ended 2009 with 21 full time employees and now has 62, so 3 times more employees but 36 times more AUM. 20x earnings is a reasonable multiple to pay for that can double assets in the next five years with very little incremental expense.
*Firm only post current AUM on website thus September 2016 could not be located but June 2016 located on Way Back Machine.
Liabilities: Total of $43M with the majority ($39M) being a deferred income tax liability.
Share Count: 100 common stock held by Edgepoint Investment Group, these are the only voting shares. As of August 8th, 2017, Cymbria had 14,409,374 Class A shares, which are non-redeemable and traded on the TSX, and 8,214,987 non-redeemable Class J shares, which are also non-redeemable that can be exchanged for an equivalent value of Class A shares on the last business day of each week. As of Q2 2017 the per share value for Class A shares was 39.46 and 43.50 for Class J, which equates to an exchange ratio of 1 to 1.102382 (J to A). This means if all J shares were to be exchanged for A immediately, there would be an additional 9,056,054 Class A shares. Finally, there are 13025 DSUs. Add all this up and you get 23,478,553 Class A equivalent shares.
Putting it all together:
In August 2017, CI announced an agreement to acquire Sentry’s $19.1B of assets for $780M, that comes to a purchase price of approximately 4% of AUM. IGM has $150B of AUM and is trading at $11B (7.3% of assets) and CI Financial had 121B of AUM (pre-Sentry deal closure on Oct 2nd) and is trading at $8B (6.6% of AUM). The weakest player, AGF, with $35B of assets is trading at 665M (1.9% of AUM), and has been shedding assets for many years. Valuing Edgepoint at approximately $1.7B is 10% of its $16.5B AUM which is very clearly on the high end and implies putting a lot of faith in the product and the management.
Risks
Competitive Landscape: The big Canadian banks have been particularly adept at acquiring and integrating asset managers and dealers. These banks may solely or partially offer their related proprietary investment funds, which could have an adverse effect on independents such as Edgepoint.
Timing: Being almost 9 years removed from the last market bottom we are statistically closer to the next bottom than during the Cymbria IPO. This might not prove to be the ideal time to own a portfolio of securities and a stake in an asset manager. However, this risk is mitigated to an extent by the fact that the portfolio in concern is actively picked by managers with a proven track record and might be cheaper than the market at large.
ETFs/Fee Pressures: CRM2 regulations came into effect in 2016, which require greater disclosure of fees to clients. This might prove to be a tailwind for ETFs, which sometimes have fees as low as single digit basis points. Asset managers as a whole will always perform worse than the index after fees but there will always be pockets of managers who will outperform over the long term. Can they be identified ex ante? I believe so. Here is one of best examples of this by none other than Warren Buffett. A large part of my investment thesis is that the bad performers are the most affected in the long term but maybe even stellar performers like Edgepoint will have to charge drastically lower fees. In that scenario, the thesis falls apart.
Recommendation: So, all of that for a mere 7.1% upside. Cymbria is still a BUY in this environment. It presents an opportunity to own what seems to be a hard to duplicate culture in the retail mutual fund space and a proven process and results at a slight discount to intrinsic value. Great business, fair price!
Some Links:
Cymbria’s Investor Relations, CETFA ETF data, CI Acquires Sentry, Benefits Canada article and PDF, IGM Financial 2016 Annual Report, CI Financial 2016 Annual Report, IFIC Industry Overview September 2017, Latest AUM figures for CI, IGM, Fiera, & AGF.
Security (in) Securities 