Imagine you manufacture luxury products. You’ve recently had to raise prices substantially, despite your primary markets being headed into recession. Your buyers use leverage to purchase your products, and interest rates are the highest in a decade and are headed up. On the production side, your supply chain is compromised, skilled workers are scarce, and the cost of powering your factories has skyrocketed because your home currency has devalued. Public market investors shun legacy participants like you because your industry subsector is in the midst of technological upheaval, and the cost of retooling is viewed as greater than starting from scratch. Equity markets are sagging, and the IPO market is dormant. To top it off, there’s a major war with an uncertain outcome that has already worsened your supply chain issues, and fighting could spill over into nations adjacent to your home country.
Does that sound like an “open window” to list as a public company?
Next week, Porsche AG is going public for the first time in ten years. Parent company Volkswagen announced the complex restructure and IPO a few weeks ago, and recently confirmed that Porsche would be organized into 911 million shares (a nod to their most iconic model), half of which will be voting, common shares and the other half will be non-voting preferred shares (not preferred in a sense we’re accustomed to in the U.S.). Post IPO, the public will own one-eighth of the company (25% of the preferred shares), while the Porsche family will effectively have a controlling stake.
The IPO was initially criticized for its complexity, governance plan, and pricing (at $75 billion, Porsche would trade about 10% lower than VW, which sells more than 30x as many cars per year). By Wednesday evening of this week, the order books were full, eight days early. No marathon for the book runners – more of a 5K.
It’s a Strange Market
Last week, Zach Milam wrote about some of the conundrums we encounter in valuing RIAs. Fair market value pricing has a tendency to lean in the direction of intrinsic value. The reality is, though, sometimes markets have a mind of their own and don’t really care what thoughtful, educated securities analysts think. Fundamental analysis suggests many factors working against the value of investment management firms, and trading in public RIAs confirms that view. Transaction activity tells a very different story.
Fair market value pricing has a tendency to lean in the direction of intrinsic value
We’re about to close the third quarter of a record number of transactions in the RIA space. In spite of plenty of headwinds: inflation-challenged margins, sagging AUM, and higher leverage costs, the pace of M&A continues and could equal last year. I say could because, even though we’ll head into the fourth quarter of 2022 with a strong lead over 2021, the Q4 2021 comp is a tough one. Last year, fear of change in tax law and the breadth of the bull market drove a ridiculous volume of transactions.
Nevertheless, momentum is strong. Even though buyers are getting picky, deal terms are less generous, and consideration is starting to shift more to earnouts; pricing is steady.
What’s Not to Like?
One thing that’s different than 2021 is that public market activity is anemic. Public RIAs aren’t benefiting from any of this private market pricing activity, and the IPO window is – despite what some people have suggested – nailed shut.
It’s difficult to reconcile public market pricing with private market sentiment
It’s difficult to reconcile public market pricing with private market sentiment. Public RIAs are commonly trading at mid-single-digit multiples of EBITDA. Private company owners scoff at those metrics, and for good reason. Even though transactions may not always be as generous as some think, they’re still better than going public. On the private side, consolidators are lauded for building wealth management empires – all while Focus trades just above its IPO price from four years ago, and CI Financial gets criticized for building a wealth management empire. The doublespeak is staggering. One wonders why more public RIAs don’t throw in the towel and go private like Pzena.
Who wants to go public in this market? In the first quarter of 2022, we heard about Dynasty Financial and Gladstone Companies going public and CI Financial offering shares in its U.S. wealth management business. None of that has happened, and until market conditions change, none of that is going to happen.
Your Mileage May Vary
I’ve heard lots of explanations of the private/public discrepancy in valuation, but nothing yet that’s altogether satisfying. Depending on who you talk to, one man’s unicorn is another man’s glue horse.
What we can say with certainty is that the differential in interest in public investment management businesses and private investment management businesses isn’t sustainable. What we don’t know is when or how. Will higher interest rates eventually wear down leveraged acquirers, as they have in other growth-and-income sectors (real estate, anyone?)? Will PE investors start to question the merits of trading companies from fund to fund instead of testing valuations in the open market? Will the public RIA group follow Pzena’s lead and go private? Or will public investors’ newfound interest in dividend stocks lead them to RIAs?
It’s tough to forecast a public RIA resurgence but never say never. Investors may not be pricing Porsche like Tesla, but they’re giving it a valuation more like Ferrari (RACE) than Ford (F). In a market full of both prancing horses and mustangs, the public companies may yet win by a nose.