Pacific Current Group (ASX: PAC) is a multi-boutique asset management firm dedicated to providing exceptional value to shareholders, investors, and partners. The Company applies its strategic resources, including its capital, institutional distribution capabilities, and operational expertise, to support its partners to excel in asset management’s competitive industry. Pacific Current has investments in 16 boutique asset managers globally.
PAC’s portfolio of businesses represents a broad array of strategies, diversified across investment strategy, geography, and revenue models such as open-ended, contractual revenues, and client type.
We recommended Pacific Current Group last year in early July while PAC shares were traded at $5.60. PAC’s shares are currently trading at $7.23 – returning 29% and a few healthy dividend distributions.
Pacific Current could be one of the best dividends on the ASX to provide steady passive income
One of PAC’s most important investments in its portfolio is its holding of shares of the now-listed GQG Partners Inc (ASX: GQG). Pacific Current frequently informs its investors about its total funds under management (FUM) managed by its asset managers within its portfolio. By the end of CY21, PAC’s total funds rose from $150.1 billion to $165.4 billion. It is worth noting that this excludes its new investment in Banner Oak. The Fund Under Management continues to grow steadily by 5%. We have seen the GQG funds keep expanding during the period, whilst Victory Park and EAM posted particularly strong inflows.
Despite its growth potential, one of the aspects we really like about PAC is its lucrative dividends. Hence, PAC informed that the Company expects $3 billion to $8 billion of gross new commitments and inflows over the next 18 to 24 months for non-GQG boutiques when it releases its FY21 result. In the first half of FY22, these boutiques had already received $2.2 billion of gross new commitments. This allowed Pacific to increase its estimate of new commitments to an impressive range of $5 billion to $8 billion. Accordingly, we could expect 2022 to be another strong year for many of Pacific Current’s investments.
A strong FY22 for Pacific Current means a return to earnings growth that we conservatively project at a CAGR of 2% from FY22 to FY24. This will support dividend growth of an already lucrative yield of 5.45%.
PAC is well-positioned to pursue more transformative opportunities in the investment industry
Since 2020, the world has been fully in the grips of a global pandemic. Uncertainty over the human and economic toll was rampant. Now, despite a surge in different variant strains of the COVID-19 virus, the clouds are slowly beginning to dissipate, in large part because of the rapid development and rollout of highly effective vaccines. These vaccines allowed many economies to post robust growth, even if interrupted by periodic lockdowns. We have seen that PAC’s portfolio follows a relative path. After higher uncertainty in 2020, we see PAC’s portfolio of companies slowly reverting to pre-pandemic levels. This is most evident in the growing interest PAC’s portfolio of businesses receives in its underlying strategies from potential capital allocators. It can also be seen in the performance recovery of some private capital strategies that experienced abrupt shocks at the onset of the health crisis.
FY21 earnings were masked by a strong US dollar
Seemingly, PAC’s financial progress during FY21 appears relatively modest. Thus, PAC reported an underlying Net Profit Before Tax growing from $32.1 million to $32.6 million and an underlying Net Profit after Tax increasing from $25 million to roughly $26.3 million. Although, when we look a little more in detail, we can see that, there is more momentum in the business than initially meets the eye. To begin with, the appreciation of the Australian dollar versus the US dollar impacts the translation of PAC’s results due to the vast majority of Pacific Current’s revenues and expenses being in US dollars. For instance, while PAC’s revenues declined 4% when reported in the Australian dollar, they grew 7% in US dollar terms. In the US dollar denomination, PAC’s underlying Net Profit Before Tax grew by 13%, from US$21.5 million to US$24.3 million, and the underlying Net Profit After Tax grew by 17%, from US$16.8 million to US$19.6 million.
PAC’s management fee-related revenues continue to grow steadily
More important than currency fluctuations was the changing composition of PAC’s revenues during FY21. Sales related revenues derived from commissions and retainers declined from $4.3 million to $2.2 million due to the COVID induced slower sales activity and the run-off of legacy commissions from its GQG business.
Performance fees are far less predictable than management fees. While management fees remained steady, performance fees declined from $9.8 million to $6.8 million, primarily due to lower collected fees from its businesses Carlisle, SCI, and Victory Park. On the other hand, boutique management fee-related revenue, the largest and most stable component of PAC’s revenue stream, grows by 10%, from $33.8 million to $37.3 million. It is important to note that these fees returned an impressive 23% growth when reported in US dollars.
PAC is improving the quality of its earnings
Furthermore, to highlight the notable improvement in the quality of PAC’s earnings, the Company began to share what PAC’s profitability looks like in the absence of any commission revenues, performance fees or commission expenses. PAC refers to this as Management Fee Profitability. The graph below details the stable growth in Management Fee Profitability over the last several years, particularly in FY21. We can interpret this as a growing portion of PAC’s overall profitability coming from management fee-related revenues and not from variable revenue sources.
We are confident that PAC delivers quality earnings as the Company emphasises management fee-related revenues over performance fees. By implementing this approach, PAC could reduce earnings volatility considerably and support high quality, sustainable earnings to shareholders.
It is also important to highlight that the management fee revenues during FY21 and the first half of FY22 were steady in US dollar terms as PAC recognised four months of GQG’s contributions. It would have grown more than 25% if Pacific Current recognised the full six months of GQG’s earnings.
Moreover, the Management Fee Profitability is expected to expand further from PAC’s recent investments, such as Banner Oak. We also project organic growth, future investment, and PAC’s ability to recognise the full twelve months of GQG’s contributions at the beginning of FY23.
PAC tightly manages a unique portfolio of cash-generative businesses
- Seizert Capital divestment: In November 2020, PAC sold its stake in Seizert Capital Partners for US$5 million back to Seizert management. The realisation of a consequential loss has allowed PAC to seek a US tax refund of more than US$5 million. PAC’s relationship with Seizert lasted twelve long years, during which funds under management grew from US$700 million to an impressive US$5 billion FUM before declining to less than US$2 billion. A combination of weak performance and a massive trend from active to passive management in US public equities were the primary causes of the decline of Seizert’s fund under management.
- GQG Partners’ FUM nearly doubled its size: PAC’s investment in GQG Partners has been a remarkable exception to the challenges faced by many active equity managers. GQG continued its unparalleled growth trajectory, with its fund under management growing from US$44.6 billion to US$84.7 billion during the year. In just five short years, this business has gone from one entrepreneur’s dream to one of the world’s most prominent long-only investment managers. This investment has been a tremendous success for PAC. Moreover, we remain confident and bullish on the GQG’s prospects.
- Victory Park Capital exhibits a positive outlook: Victory Park Capital (VPC) had an exceptionally busy and productive year. The firm was a very active participant in the US Special Purpose Acquisition Company (SPAC) market, launching four new ones and announcing three business combinations. VPC sponsored SPACs do not increase VPC funds under management. However, Victory Park enhanced its investment return for its clients, which ultimately benefits PAC through greater incentives and performance fees. Aside from SPACs, VPC announced US$500 million allocations from one of the world’s premier private capital investment firms, Apollo Global Management.
- Carlisle: Carlisle also made excellent progress securing capital for another closed-end fund, ultimately securing commitments of US$290 million, exceeding its US$250 million fund target.
- Astarte Capital Partners: PAC’s new investment in FY21 was a GBP4.4 million investment in London-based Astarte Capital Partners. Astarte is pursuing a highly innovative private capital seeding strategy focused on “real asset” managers. While we do not immediately assume Astarte to contribute to PAC’s results in FY22, we believe that this firm’s business model is such that there is potentially enormous operating leverage for PAC in the near term.
We have been pleased with PAC’s ability to weather its portfolio over the last eighteen months, and we are optimistic about its prospects for FY22, FY23 and beyond. We are convinced that PAC will reward well its shareholders. Thus, the Company manages its portfolio diligently while periodically making judicious incremental investments. Given the dynamic nature of the investment management industry, we believe PAC is well-positioned to pursue more transformative opportunities going forward.
FY22 onward outlook: PAC to continue delivering its strategy for strong and sustainable earnings growth
PAC has shown incredible adaptability and strength through this difficult period and has continued to push the business forward. The last year has tested the resilience of individuals, businesses, and the economies where PAC operates. We are pleased to see that PAC has come through it relatively unaffected. PAC has shown extraordinary adaptableness and strength through a challenging trading environment and has continued to push its business forward. We have also been pleased by the businesses PAC has invested in. They have also come through this period in good shape, and their prospects continue to improve.
PAC has shown great adaptability and is thriving in the niche market segment of the GP Stakes business
It is important to remind that PAC operates in the GP Stakes business. GP Stakes is the investment market segment that invests in General Partners. General Partners may not be a term that is familiar to all Australian investors, but it is the party responsible for investing the associated funds under management. It is worth looking at some of the large players in the American GP Stakes market, such as Dyal Capital, as it allows us to compare the size and interest in this investment market segment. We can say that PAC now has a solid record of performance in this area, which we have continued to see it builds on since FY21.
PAC’s good performance during FY21 and the first half of FY22 was affected by a strong US dollar
Unfortunately, during the period, the currency movement between US dollars and Australian dollars has consumed the uplift in the underlying performance in US dollars, so the success during the period was slightly hidden. During CY21, the Australian dollar depreciated by more than 6% against the US dollar and has continued to lose ground. The underlying performance is up over 15% in US dollars on a like for like basis. More importantly, the core contribution from management fees, which is the most stable component of PAC’s earnings, rose substantially and gave us confidence in the Company’s outlook. The success of FY21 and a positive outlook for the business allowed PAC to increase its final dividend to 26 cents for a full year to 36 cents per share. This will be fully franked again this year.
PAC is expanding its earnings potential with its latest investment in Banner Oak Capital Partners
PAC continues to expand and is constantly looking for new investments to grow its earnings potential. The latest in date is Banner Oak Partners. Banner Oak is a Dallas-based alternative investment manager offering a private equity real estate strategy focused on creating and growing fully integrated private real estate operating companies. Currently, Banner Oak manages approximately $5.7 billion in assets across its platform.
PAC is making an initial investment of US$35 million, which is equivalent to $48.2 million. This agreement also includes an “earn-out” provision that could result in Banner Oak receiving additional consideration of up to US$5 million. PAC will receive 35% of the management company’s earnings from that agreement, excluding carried interest. This also includes provisions that will provide PAC with more than its 35% pro-rata share of Banner Oak earnings in the initial years of the investment. PAC classifies Banner Oak as a Tier 1 investment and estimates its contribution to PAC over the next twelve months to be a massive ~25% of PAC’s FY21 underlying Net Profit Before Tax.
PAC has acquired a passive, non-voting minority interest. The transaction will have no impact on the day-to-day management or operations of Banner Oak. We welcome this initiative as Banner Oak is a unique manager with a distinctive value proposition and a stellar track record and will be a major contributor to PAC’s future earnings.
The market for buying and selling stakes in investment management has become very active. In the United States, an entire sub-sector within the private equity industry has evolved with this particular focus, referred to as “GP Stakes” investing. The industry has recently seen a flurry of new entrants. At the large end of the market, companies such as Dyal Capital, now known as Blue Owl, have been raising funds in the US$5 billion to US$10 billion range to buy interests in large private equity and private credit firms. On the other hand, Pacific Current has always concentrated its effort on the opposite end of the scale. PAC also casts its net much wider than most competitors by targeting the asset management space instead of specific asset classes such as private equity or private credit. Given the intensified interest in the acquisitions of investment management firms, it is no surprise that the valuations of investment managers have been increasing.
In our opinion, the scope of PAC’s opportunity set is a key competitive advantage, as it allows PAC to be more selective and focus on prospects where the Company faces less competition.
Navigating a market of higher valuations for Pacific Current has posed some challenges. Indeed, PAC has lost out on some investments as the Company refused to pay for acquisitions whose valuations were excessive. Despite this trend, PAC has still been able to identify interesting opportunities at fair value.
PAC is now working on a new debt facility in response to these challenges. A new facility that will provide the Company flexibility to pursue new opportunities. Moreover, PAC has also made substantial progress in its efforts to begin seeking and managing capital from institutional investors interested in investing alongside the Company.
PAC reported a surprising return to net profit, which grew by 26% to $14.6 million
Pacific Current continues to report solid figures supporting its impressive growth profile. PAC shares’ performance reflected the Company’s robust fundamentals and appreciated by more than 37% over the last twelve months.
PAC financials in a nutshell:
- PAC’s underlying NPAT grew by 26% to $14.6 million during the first half of FY22.
- NPAT growth was contributed by a 21% growth in underlying revenues, driven by increased performance fees and commission revenues.
- From this strong earnings growth, the Company decided to distribute a fully franked interim dividend of 15 cents per share, up 50% from the first half of FY21.
- The Fund Under Management grew by 16% to $165 billion. While excluding PAC’s new investment in Banner Oak, the Company’s Fund Under Management grew by 11%.
- GQG is now listed on the ASX. This resulted in proceeds of $59 million and a remaining stake valued at $210 million as of the end of CY21.
- PAC invested US$35 million in the private real estate manager Banner Oak Capital Partners on the 31st of December 2021.
PAC reports impressive operating performance
PAC’s Underlying NPAT for the half-year grew 26%, from $11.6 million to $14.6 million. This growth was fueled by a substantial rise in performance fees, leading to a 21% increase in underlying revenues. Pleasingly, underlying expenses remain flat versus the prior comparable period. Performance fees from Victory Park strengthened considerably during the period, in part due to contributions from a few Special Purpose Acquisition Companies (SPACs) that the firm backed. Victory Park was the largest contributor to PAC revenues during the first half of FY22 and posted the strongest Fund Under Management growth rate in the overall PAC’s portfolio.
PAC’s Fund Under Management grew by 16% in the first half of FY22. If we exclude PAC’s new investment in Banner Oak, FUM grew by 11%. At the beginning of the first half of FY22, PAC forecasted that its portfolio of companies, excluding GQG, would receive $3 billion to $8 billion of gross new commitments by the end of FY23. We have been pleased to witness that this target was subsequently revised upward from A$5 billion to $8 billion. After six months, PAC’s non-GQG boutiques have received $2.2 billion of gross new commitments.
The return of dividends growth
PAC has declared a fully franked interim dividend of 15 cents per share, up 50% from the first half of FY21, reflecting PAC’s stated intention to reduce the skewing in dividends between the two halves.
PAC continues its expansion while maintaining a robust balance sheet
Continued momentum in PAC deal flow onward FY22
The listing of GQG on the ASX was the most significant development in PAC’s portfolio during the first half of FY22, which yielded PAC significant cash proceeds. These proceeds have already been redeployed through PAC’s US$35 million investment in Banner Oak Capital Partners. From an earnings perspective, Victory Park was the standout in the first half of FY22. The firm posted large gains in incentive fees and secured a large amount of new Fund Under Management. PAC expects the firm’s business momentum to keep going into FY23. PAC’s EAM business also secured large new commitments, primarily from a prominent Australian institutional investor. Earlier stage investments in IFP and Astarte detracted from results, but both firms are making solid progress and should deliver improved results in FY23.
We expect PAC to stay on track for solid growth in FY22, with the potential for an accelerated expansion in FY23 due to these five catalysts:
- In FY22, PAC will receive 9 months of earnings from GQG, while in FY23, PAC will receive 12 months of earnings.
- PAC’s investment in Banner Oak was made on the 31st of December 2021 and will contribute six months of earnings in FY22 and 12 months in FY23.
- We expect PAC’s fundraising to progress in the second half of FY22 from key private capital boutiques, significantly impacting FY23 results.
- PAC’s earlier stage investments are expected to produce improved results as they move to profitability.
- PAC’s Management fee revenues will grow for some private capital strategies as the recently acquired Fund Under Management is invested.
We have seen how PAC’s portfolio of businesses weathered the pandemic effectively. Moreover, PAC also exhibited improved growth prospects as we see them emerge across the portfolio. Furthermore, although the equity markets are off to a weak start in 2022, we believe this should not have a meaningful impact on PAC because of the broad diversification of its businesses. PAC’s largest exposure to equity markets comes from its business GQG. We remain confident as GQG has historically produced its best relative performance during periods of uncertainty in the equity market.
PAC is aware of the importance of scaling up its investment portfolio and recognising it as a key factor for earnings growth. Thus, the Company has been significantly accelerating its deal flow since the beginning of FY21 and is exploring and developing a strong pipeline of high-quality investment opportunities. PAC evaluated more than 180 opportunities in the last 12-month period and is expected to review more than two hundred throughout this year. Opportunities span across asset classes and range from US$ 4 million to US$ 25 million.
PAC is poised for material growth upon a rebound of developed economies
The global economic rebound from the health crisis has picked up speed but may remain uneven across countries facing multiple headwinds. We think that the emerging market will likely underperform due to ongoing issues with slow vaccine deployment. On the other hand, the developed world has been doing a lot to get the economy through the pandemic recession and back on the growth path through relief and stimulus measures.
The return to normal is a critical factor for Pacific Current and will likely influence the Company’s results. The second half of FY22 and the first half of FY23 is expected to rebound following the 2020-21 contraction of 3.5%. The global output is forecasted to rise by 3.5%. We can anticipate the US economy to expand by 2.5% in FY23. This rebound of the developed economies will certainly support Pacific Current’s operating performance.
We think that development prospects appear to be strong across PAC’s portfolio. Hence, the PAC portfolio comprises subsidiaries and boutiques exclusively in Australia, the US, and the UK. During FY20, all the boutiques that deferred capital raising efforts progressively resumed their fundraising activity by the first half of FY22. With the expected fundraising momentum to accelerate through the second half of the year and FY23 and the ramp-up of sales activities, we are confident that PAC will be able to report consistent earnings growth by the end of FY22.
Valuation: PAC remains bullish while the equity market remains subdued
PAC has been bullish since the onset of the COVID-19. PAC’s shares have, since March 2020, appreciated by more than 115%, reflecting the Company’s solid fundamentals. Looking at PAC’s multiples, we think that despite significant growth in the last few years, PAC remains fairly valued with an estimated EV/EBITDA of under 12x and a price to book value under 1x. We believe PAC has some room for further growth.
We like PAC’s approach to investing – which we think continues to be really effective as their strategy is fairly conservative and defensive. Most importantly, we believe PAC is a resilient business, as proved by its performance during the peak of the pandemic crisis.
Overall, PAC exhibits reliable dividends distribution, stable revenue and earnings predictability, and with the ramp-up of sales activities, we are confident that PAC will be able to report consistent earnings growth onward FY22. A “Buy” for us.