Invest in US Global Investors Now (NASDAQ:GROW)
We believe US Global Investors (GROW) is deeply undervalued primarily due to ownership of the US Global Jets (JETS) ETF, which is worth up to 3x the company’s current market capitalization. A renewed interest in the ETF business from management and the announcement this quarter of exploration to unlock shareholder value are likely catalysts that will play into the coming months.
This article is a summary of due diligence calls with current and former employees of BlackRock iShares, Goldman Sachs ETF desk, WisdomTree ETF desk and Roundhill Investments on the economics of ETFs. Seeking Alpha analyst Josh Klein has done a great job monitoring and highlighting the value of the rest of the GROW platform (see here and here). If you are unfamiliar with this story, please review its articles before continuing to read.
ETFs are a fund manager’s dream
The quality of ETF management fee income and earnings contrasts sharply with that of mutual funds. Unlike mutual funds, there is a very clear flywheel effect for innovative ETFs that creates a lasting moat. See an example below with JETS:
US Global JETS ETF is launched as the first-ever airline ETF. US Global Investors is bringing a new differentiated product to market that is enjoying first-mover advantage and starting to build brand equity.
Investors who want to gain passive exposure to this group of airlines are investing and assets under management are starting to increase.
As the ETF’s assets under management increase, the liquidity of the product improves significantly. The increased liquidity attracts market makers, options traders and institutional investors.
The ETF becomes the de facto measure of airline stocks (acting as an indirect index), and the resulting publicity adds brand power and attracts an increasing flow of investors.
Investor flows increase assets under management, which brings in more cash, which introduces new assets under management, bringing increased brand recognition and generating additional inflows.
The end result of the flywheel effect above is a highly defensible revenue stream due to a captive asset base:
Sustainably achievable value proposition: Investors choose JETS to gain direct exposure to a basket of stocks and pay a management fee of 0.6% for this exposure. The investor does not expect active management of this basket of stocks, he pays for a diversified and liquid exposure.
Real change costs: Retail investors have little or no means of gaining direct exposure to the portfolio of underlying stocks (other than buying and balancing those stocks on their own), and institutional investors, custodians Market traders and options traders need the liquidity created by JETS to do their job. .
Very high barriers to entry: Even if a larger ETF player tried to recreate JETS, they would not enjoy the same first mover advantage. The only way to gain market share would be to cut fees, making the already difficult proposition of breaking into the established market even more difficult. Investors who were most enthusiastic about getting exposure to airlines already have the exposure they need with JETS. Since the ETF’s value proposition to customers is exposure rather than performance, first-mover advantage plays a lasting role in market structure.
Income quality: The completely passive nature of ETFs means that the fixed costs for trading operations are very low. Our due diligence with industry participants suggests margins as high as 90%. The proof is in the pudding: Roundhill Investments, a private ETF provider founded in 2018, has 8 ETFs with 11 employees on their LinkedIn. GROW has 3 ETFs with 42 employees on their LinkedIn (a quick LinkedIn search would show you that the majority of these employees are mutual fund related).
Assuming a range of assets under management between $3 billion and $4 billion (JETS assets under management today are approximately $3.5 billion), a gross margin of 90% and a earnings multiple of 10 to 15 times, JETS market capitalization value is between $160 million and $320 million. This asset alone is worth over 170% mid-term stock price appreciation:
Comparable companies support this earnings multiple of 10 to 20:
Active vs Passive Investing: The Passive Clearly Wins
JETS is a real gem, but that’s just the beginning. The company has announced a third ETF launch, and we expect more ETFs to be announced in the future as the organization becomes more passive. A more diversified stream of extremely high-margin ETF management fees will be essential for GROW, and the board should focus entirely on this OKR if it is serious about building shareholder value in the 1-2 next 3 years.
The trend of passive versus active investing has accelerated since 2015, with passive investment vehicles now accounting for the majority of US domestic equity funds with over $6.2 trillion in assets under management:
The debate between active investing and passive investing has been going on for more than a decade, and perhaps the most publicized outcome was Warren Buffett’s million-dollar bet with active investor Ted Seides, co-founder of Protect Partners. The conclusion is very clear: for the average investor (and even professionals like Seides), passive investing is likely to generate better returns.
We recognize the immediate irony of highlighting bullish trends around passive investing while making the case for active investing in US global investors, but this is critical to understanding why the company is at an inflection point. key. GROW has two businesses: a new passive ETF business with a growing number of ETFs under management, and a legacy active mutual fund business with declining assets under management and overall performance well below the S&P 500 .
In the past, GROW management has chosen to combine ETF and mutual fund businesses for reporting purposes. This was a clear mistake in our view, as these revenue streams could not be different.
Mutual funds need performance to attract assets. If performance declines relative to similar mutual funds, investors will move their money elsewhere. Investors are fickle and if performance fails to outperform their peers, assets under management suffer. This makes the mutual fund fee structure volatile – fees are non-recurring, non-sticky and require continuous outperformance.
Fund managers are aware of this, and to encourage investors to stay invested, mutual fund fees continue to come under pressure:
GROW is no exception to this trend. The company’s mutual fund business was a melting ice cube from more than a decade of poor performance and outsized fees:
Unlike ETFs, mutual funds are also required to hire active stock pickers, with a typical fund requiring a portfolio manager and a number of paid investment analysts. When performance is good, salaries go up – but when performance goes down, they still need to be paid. And when revenues are volatile and expenses are variable, earnings quality is doubly bad.
It should be obvious: charging 1% to 3% for average annual performance since inception below the S&P 500 cannot generate sustainable economic profit. It is for this reason that investors value mutual fund fee income at a significantly lower multiple than ETF management fee income. It’s also why CIR sees management’s signal this quarter to double down on ETFs as a critical first step to unlocking shareholder value.
In terms of next steps, here’s what we would do to create shareholder value and impress upon the market that there is deep value in the stock:
- Complete divestment, sale or spin-off of the mutual fund business: Show the market the full profit potential of the ETF business.
- Extra doubling of ETF activity: Launch more ETFs in less time. Roundhill Investments has launched 8 ETFs in the past 3 years, with significantly fewer employees.
- Key Leadership Team Hires with Deep ETF Expertise: Leverage industry expertise to build a sustainable ETF business and hire an internal IR team to help send a better message to the market.
- Act on the “revisit strategies” commentary to unlock shareholder value and buy back $10-20 million in stock: The most undervalued investment opportunity is the company stock itself.
We believe GROW is hugely undervalued and no one is more likely to benefit from long-term stock appreciation than CEO Frank Holmes, who owns 17% of the stock. Although options are relatively inexpensive compared to the implied 2x-3x upside based solely on ETF earnings, it is difficult to predict when any buybacks or special dividends the company is considering, which is the main catalyst. of a revaluation of the action. We therefore recommend ownership of GROW shares themselves as the company reassesses its prices over the next six to 12 months.