Value Line: Why I like Platinum Asset Management

PORTFOLIO POINT: Fund managers, at the right price, can be wonderful investments.

The first two weeks of the financial year have been quite eventful. Not performance-wise, mind you. Our eight-stock portfolio is down 0.33%, compared to the All Ordinaries Accumulation Index which is down 3.2%.

I’m not concerned – outperformance is usually something to crow about but when the absolute result is negative, that right is removed. In any case, any investor who crows about his performance over two weeks is not an investor at all.

This has been a memorable week for some of the businesses in the Value Line portfolio, particularly Platinum and Cochlear.

Platinum announced, after a $1.1 billion distribution, that funds under management (FUM) is $14 billion, down substantially from a peak of $22.4 billion in May 2007 but up $500 million from February this year. As such, Platinum expects net profit after tax to fall to $116 million to $130 million, near enough to 70% on net equity.

Funds management is an easy business to understand. They don’t need a lot of equity or inventory or machinery and they don’t really need the battalion of staff they keep to give comfort to the rating agencies and asset consultants. Most fund managers will tell you that without the distraction of managing applications and redemptions, similar returns could be generated with just a couple of key people.

Platinum, led by managing director Kerr Neilson, has a good team. They have been together a long time and they earn $16 million a year. The total cost of running the show is $40–50 million a year, which, compared to revenue of about $195 million still represents a paltry overhead and produces a stunning pre-tax profit margin of about 75%.

Such margins and returns on equity are difficult to find in any other business. That is why so many find it hard to leave the industry and set up boutiques instead.

In funds management the economics are so good that even a year in which clients lose money is a good year for the business. Let me explain.

nValue Line portfolio, as at July 14, 2009
Company Name	ASX	July 1 price	Price today	Est value	Margin of safety*	Shares purchased	Invested capital ($)	Capital value ($)	Divs received	Total return	Total return (%)
JB Hi-Fi	JBH	14.8	14.63	17.68	20.8%	845	$12,500	$12,356	0	-$144	– 1.15%
The Reject Shop	TRS	11.62	12.01	11.45	-4.7%	513	$5,959	$6,159	0	$200	3.36%
Westpac Banking Corp	WBC	19.68	19.5	18.13	-7.0%	295	$5,811	$5,758	0	-$53	– 0.91%
Cochlear	COH	56.36	52.99	48.7	-8.1%	102	$5,744	$5,401	0	-$343	– 5.98%
Woolworths	WOW	26.16	26.57	22.86	-14.0%	206	$5,377	$5,462	0	$84	1.57%
CSL	CSL	31.81	30.28	25.18	-16.8%	163	$5,197	$4,947	0	-$250	– 4.81%
Reece	REH	17.8	19.02	12.81	-32.6%	236	$4,209	$4,498	0	$289	6.85%
Platinum Asset Management	PTM	4.06	3.93	2.18	-44.5%	854	$3,467	$3,356	0	-$111	– 3.20%
Since July 1, 2009
Security Value											$47,936
Cash Value											$51,736
Total Value											$99,672
Total Return ($)											– $328.41
Total Return (%)											– 0.33%
XAO Change											– 3.46%
Outperformance											3.13%
Under observation
ISOFT	ISF	0.635	0.66	0.038	-94.2%	'”	'”	'”	'”	'”	– 3.94%
Amcor	AMC	4.79	5.1	2.66	-47.8%	'”	'”	'”	'”	'”	– 6.47%

* The safety margin is the difference between the price of the security and its valuation.

Start a funds management business with a $1 million capital injection and raise $100 million of FUM on which you are going to charge only a management fee of 1%. In the first year you manage to generate a 200% return and FUM grows to $300 million. Average revenue at 1% is $2 million. Given few overheads, most of this drops to the pre-tax profit line so let’s call it a return on equity of about 200%. Try getting that kind of return in a term deposit!

With virtually all the profits distributed as dividends, you start the second year with your original $1 million. This time, however, disaster strikes and performance is minus 67%. FUM falls from $300 million back to $100 million. Average FUM was $200 million, on which you charge 1%. You earn another $2 million in revenue and – voila! – 200% return on equity.

Clearly, to maintain these returns, you do have to be good at what you do. Too many years of poor returns and your FUM or capital will eventually and rightly desert you and that return on equity will be zero. But maintain modest performance and the returns on capital can be extraordinary.

Platinum is a business with these extraordinary economics, and such economics are difficult to find – perhaps the odd real estate agent comes close but without the scale. And it is this scale that Platinum has achieved that is and will be nigh on impossible for so many others.

It does seem, however, that everyone else has worked this out and while Platinum is undoubtedly a wonderful business, its unrealistic price makes it a less-then-wonderful investment. Platinum is worth about $2.15 a share. Any significant discount to that valuation would make me happy to be the owner of a funds management business again – having sold mine some years ago and resigned from it more recently. But at close to $4 the stockmarket is way ahead of itself and you should zip up your wallet.

Next week, expect an update on what Cochlear’s revised outlook means or why we decided not to own the ASX or even why ANZ’s snout at the capital-raising trough means it will have to stretch a long way to avoid going backwards and taking shareholders with it.

(See last week’s column and my answer to one subscriber’s question as to why the Value Line portfolio owns a few shares in Platinum even though the price is above its value.)

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