value and opportunity

That some Brazilian investors know how to make BIG money is no secret anymore, especially since Warren Buffet teamed up with Brazilian 3G to take over Heinz in a 26 bn USD deal.

What if you could team up with similar Brazilian guys like good old Warren did ? In theory, there is a good chance by buying shares in GP Investments, a listed Brazilian Private Equity company. GP Investments is not any Brazilian Private Equity company, but was the original Private Equity vehicle of “genius” investor Jorge Paolo Lemann. He sold the company in 2003 to his Junior partners and then went on to found 3G.

So in theory, GP Investments is like the “Junior” version of 3G with a LatAm focus and some of the employees of GP have actually been hired by the 3G guys which are all bilionaires now (Lemann is according to Bloomberg now number 28 in the world with a net worth of 24,8 bn USD).

Back to GP Investments:

There is a pretty comprehensive case study on Value Investor’s Club, so no need to replicate everything here.

The basic investment idea is simple:

GP investments trades at a discount to its holdings (in which it invests along its 3rd party private equity funds) plus you get the asset management company for free. On top of that, management is aligned with shareholders and repurchases shares.

Further, two “gold standard” value investment firms have large positions, Third Avenue with 11,65% and “legendary” Sequoia with 11,8%. Finally, GP Investments announced two very succesful exits over the last weeks which made them good money (BR Towers and SASCAR).

The stock price increased a little bit since then, but still, the stock looks very much undervalued and almost a “No brainer” if one is looking for a Brazilian investment opportunity.

What is the asset management business worth ?

My answer: Not much. Look at this table:

	Management Fees	Salaries, expenses	Bonuses	Net
2006	15.5	-18.99	-5.2	-8.69
2007	26.2	-38.1	-9.2	-21.1
2008	13.9	-47.9	-3.9	-37.9
2009	16.2	-47.9	-13.4	-45.1
2010	25.0	-48.6	-15.3	-38.9
2011	17.4	-45.4	-7.7	-35.7
2012	22.4	-60.2	-19.3	-57.1
2013	20.5	-74.9	-8.4	-62.8
Total	157.1	-382.0	-82.4	-307.3

Based on the available US GAAP account I created this table showing the assets maganagement fees charged to third party investors against salaries, expenses and bonuses for GP’s employes and operation. We can easily see that the balance has been increasingly negative over the years. Since the IPO, the “Asset Management Business” has cost the shareholders some serious money. Even if we assume that expenses include other general expenses, then to me the value of the Asset Manegement looks rather negative, it looks like that GP shareholders are subsidising 3rd party investors to a significant extent.

Private Equity track record

If you read through GP’s investor presentation, they always stress their great track record since 1993 with a lot of examples of exits where they made a lot of money. However, we never find a “real” track record which shows the real IRR for all assets. For an Asset Manager, the track record is the most important asset, before anything else.

In the following table, I tried to recreate their PE track record based on their published numbers since their IPO 2006 (in USD). I used disclosed US GAAP numbers and then calculated a simplified annual IRR. One remark: Minorities are a big contributor in GP’s P&L. I assumed that all minority results are PE related. In the table, a positive number in the column minorities means that the loss has been shared with minorities and vice versa for profits.

	Investments eoy	Realized gains, Div	increase in value	Minorities	Total return	in % a.m.
2006	173.9
2007	1165	59.2	279.8	-169.0	170.0	25.39%
2008	1381	11.8	-513.9	304.2	-197.9	-15.55%
2009	1568	229.0	241.5	-284.0	186.5	12.65%
2010	1431	-47.8	-39.0	68.2	-18.6	-1.24%
2011	1173	38.3	-348.0	236.0	-73.7	-5.66%
2012	1279	133.0	-120.3	44.0	56.7	4.62%
2013	998.3	-284.2	191.6	89.6	-3.0	-0.26%
Total		139.3	-308.3	289.0	120.0

It’s not hard to see that the Performance only looks good the first year, after the they went public.Since then, the track record has been very weak. The Bovespa made in the same period a total return in USD of ~0,7% p.a. So yes, they performed slightly better than the Bovespa, but after bonsues and expenses, GP shareholders would have been better off with an index fund. Bad timing plays clearly a certain role here as well, however on the other hand it is hard to understand how the justify paying out more than 80 mn USD in bonuses for such a mediocre perfomance.

A few additional remarks on that from my side:

Debt/leverage

After the IPO, GP took on leverage, both as a bank loan and with an issuance of a perpetual note. Especially the perptual note in USD with 10% might have looked as a good idea when interest rates in Brazil were high and the real gained against the dollar, but now, with the real loosing significantly, this currency bet is of course making things worse. Additionally shareholders have additionally lost money via a “negative carry” on the debt funding compared to their low single digit investment returns.

Stock options / Alignment of interest

Since 2006, more than 50 mn options have been granted to the employees (against around 160 mn shares). Some are pretty far out of the money, but still, combined with the bonuses it doesn’t look like that there is “full alignment” between shareholders and employees. The executed share repurchases look rather small compared to the option grants.

“Diworsification”

In the last few years, GP diversified into infrastructure and real estate. For me, this is a clear sign that they focus on asset gathering rather than on performance. I think their problem is that they cannot raise a new PE fund as their perfomance is most likely substandard and many more competitors are now active in Brazil then when they started. Additionally, on of their recent pruchases, a Swiss based listed fund-of-fund vehicle called “APEN” s also not really consistent with their LatAm focused strategy.

So the big question is:

Is GP Investments a good investment despite the substandard track record ? Will they be able to generate better returns going forward ?

What I am concerned about is the fact that they seem to hang on their loosers and sell winners pretty quickly. Making 100% in 3 years sounds good, but the real money is made with investments that make 5 or 10 times their initial investment. Overall, to me it looks like that the bonuses which are paid independent of overall investment results are the biggest issue. In a “Good” private equity structure, the employees only cash out AFTER the full portfolio has been cashed out and the overall result. In my opinion, this is the only way how to align incentives in such an environment.

Finally, a few words on the “Lemann / 3G” connection: In the book “Dream Big”, which I just finished reading (review follows soon…) and which sketches the carreers of the 3G guys, Lemann is quoted that he left GP Investments because of 2 reasons:

1. GP did chase too many deals, as he wanted to focus only on a few for the very long term
2. He didn’t like the way his younger partners payed themselves big salaries. His credo was always that salaries and bonuses had to be fully reinvested into the company and employees should have a simple life style

So for me at this stage, I will not invest in GP. Despite the interesting and initially compelling story, I am simply not convinced that GP going forward will be a better investment than a Bovespa index fund. Full stop.