The below investment thesis was originally posted on SumZero, the leading community for hedge fund and mutual fund investment analysts where professional investors share investment ideas exclusively with one another. Through The Motley Fool, select content from SumZero is now available to individual investors. This post was written on SumZero by Tim Eriksen, who is the founder and president of Eriksen Capital Management. He has managed a private investment fund that focuses primarily on small and micro-cap stocks since 2006.
The goal of every enterprising investor is to achieve attractive absolute returns and to outperform a passive index approach over time. The best way to achieve that is to focus on the least efficient segments of the stock universe. As Seth Klarman wrote in Margin of Safety, "ample investment opportunities may exist in the securities that are excluded from consideration by most institutional investors. Picking through the crumbs left by the investment elephants can be rewarding." In other words, we should fish where others are not.
That is the basis of how we manage money. We spend our time looking at the most ignored segments of the market -- companies with market capitalizations of less than $200 million, spinoffs, misunderstood mid and large caps, stocks trading under $5 per share, and unlisted companies. Ideally, we want companies that also have a near-term catalyst that will result in a narrowing of the gap between the market price and our estimate of intrinsic value.
Calamos Asset Management -- Complicated Ownership Structure Hides True Value
Calamos Asset Management
As of the end of April 2011 Calamos had $39.1 billion in assets under management (AUM). Seventy-five percent of AUM was in mutual funds, and the remaining 25% was in separate managed accounts. Before looking at the stock in greater detail, it is essential to understand the firm's structure, which we believe is clouding the true picture of the company.
Calamos Asset Management is a holding company which owns a 21.9% economic interest in Calamos Holdings LLC. The remaining 78.1% of Calamos Holdings is owned by Calamos Family Partners. This is important, first of all, because a number of investors have looked at CLMS based on some back-of-the-envelope valuation metric and moved on because they did not take the time to understand the company's structure, and make the proper adjustments.
Second, it is important to understand the organizational and ownership structure in order to understand Calamos' financial statements and thus its true value. The financial statements consolidate the results of Calamos Holdings, thus the investor has to make some adjustments to understand what is owned by CLMS (the publicly traded company) and what is owned by Calamos Holdings (which CLMS has a 21.9% economic interest in).
Unraveling Calamos
Many companies that have complicated structures can be hard to unravel. In Calamos' case they have done most of the work for us. In the section titled "Other Information" in their most recent 10-Q filing it says:
Calamos Asset Management, (CAM) is comprised of two groups of assets: a) CAM's 21.9% ownership interest in Calamos Holdings LLC and b) assets other than its interest in Calamos Holdings LLC (Other Assets), principally comprised of cash and deferred tax assets with a combined book value of $122.4 million. Because CAM controls the operations of Calamos Holdings LLC, CAM presents the entire operations of Calamos Holdings LLC with its own in the consolidated financial statements. The Calamos Interests' 78.1% ownership in Calamos Holdings LLC is presented as non-controlling interest in the consolidated financial statements ...
As previously stated, in addition to the approximate 21.9% ownership in Calamos Holdings LLC, CAM owns certain Other Assets. These assets include cash equivalents and current income tax receivables with a book value of $49.4 million, which approximates fair value, as well as net deferred tax assets with a book value of $73.0 million. The most significant deferred tax asset relates to an election made under section 754 of the Internal Revenue Code following CAM's initial public offering that expires in 2019, which allows CAM to reduce future income tax payments by approximately $8.0 million annually. The net present value of the net deferred tax assets would be approximately $45.7 million if a hypothetical 12% discount rate were applied over the remaining life of the assets. Using this assumption, Other Assets would collectively have a discounted present value of approximately $95.1 million, or $4.72 per share.
In other words, a shareholder of CLMS owns more than just a 21.9% economic interest in the assets and earnings of Calamos Holdings; he also has exclusive ownership to $49.4 million in cash ($2.47 per share) and $73 million in deferred tax assets with a discounted present value of $45.7 million ($2.25 per share) as of March 31, 2011.
As we previously noted, the financial statements consolidate the results of Calamos Holdings, and then allocate the 78.1% not owned by the publicly traded CLMS to non-controlling interests in Calamos Holdings. This is helpful because it allows us to clearly see the profitability of Calamos Holdings. In the first quarter of 2011, Calamos Holdings had $37.3 million of pre-tax operating income. Adjusting for taxes of 38.5% it results in $0.25 per share, or a $1.00 annualized run rate (($37.3MM x (1-38.5%) x 21.9%) divided by 20MM shares).
In addition to the cash that is owned solely by CLMS shareholders, there is also cash and debt at Calamos Holdings. We can back into it by taking overall cash and investments of $450.4 million and subtracting the $49.4 million owned solely by CLMS to get $401 million. We need to reduce that figure by debt to get net cash on the books. Total debt is $125 million. Thus net cash is $276 million, or $3.00 per share (($276MM x 21.9%) divided by 20MM shares).
Since we know that the current share price of CLMS is $13.37 per share, we can make adjustments to figure out what value the market is placing on the ownership interest in the $1 per share of annualized earnings in Calamos Holdings and then determine whether that is attractive to justify a purchase of CLMS' shares. The result is an effective purchase price of $5.65 per share (or just 5.65 times after tax operating earnings).
- Share Price $13.37
- Less CLMS cash $(2.47)
- Less CLMS tax assets (NPV) $(2.25)
- Calamos Holdings $8.65
- Less cash $(3.00)
- Effective net price $5.65
- After-tax Operating EPS $1.00
- Effective P/E ratio 5.7
In my opinion, CLMS is a strong buy at this level. Our estimate of fair value is $20 for CLMS. We derived that based on our estimate of a fair value of 13 times after-tax operating earnings for Calamos Holdings and adding back in $5.47 in net cash and investments and $2.25 of present value for the deferred tax assets. Lastly, barring any significant changes in AUM, the buyer can also confidently view any further drop in CLMS shares price as an even more attractive opportunity.
Note: There is a helpful Organizational and Ownership Structure Chart in Calamos's 3/31/11 10-Q filing.
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