A wise man once said to me that it’s better to own the asset managers themselves than the funds they actually manage.
I don’t know if that’s the case with Artisan Partners, which plans to go public soon — nine out of the 11 Artisan funds eligible for rating from Morningstar have at least four stars.
This week, the independent investment manager set the terms of its IPO, which will include selling 11.5 million shares in a range of $27 to $29 each in hopes of raising as much as $352 million in net proceeds. Known in the industry for providing its portfolio managers significant autonomy, its business model has led its investment teams to outperform the appropriate benchmarks. However, with just $79.5 billion in assets under management, it definitely can’t be confused with BlackRock (NYSE:BLK).
So, should you own its shares, its funds or both?
Approximately 53% of Artisan’s assets are invested in 12 mutual funds (one isn’t eligible for a Morningstar rating), with the remainder in separate accounts held by pension funds, etc. Like all investment managers, it generates most of its revenue from management fees — in 2012, its mutual funds accounted for $336.2 million in revenue, while separate accounts added $167.8 million. Another $1.6 million in performance fees were kicked in for good measure.
The weighted average fee for its Artisan Funds in 2012 was 0.94%, while separate accounts were 38 basis points lower at 0.56%. So, a 10% increase or decrease in its overall assets would cause revenues to increase or decrease by $56.5 million. Revenue changes occur for two reasons: asset appreciation or depreciation and inflows or outflows of client assets. In 2012, it achieved net client cash inflows of $5.8 billion along with $11.4 billion in appreciation, making this past year one of its best in its 19-year history.
Any time you analyze an organizational structure that incorporates partnerships into the equation, it can get confusing trying to figure out how profitable that business will be as a public company. Sure, you can examine the pro forma income statement, but when all sorts of line items are thrown in related to the limited partnership structure, it becomes somewhat of a puzzle.
I’ll save you some time by going to Page 97 of Artisan’s registration statement:
|Year Ended Dec. 31 (Note: dollars in millions)|
|GAAP Operating Income||$47.1||$154.3||$65.2||$73.1||$208.9|
|Distributions on Class B
|Change in Value of Class B
|Adjusted Operating Income||$202.9||$188.9||$161.9||$117.4||$157.9|
|GAAP Operating Margin||9.3%||33.9%||17.1%||24.7%||$58.5|
|Adjusted Operating Margin||40.1%||41.5%||42.3%||39.6%||$44.2|
Here, you’ll notice that Artisan has increased its adjusted operating income in each of the past three years, practically doubling to $202 million. Although its adjusted operating margin in 2012 was lower than in previous years, it’s still a very healthy 40.1%. While a lot depends on the health of the markets to estimate future revenue and operating profits, its average revenue growth over the past four years was 10.5%, so I’m going to go with that. Based on $506 million in revenue in 2012, I’ll project 2013 revenue of $559 million and operating profits of $224 million at an operating margin of 40.1%.
At this point it’s important to remember that Artisan Partners Holdings LP, through wholly owned Artisan Partners Limited Partnership, will operate the investment management business. Artisan Partners Asset Management Inc. — which is the public company — will receive 20% of Artisan Partners Holdings’ net profits.
Investors in the IPO are simply buying a revenue stream. Nothing more.
After interest expense is taken into account, APAM should receive approximately $43 million in profits in 2013. Deducting 30% for taxes, we’re looking at $30.1 million in profits, which will leave more than enough to pay a $1.72 annual dividend to the Class A shareholders.
At a $29 offering price, investors are looking at a yield of 5.9%. Assuming the shares open 20% higher in their first day of trading, you’d still have a yield of 4.9%. Even if the markets don’t move higher for an extended period of time, APAM investors will achieve a decent return while waiting for the next move up.
If you’re an income investor, I especially like the investment.
What About The Funds?
As I mentioned previously, its funds have done extremely well. All 12 correspond to an investment strategy that it also makes available to its separate account clients. Artisan’s management expense ratios are about average for the industry; they’re not dirt-cheap, but they’re not outlandish either.
In terms of AUM, its three most popular funds are Artisan International (MUTF:ARTIX), Artisan International Value (MUTF:ARTKX) and Artisan Mid Cap (MUTF:ARTMX). The three funds have combined assets of $23.7 billion, or 61% of the overall AUM for the mutual fund segment of its business. The international value fund is rated five stars; the other two get four stars.
Unfortunately, while ARTKX’s 10-year annualized total return is 14.4% — 623 basis points higher than the benchmark MSCI EAFE Index — it’s unavailable to most new investors. Don’t despair, though. That can change at any time.
Overall, I see a competent and experienced group of portfolio managers at the helm of Artisan Funds. I wouldn’t hesitate to look more closely at their small product offering.
This is one of those rare occasions where the fund managers eat their own cooking. With 52% of Artisan owned by employees, they live and breathe investment management. That’s essential when all you’re buying are little pieces of paper. It’s also a rare example of an IPO I’d actually consider buying on the first day of trading.
The biggest thing to watch out for — whether you’re buying shares in the IPO or considering one of their funds — is the fact that 25% of its total assets are invested in its Non-U.S. Growth strategy, overseen by Mark Yockey. Yockey has been with the company since 1995 and has 32 years investment experience; if he bolts, business will face a hiccup.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.