Share capital associated: many free embedded options (NYSE: AC)

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Investment thesis

Associated Capital Group (NYSE: AC) is an opportunity to invest alongside Mario Gabelli, who owns ~85% of the company, at 92 cents on the dollar. Current price gives no value to growing merger arbitrage hedge fund inside AC, the company’s own investments expected to accrue over time, or the free option on all future AC companies and products. The company understands that there is a gap between price and value and has been slowly buying back shares.

Background

Associated Capital Group is an asset manager with $1.8 billion in assets under management (or AUM) and is primarily involved in merger arbitrage (~$1.6 billion in AUM). Based on the recent 10-K, the merger arbitrage fund’s objective is to “earn absolute positive returns” and has “achieved net annual returns of 7.4% with 35 of 37 positive years.” The breakdown of AUMs (as of March 31, 2022) was:

  • Merger Arbitration: $1.6 billion

  • Event value (excluding merger arbitrage): $191 million

  • Other (includes investment vehicles focused on private equity, merchant banking, lower quality credit and capital structure arbitrage): $42 million

Associated Capital was originally a spin-off from GAMCO Investors (GBL). As John Huber wrote in his 2016 AC article:

Why does AC exist?

Well-known investment manager Mario Gabelli of GAMCO Investors (GBL) decided that the market did not recognize his company’s value for the considerable excess cash and investments that GBL held on its balance sheet. So he decided to create a new company, fill it with excess cash and investments among a few other assets (as well as a going concern), and separate it from GAMCO. The result is an under-followed, under-traded company called Associated Capital. Gabelli, who owns a majority stake in GAMCO, has retained his pro rata share of AC and he owns approximately 74% of the outstanding shares (18.9 million shares of the total 25.4 million shares outstanding ).

AC had an institutional research business (Morgan Group Holding Co.), but it was spun off in August 2020.

Evaluation

With ~3 million class A shares and ~19 million class B shares outstanding, the total number of shares is 22 million shares (class B is entitled to 10 votes per share, while class A is only entitled to 1 vote per share). At the current price of $36.69, the market cap is around $809M.

Assets (as of March 31, 2022):

  • Cash: $348 million

  • Securities Investments and Partnerships: $500 million

  • Investment in GAMCO shares (~2.4M GBL shares @ $21.32/share): ~$51M

  • Investments in marketable securities held in trust: $175M

  • To be received from brokers: $177 million

  • Total assets: $1.25 billion

Passives

  • Total responsibilities: $161 million

  • Refundable non-controlling interests: $205M

Adjusted book value: $1.25B – $161M – $205M = $884M

P/VA = $809M / $884M = 0.92x

Management fees received by AC from managing the $1.8 billion capital pool were not included in the calculation. They earn an asset-based advisory fee of 1-1.5% per year, based on AUM. They also receive a performance-based advisory fee, which amounts to 20% of the performance of the investment. They earned $20.5 million in investment advice and incentive fees in 2021 (and $18.3 million in 2020). Fees earned aren’t enough to cover expenses (~$30-40M), but over time as AUM increases, I could see the fee revenue stream (or FRE) become more important.

Insider ownership + purchase

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DEF 14A

Well-known investor Mario Gabelli owns about 18.8 million shares, which is about 85% ($686 million). Additionally, Horizon Kinetics Asset Management, another well-known value company (and my favorite), owns about 1.2 million shares or about 5.5%. As for insider buying, there have been no insider trades in the past 2 years, but Gabelli was buying a decent amount between December 2018 and April 2020 in the range of $26 to $36 .

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Catalysts

  • Growth in assets under management: if AC is able to increase its AUM, its FRE may evolve. Asset management is one of those rare businesses where revenues can grow faster than expenses; it’s just a matter of reaching that point where it can evolve.

  • Composition of equity: AC should be able to build its direct investment portfolio over time and use cash/investments to fund new products

  • Seeds of new products / Optionality: AC is slowly diversifying into new ventures; for example, AC launched the PMV Consumer Acquisition (PMVC) SPAC in September 2020; another way to think about it – at current prices, investors get a free option on everything future companies and products that AC/Gabelli will launch or participate in (such an option is difficult to assess, but investors do not pay for it)

  • Share buybacks: Gabelli understands capital allocation and how to properly use share buybacks to increase intrinsic value; AC has reduced its number of shares from 25.4 million to 22 million over the past 7 years and continues to buy back shares; in Q1 2022, AC repurchased 7,536 Class A shares at an average price of $38.84

Risks

  • Improper capital allocation / Controlling shareholder: as AC is mainly controlled by Gabelli, there is always a risk of misallocation of capital; however, given his track record as a prudent and discerning investor, this risk is mitigated.

Carry

AC represents an attractive investment opportunity alongside Mario Gabelli, who owns ~85% of the company and is a savvy investor who understands capital allocation, at 90 cents on the dollar. Although not a real bargain, the current valuation does not take into account the built-in options that AC offers; optionality on the growth of assets under management of its merger arbitrage funds, the capitalization of AC’s book value over time, and future ventures that AC will initiate or participate in. Additionally, the company has repurchased shares over time, which should help close the gap between price and value.

Based on the analysis above, I recommend a long position in AC for the conservative investor with a holding period of a few years.

Sallie R. Loera