Catella: Cheap Price Signal or Noise?

Introduction

Catella is a collection of loosely connected financial businesses where obscure reporting hides potential value.

Catella owns corporate finance, property asset management, mutual fund, hedge fund, wealth management, private bank and a credit card processing businesses. Depending of the subsidiary ownership is 50-100%, adding complexity.

It also owns ton of net cash and investments in non-bank related operations which are hard to identify because bank and non-bank related items are not clearly separated in the financial statements.

Catella has 1495 MSEK market cap and 770 MSEK adjusted net cash so enterprise value is 725 MSEK.

With 190 MSEK operating earnings after tax for parent EV/E is 3.8. With my 98 MSEK earnings power estimate based on long-term averages and excluding temporary bank losses EV/E is 7.4.

Valuation is too cheap for growing business like Catella, absolutely and relative to similar alternatives (EQ is trading at 13x EV/E multiple based on peak earnings).

Typically so low EV/E valuations are found in situations where there is a problem with cash, earnings or management

But with the heavy adjustments included in the net cash figure, opportunistic management which was for example buying subprime mortgage portfolios in 2009 and mostly growing and profitable businesses, I think there is a problem with none of them.

1. Swedish Mutual Fund Management

Catella’s crown jewel is the well established mutual fund business in Sweden which has been around since 1995.

It’s responsible of more than half of group’s operating profit and 100% owned by the parent company. Earnings were 150 MSEK in 2015 and 57 MSEK on average in 2008-2015.

To understand the earnings power better I think it is helpful to split the 2008-2015 period into two different periods, 2008-2013 and 2014-2015, because of the significant change in scale of operations between them.

In the 2008-2013 period average earnings were 34 MSEK, when AUM averaged 18 BSEK, and in the 2014-2015 periods average earnings were 127 MSEK, when end AUM was 45 BSEK.

From valuation point of view the question is whether the 34 MSEK average earnings in 2008-2013 or the 127 MSEK average earnings in 2014-2015 is most reflective of expected future earnings power.

I think the earnings power as having three parts, “base rate earnings power”, “hot money earnings power” and “growth earnings power”.

Base rate earnings power

I define the base rate earnings power to be 34 MSEK which is the same as the 2008-2013 average earnings.

It is based on the 18 BSEK average AUM at the time, which I consider long-term sustainable level of AUM without significant risk of in- or outflows because it was the normal level for Catella’s AUM before recent run-up.

With 10x earnings multiple the 34 MSEK base rate earnings power would be worth about 340 MSEK.

Hot money earnings power

The hot money earnings power is more difficult.

Catella has 28 BSEK hot money by which I mean the new AUM over the 18 BSEK base AUM.

I think the new AUM as hot AUM because most of the new AUM went to three “market neutral” or “higher yield low risk alternative” funds, themes that have been hot in recent years among yield chasing public.

Hot money AUM is problematic because it has higher probability of leaving than the base AUM if market environment changes, and therefore it’s worth less than the base AUM, although not worthless.

Catella’s average earnings with the 18 BSEK base AUM was 34 MSEK.

The 28 BSEK hot AUM is 55% more than the 18 BSEK base AUM, so I assume that the hot AUM earnings are 55% more than the base AUM earnings, about 50 MSEK.

If the base earnings are worth 10 times earnings, the hot money earnings could be worth say 6 times earnings, to reflect the hot AUM’s higher probability of leaving sooner than the base AUM’s.

With these valuation parameters Catella’s 50 MSEK hot money earnings would be worth 50×6=300 MSEK.

Growth earnings power

Since the new management took over in 2010 Catella has developed and has increased efforts to develop new products. As per its strategy goal is to develop product portfolio suitable for all market environments and to grow.

One Example of successful product launch is the Corporate Bond Flex fund which went from 0 to 4.6 BSEK AUM in four years, but there are others.

Part of the strategy has also been to improve distribution and sales.

There is a lot of talk about third-party distributors, proprietary institutional channels and recently cross selling to private bank/wealth management segment’s clients. Last annual report also mentioned shortly something about direct sales through internet.

Evidence of improved sales, distribution and products is the doubling of Catella’s market share from 0.7% to 1.4% in three years, mainly through better than market net inflows.

My no-growth valuation model for the base earnings power assumed 10x earnings multiple, which is suitable for some average company with no clear direction but quite low for constantly developing company like Catella.

If the valuation multiple is increased to say 13, to allow for some growth, the 34 MSEK base earnings would be worth 440 MSEK (100 MSEK more than the 340 MSEK base valuation).

That 100 MSEK “growth value” can be assumed to include some value for growth initiatives, and also some value for the occasional performance fees, which were not included in the base earnings value.

Total value

Including all the components, my fair value estimate for the fund business is 740 MSEK; 340 MSEK for the 34 MSEK base earnings, 300 MSEK for the 50 MSEK hot earnings and 100 MSEK for the growth initiatives and performance fees.

Note that my 740 MSEK fair value estimate implies about 5x P/E multiple for the 150 MSEK earnings in 2015 so it doesn’t seem like overly enthusiastic based on current facts, but inclusion of unknown but unsustainable level of performance income in recent earnings prevents me from capitalizing them fully with say 10x earnings multiple.

I consider my method of valuing the business by its earnings component better.

The 740 MSEK fair value estimate is alone more than the implied 725 MSEK enterprise value. If I’m right, essentially rest of the businesses comes for free.

2. Corporate finance

Catella Corporate Finance is a Swedish corporate finance advisory focused on real estate sector. It’s no joke either.

Catella is fourth largest property transaction adviser in Europe with stableish 6% market share over time (excluding UK where it doesn’t operate). It’s number one adviser in Sweden with 20% share and number three in France with 15% market share.

Year on year earnings fluctuations are big and typical for the industry. For Catella stability over time comes from fact that real estate speculators need help both in bull and in bear markets and the strong market position.

Catella has had two unprofitable years since 2001 (after Lehman collapse) and two years of abnormally high earnings (just before Lehman collapse). Other than that earnings have shown some stability and average about 80 MSEK over last 15 years

Last year earnings were close to the long-term average so they don’t seem abnormally high relative to historical standards, although it must be admitted that European real estate market looks uncomfortably hot currently.

With the many 50-100% owned subsidiaries I assume that 75% of the earnings belong to parent company which from the 80 MSEK average earnings means 60 MSEK.

With eight times long-term average earnings my fair value estimate for corporate finance business is 480 MSEK.

3. Banking business

Catella has a “Banking” segment which processes credit card transactions and offers private banking/wealth management services. Both businesses are reported in the same segment which showed 30 MSEK losses last year.

Without the segment’s losses Catella’s core earnings for parent would have been 220 MSEK instead of the 190 MSEK, so currently the losses are major drag on Catella’s earnings (and without the losses EV/E would have been 3.3).

According to management the credit card processing business is profitable and the losses are caused by the wealth management business. Management’s comments indicate that they are committed to building the wealth management into profitable business and suffer the losses meanwhile. Management says that the wealth management segment will get fixed but it will take some time to gather enough AUM to be profitable.

They said same thing few years ago from the credit card processing business and it got fixed, which is the reason I believe them and consider the 30 MSEK losses temporary and will not capitalize them in valuation.

The transaction bank together with some wealth management parts was bought for 270 MSEK in 2010 with P/B 0.7. There has been some add-on acquisition afterwards for 50 MSEK, implying 320 MSEK original price for the whole banking segment.

It might be worth similar amount today as it is not in worse shape than at the time of acquisition; transaction volumes are higher, computer systems have been updated and there is more AUM.

Yet, to account for few years of the losses going forward I haircut my the original acquisition price by 120 MSEK to 200 MSEK.

4. IPM hedge fund and property funds

Catella bought last part of their 51% stake in IPM-hedge fund in Q3’2014 for implied 200 MSEK valuation for the whole business.

Since then IPM has cumulatively earned about 88 MSEK, implying that 44% of the purchase price has been paid back in little over a year. Excellent acquisition.

IPM is a macro/quant hedge fund offering services for institutional investors with 49 BSEK AUM and seems like a real deal. It manages Swedish National Debt offices interest rate and currency risk, for example.

After Catella bought the majority company new CEO was hired with idea of taking the business to new level.

The 51% stake was bought for 100 MSEK fairly recently so I use it as my target valuation, although in light of recent performance and growth prospects it looks cheap.

Catella also has property fund and asset management business with 31 BSEK AUM.

Property fund management is conducted through Catella Real Estate AG in Germany which has 12 funds and 20 BSEK under management. It invests all over Europe.

Property asset management operates in France and in Finland. It has 11 BSEK under management and is expanding to Spain, Norway and all over the place. Business is little bit of a black box as it is unclear to me what exactly they are doing.

Together the two businesses earned 27 MSEK in 2015 and 20 MSEK on average in 2013-2015. Long term profitability, which can be inferred only with some accuracy, is dismal at best, hovering between small profits and small losses.

With 10x average earnings the business would be worth 200 MSEK, but because black box nature of the segment, some minority interests and because latest figures include a lot of performance income, I haircut the valuation by half to 100 MSEK.

That’s equal to four times 2015 earnings and therefore should not be exaggeration and account for my ignorance.

6. Total operating business value

Combining all the operating valuations together Catella’s operating businesses are worth 1260 MSEK.

(Note that the valuation assumes that 30 MSEK concern costs are capitalized with 12x multiple to 360 MSEK.)

The valuation more or less assumed steady state value for all the entities. But Catella is forward-looking company with several growth initiatives.

Catella’s operating businesses were bought as separate independent entities in 2010-2014. New strategy is to build coherent whole so that each segment cooperates with each other, and that products are cross sold between the entities.

For example wealth management segment can sell property fund and mutual fund products for their clients. Wealth management segment’s deposits can be used to finance deals in asset management and corporate finance segments.

And as the corporate finance segment has office in every major town in Europe with local knowledge, it can be utilized by developing property fund products based on proprietary local knowledge.

There is not much talk what the management’s plans are but direction is clear, more cooperation and cross selling.

In addition to building coherent whole Catella is expanding geographically and otherwise.

Recent property asset management expansion to France was success and now it is trying to do the same in Norway and Spain.

Corporate finance is expanding in Germany and increasingly conducting capital market transactions.

IPM’s goal is jump to next level.

Credit card processing business grew 19% last year.

Wealth and fund segments are gathering new AUM with more resources put on sales.

Excluding the Swedish mutual fund segment, I did not put any value on these growth activities, which in the future could become considerable source of earnings.

7. Adjusted net cash by component

Investment portfolio

Catella has 100% owned investment portfolio. It includes first and second loss tranches of residential mortgage-backed securities where underlying assets are in Spain, Portugal, Germany, France and the UK.

The portfolio was bought during 2008-2010 for pennies and valuation has since H1/2014 been adjusted up 50% as discount rates, arrears, default rates and prepayment have trended down.

The portfolio is valued mark-to-model by outside consultant as there is no active market for the portfolio.

Cash

Catella has 832 MSEK consolidated cash excluding the bank operations. Some of the cash is in subsidiaries of which Catella owns less than 100 % so it must be adjusted.

One problem area is the 220 MSEK cash in the Corporate Finance segment.

Worst case would be that all of the cash is in the subsidiaries which parent company owns 50% and best case that all of the cash is in subsidiaries which parent company owns 100%.

As I don’t know any better I have taken mid-point of the two and assume that 75 % or 165 MSEK of the segment’s cash belongs to parent, a 55 MSEK haircut.

Second problem area is the IPM-hedge fund of which parent company owns 51%. It has 140 MSEK cash of which 51% or 71 MSEK belongs to parent, a 69 MSEK haircut.

After the 55+69=144 MSEK haircut to Corporate Finance and IPM cash my estimate of the group’s cash belonging to parent company is 832-144=688 MSEK.

Sale of Visa Europe shares

Catella’s credit card processing bank is member of Visa Europe which Visa Inc. decided to buy in late 2015.

After the transaction closes in Q3’2016 Catella will receive about 180 MSEK in cash and Visa Inc. preference shares as compensation for selling the shares, which I assume to be a financial asset already now.

Bonus payment liability and debt

I think the 233 MSEK bonus payment liability must be deducted from financial assets to get realistic estimate of how much financial assets could be taken out of Catella and still continue operations normally, although strictly speaking it’s not a financial liability.

Catella also has 200 MSEK outstanding bond loan.

Combining the two, total “financial” liability is 433 MSEK

Summary

After all the adjustment items my estimate net financial assets belonging to parent company is 769 MSEK or 770 MSEK as a round number.

Net cash is not much value for shareholders if it is not paid out or invested to operations.

As per the CEO Catella seems to have some plans for it:

“The Board and Management see a number of growth opportunities in existing and new businesses, which are expected to generate long-term shareholder value. Accordingly, we think that the group should retain a significant portion of earnings so it can realise these opportunities.”

Note that Catella’s subprime investment portfolio was bought in 2008-2009 and fund management business in 2010 during major market turmoils.

Doing so unpopular things at so unpopular times suggests that Catella is willing and capable of deploying capital opportunistically.

The IPM acquisition I told earlier shows that they are not likely to over pay either.

Thus I think the 770 MSEK adjusted net cash and investment portfolio can be valued at face value with full expectation that something useful is done with it when the time is right.

8. Conclusion

So the 3.8 EV/E multiple based on the 190 MSEK earnings in 2015 looks illusory cheap. That’s because to high and temporary performance fees in asset management businesses.

Yet with the 98 MSEK long-term average earnings (122 MSEK EBIT excluding bank losses from the summary operations valuation table above, minus 20% tax) the EV/E valuation is still only 7.4.

I think that’s too cheap for growth company like Catella.

Another way to say the same thing is that my no-growth fair value estimate for the operating business is 1290 MSEK and valuation for the net cash 770 MSEK, total of 2060 MSEK.

Catella’s market cap is 1495 MSEK so there is 38% baseline upside.

In addition Catella has the many growth initiatives going on which could increase the operations value in the future.

There is also the giant cash pile that management can use opportunistically to buy more earnings, which it has done successfully many times in the past.

If the discrepancy with price and my fair value estimate diminishes, and some of Catella’s growth initiatives proves successful, returns should be satisfactory.

Disclosure: Long Catella with 12% position