Pzena Investment Management: Buyout At 49% Premium, Company Going Private

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Along with its 2Q22 result release yesterday, Pzena Investment Management, Inc (NYSE:PZN) also announced that the company has entered into a transaction to go private after 15 years as a listed company. While we aren’t surprised that the company is looking to go private given its relatively cheap valuations [see details below] and cash on the balance sheet, the timing has been a positive surprise. In this all-cash transaction that is expected to close in 4Q22 [subject to approvals], Pzena’s Class A shareholders will receive $9.60 per share, which is a 49% premium to the stock’s closing price yesterday. This is significantly positive for the company’s shareholders, and the stock was up 44% in the after-hours.

Interestingly, our target price of $10.00 for the stock is very close to what the company is going to pay Class A shareholders. Given that the company is going private and that PZN stock is up 44% in the after hours, close to our $10.00 target price, we are closing our recommendation on Pzena. We had only initiated coverage on the stock in late June 2022, and at the $9.60 price that the company will pay Class A shareholders, investors would’ve received a total return of around 45% in just one month.

For its 2Q22 results, Pzena’s net income was down 39.8% YoY with an EPS of $0.15 as compared to $0.25 in 2Q21. The company’s assets under management (“AUM”) as of June 2022 was $45bn, down from $52.8bn in March 2022. This decline was driven by $1.1bn in net outflows, market depreciation contributing to a $5.3bn decline and forex reduction of $1.4bn. Overall revenue was down 4.3% YoY and the weighted average fee rate showed a small decline. Net cash per share amounted to 28% of market cap.

Privatization doesn’t surprise us given financial metrics

The privatization of Pzena does not surprise us, given the financial characteristics we highlighted in our initial report last month. First, Pzena had a huge net cash position [cash + investments] of $177mn in 2021, which equated to 37% of the stock’s then pre-privatization current market cap. Significantly, net cash had increased from $100mn in 2020 to $177mn in 2021.

Second, Pzena has reported high free cash flow (“FCF”) numbers despite the impact from Covid-19. FCF of $51mn in 2020 accelerated to $76mn in 2021. This is on the back of strong operating cash flows and a negligible CAPX business model. These numbers imply a FCF yield of 9.2% and 13.7% for 2020 and 2021, respectively, on the prior stock price. Our forecasts called for a continued significant FCF yield of 13.2% and 16.0% for 2022 and 2023 on the pre-privatization stock price.

Finally, Pzena has a track record of paying regular and special dividends over the last three years. For 2022, we had estimated a dividend yield of 9.4% [including the special dividend] on the then pre-privatization stock price. The company has stated that they will target a dividend payout ratio of between 60% – 70%. Looking forward, we had estimated a 2023 dividend yield of 9.8%. Such high FCF [and dividends] will enable management to service any debt load resulting from the privatization transaction.

Conclusion

Pzena Investment Management’s decision to go private is very positive for its shareholders. The company will pay $9.60 per share to stockholders which is a 49% premium to yesterday’s closing price. This is also very close to our target price of $10.00. Given this, we are closing out our recommendation on the stock. The stock was up 44% in after-hours yesterday.