Affiliated Managers Group (AMG) Q4 results

Affiliated Managers Group reported Q4 earnings yesterday that were not as disastrous as feared. Unfortunately, the most appropriate word for this quarters result is "messy". On a GAAP basis, AMG lost $1.73 per share, but made $1.24 in pro-forma cash earnings. The delta was mostly driven by a non-cash impairment charge on two affiliates (but mostly on Value Act). There was also a net non-cash gain of $.06 from the repurchase of some trust preferreds at $.35 on the dollar, offset by the accelerated amortization of options expense due to management forfeiting them (strange accounting rules if you ask me). Even worse, management announced some changes to what they add back to get their cash earnings number. That was the noise.

Just to get this off my chest, I'm really surprised they decided to add another add-back item to get Cash Earnings. The reality is that the AMG story is already complicated and it hurts valuation. Increasing the complexity level seems like a bad idea to me. The only thing I can come up with is that management thinks they are already being penalized for the complexity, so they are making a change now that will increase cash earnings in the future, and there will come a time when investors do not shun complexity like they do now. When that happens, the stock will get an undiscounted multiple on a higher earnings number. I don't know if that was the rational, but either way, I don't like it. I still like this stock, but I disagree with the change to pro-forma presentation.

Fundamentally, times were tough. Net new flows at their affiliates was a negative $3.3 billion. This is actually a meaningful improvement from very recent quarters but is still negative. The markets were down significantly as we all know which hurts revenue at the affiliates and subsequently for AMG shareholders. The holding company still has $200m in cash as well as access to another $120 via a forward equity sale they entered last year (they can sell about 1.2 million shares for about $95 per share).

The assumptions going into the 2009 guidance were modified, which was probably an attempt to distract investors from the fact that AMG will earn a lot less than we thought they would even six months ago. Having said that, the guidance is very conservative in order to give management a very good chance of beating (if you lower the bar enough…). The 2009 guidance was $3.75 - $4.30. Both ends of the range assume no market appreciation from yesterday, but the upper end does assume some modest performance fees and some modest organic growth. For the sake of easy math, I’ll use $4 as the midpoint. Consider that AMG’s revenue grows for three main reasons: market appreciation of AUM, net new inflows (or subtract outflows), and accretion from new acquisitions. A $4 estimate for 2009 assumes that two of the three drivers will be non-existent and that the third (organic growth) will be very modest. So in my mind $4 will end up being too low. I think this business model should trade at 15x bear market earnings, so I get $60 even if two and a half of three drivers are turned off. Bottom line, I think this stock continues to have meaningful upside.

Last thing: I was reminded again this quarter that management is very astute at capital management. When the market cooperated, they raised convertible debt that had very low after-tax interest expense. Before the market really dropped, they sold equity forward which looks brilliant now. Most recently, as market participants are scared and afraid of complexity, they bought back some of that convertible debt at $.35 on the dollar. These are smart guys running the show.