Hennessy Advisors (HNNA)

Price: $12.25
Shares Outstanding: 5,899,000
Market Cap: $72.26
Debt: $28.5m
Cash: $4.1m
Enterprise Value: $95.2m
Assets Under Management 03/2014: $4.77B
Average AUM Fee: 0.70%


Summary of Thesis:
Hennessy Advisors is an undervalued investment manager offering a suite of no-load
mutual funds primarily bought by retail investors and for for retail investors by their financial
advisors. HNNA funds have strong organic flow and the company trades at a considerable
discount to comparable investment managers (9.75x 2014 run rate earnings vs. 18.5x for
the small cap asset manager comp set). Hennessy is relatively unnoticed, with no analyst
coverage, and until recently (April 22) traded OTC. They have since up-listed to the
Nasdaq and we expect the valuation gap to narrow as investors become aware of the
strong organic inflows and overall cheapness of this asset manager. Valuation is supported
by public comparables and private market valuation of recent transactions.


Overview & History:
Hennessy Advisors was started by Neil Hennessy in 1989 and went public in May
2002. The firm has historically pursued growth via M&A, acquiring several sets of assets in
the last decade and most recently FBRs mutual fund assets. Until they acquired the FBR
funds in June 2012, HNNA had a spotty acquisition history. Previously, theyd rolled funds
into their own and the flows turned negative when performance sagged. Learning from this,
the recent FBR acquisition was different in that they retained subadvisory agreements for
the AUM. The FBR funds were acquired with cheap financing and integrated well. HNNA
still has some debt ($28.5m) associated with the acquisition.


The terms of the FBR deal are as follows:
HNNA acquired $2.2B of client assets, most notably the Focus Strategy.
The deal price was $38.8 million funded 60% upfront and the remaining 40% to be
paid on the first anniversary of the deal, subject to AUM at the time


As it stands today, three of the acquired funds were rolled into existing HNNA funds and the
remaining funds were simply rebranded under the HNNA name.






Comment [u1]: Anything that you can do to
strengthen this paragraph would be helpful.
Perhaps some more details about why they are over
their spotty acquisition history? Why else was
this a good deal? Did they get lucky? What was
going on at FBR? How much do I have to worry
about these guys doing bad deals again in the
future? Just some quick thoughts.


Below summarizes HNNAs lineup of funds and AUM as of 3/31/2014:

Name AUM
Morningstar
Rating YTD 1 Year
3 Year
Annualized
5 Year
Annualized
Hennessy Gas Utility Index 1,675,596,574 * * * * * 10.74% 18.42% 18.01% 23.29%
Hennessy Focus 1,448,770,839 * * * * * -3.80% 15.84% 15.51% 19.46%
Hennessy Equity and Income 328,856,672 * * * * * 1.73% 9.18% 9.67% 14.39%
Hennessy Small Cap Financial 264,361,438 * * -6.54% 16.27% 8.66% 14.27%
Hennessy Cornerstone Growth 241,354,341 * -0.40% 22.74% 11.65% 16.61%
Hennessy Cornerstone Mid Cap
30 226,841,713 * * * * 5.02% 18.75% 13.07% 21.69%
Hennessy Cornerstone Value 159,154,003 * * * 3.81% 17.86% 13.17% 21.57%
Hennessy Large Value 147,804,483 * * * 2.20% 17.31% 12.72% 17.06%
Hennessy Cornerstone Large
Growth 113,982,566 * * * * 5.48% 29.50% 13.05% 21.36%
Hennessy Large Cap Financial 103,917,421 * * * * -3.87% 21.66% 12.32% 15.78%
Hennessy Total Return 85,769,419 * * * 2.41% 8.22% 10.23% 15.70%
Hennessy Japan 37,918,550 * * * * * -1.81% 6.07% 9.18% 15.79%
Hennessy Japan Small Cap 15,798,551 * * * * * 2.20% 11.56% 14.08% 18.59%
Hennessy Balanced 11,904,181 * * 1.13% 4.85% 6.11% 10.52%
Hennessy Core Bond 6,405,195 * * * 1.55% 6.70% 4.03% 6.03%
Hennessy Technology 6,029,582 * * -9.38% 14.94% 2.32% 12.42%


The HNNA Focus fund and HNNA Gas Utility fund account for 54% of their
AUM. Additionally, whats worth noting is both of these funds are 5 star rated funds for
Morningstar. A number of other funds also receive high marks and appear to be
investable. While this ranking isnt important for most sophisticated advisors and investors,
this is important as the star rating is a heavily weighted factor for retail investors and most
financial advisors.


Evaluation & Valuation:
While the acquisition of FBR certainly improved AUM, strong performance and marketing
efforts have led to significant organic asset flows. Since the end of quarter fund values are
published along with the funds performance once can back into organic asset flow which is
summarized below:






AUM Actual Actual Actual Actual Actual Est

12/31/2012 3/31/2013 6/30/2013 9/30/2013 12/31/2013 3/31/2014
Comment [u2]: Maybe something on fund
strategies for Utilities and Focus? Gas utilities is
pretty obvious, but if I wanted to invest in HNNA, Id
want to know my exposure to whatever Focus style
is
Comment [u3]: Any chance you can show
benchmark info for these funds? You point out the
shortcomings of the 5 star fund, but would be nice
to demonstrate the successful track record of the
funds.
Comment [u4]: Details on marketing? What
changed there? A little vague here, and something
that Id want to understand better (even if it is just a
sentence long)
Comment [u5]: Probably not necessary, but you
could do this since the 1
st
Q post FBR and highlight
organic growth since that deal.


Qtr End AUM $3,024,068,000 $3,406,426,000 $3,593,673,000 $4,034,181,000 $4,480,322,000 $4,770,000,000
AvgAUM for QTR

$3,215,247,000 $3,500,049,500 $3,813,927,000 $4,257,251,500 $4,648,661,000
Market Performance

12.15% 1.59% 4.55% 6.79% 1.60%
Organic Flow

0.50% 3.90% 7.71% 4.27% 5.20%


Furthermore, we estimate the flow rate from March 2014 to April 2014 has been 1.4% which
annualizes at 18%. The organic flow is significant due to the strong operating leverage that
exists with investment managers since on-going capital requirements are low. The
operating leverage gets compounded further when markets cooperate with their strategies.


Regardless of future organic and market growth, HNNA still represents an undervalued
asset from a public and private market standpoint. Based on our current estimates,
quarterly earnings run at about $0.31/share for an annualized EPS of $1.24 for 2014. This
assumes 0 organic growth, 0 market performance, and stable AUM. FCF should be a bit
higher than that, by (?) roughly $0.05/qtr, due to the deferred taxes. As of the time of this
write up you have an opportunity to buy an asset manager with marketable strategies that is
experiencing organic flow at less than 10x earnings and a FCF yield greater than 10%.


Below is a comparisons table of various smaller cap asset managers. The most applicable
comps are Pzena, Cohen & Steers, Manning & Napier, Calamos, and Janus as they are
similar in size and capital structure; both of which trade at significantly higher multiples than
HNNA while having an organic in-flow rate less than HNNA, several are actually
experiencing negative flows.

Company MV AUM (B) P/E TTM Est. P/E 13 Organic Flow
Hennessy Advisors, Inc. 72.3 4.8 12.94x 9.29x +20.28%
Pzena Investment Management, Inc. 132.7 25.4 23.70x 20.37x +5.8%
Janus Capital Group Inc. 2,297.9 174.1 19.50x 15.64x -11.3%
Cohen & Steers Inc. 1,743.6 49.00 24.36x 22.02x -4.4%
Manning & Napier, Inc. 217.8 52.2 13.89x 12.88x -5.5%
Calamos Asset Management, Inc. 246.6 26.1 13.05x 23.01x -16.8%
Avg Ex-HNNA 927.73 65.36 18.9x 18.78x -6.44%


We wont argue that HNNA should trade at a peer average multiple, though with the inflows
you could stretch to make that argument. We think as the story becomes better known to
the investing public liquidity should improve and the multiple should rerate. HNNA probably
deserves a discount due to the relative size of the company and the concentration of the
assets with 54% in two strategies. However, given the strong flows, especially relative to
Comment [u6]: Just reads a little awkward to
me. Perhaps explicitly say what you have for FCF
(rather than add it to eps)?


the small cap peers, a multiple thats half the peer group seems far too low. Using the
assumption of no organic and market growth and assigning a comparable multiple of 13x
would value HNNA at $16.12/sh which represents 31.6% upside to todays price. Assuming
they can continue to flow 3%/qtr and they get 2%/qtr out of their strategies, we think 2014
earnings can get to $1.31/sh. A 13x multiple gets us to a $17 share price. This is a
discount to the market, and a discount to the peer group.


Recent private market transactions also provide support. Epoch, a small equity asset
manager, was taken over @ an EV that was about 2.75% of AUM by TD Bank. A similar
multiple for HNNA, adjusting for net debt, would imply a roughly $18 price. Its worth noting
thats on current AUM & cap structure, by YE AUM could be significantly higher and we
expect the business to generate about $9m in cash.


Management:
The company is led by Neil Hennessy. Neil is also the majority shareholder in the firm
owning 1,852,480 shares per his Form 4 filing in February of 2014. Neils ownership
represents a 31% ownership in the company. Neils base compensation is a fixed salary at
$350,000 and his incentive compensation is 10% of operating profits. His interests, outside
of an outright sale of the company, are aligned with ours.


Risks:
The biggest risks to the thesis are as follows:
Poor market performance and/or underperformance relative to their peer groups.
o Either of these situations could result in outflows & AUM declines.
Poor capital allocation, specifically a failed acquisition.
o Hennessy has a history of acquisitions outside of FBR that have had mixed
results. However, we believe theyve learned from their experience and
would pursue deals of a similar structure.





Comment [u7]: If you are submitting to VIC,
anything you can do to hype a catalyst would be
helpful. Why did these guys uplist? Any chance
they will get out on the road to tell their strategy? I
think you did a good job, but I really get the
impression that is an important criteria they judge
on for submission pieces