BX - Patria Investments: Solid LATAM Focused Asset Manager

Summary

• Patria has made a few acquisitions since going public, improving its platform.
• The company is currently undervalued by slightly more than 10%.
• The main catalysts are LATAM growth and diversification benefits.
• The main risks are the LATAM governments and FX risks.

Recently, I expanded my position in Patria Investments ( PAX ), an alternative asset manager that is active in LATAM. The LATAM market is expected to grow significantly faster than North America and Western Europe, which makes it interesting to gain exposure. In this article, I will explain why I decided to increase my position in Patria.

The Company

Patria Investments or Patria is an alternative asset manager headquartered in the Cayman Islands. The company was founded in 1988 in collaboration with the Salomon Brothers. In 2010, it formed a partnership with Blackstone ( BX ), which subsequently purchased a 40% stake in the company. In 2021 the company went public on the NYSE and Blackstone decreased its position to 14%. Since going public, the company has made three acquisitions to strengthen its platform. It acquired Brazilian Real Estate Asset Manager VBI, it acquired Chilean Moneda Asset Management a leading asset manager in credit investments, and Kamaroopin, a venture capital firm. This has made the company even stronger and after these acquisitions, the company is active in the following segments: Private Equity (incl. VC), Infrastructure, Real Estate, Credit, Public Equities, and advisory and distribution.

The acquisitions in combination with the company's organic growth have led to a significant increase in assets under management. Compared to Q3 last year, the company's AUM has grown 76%, while its Fee-earning assets under management (FEAUM) Grew by an astonishing 101%. Unfortunately, YTD revenues went down approximately $20 million as performance fees dropped from $89 million to $0. In my opinion, this shouldn't worry investors as the stickier management fees were up approximately $65 million.

As the company continues to invest more money, I think its FEAUM will grow and this will lead to higher management fees. As the markets eventually stabilize, the company's realized performance fees will most likely also return to higher levels, and this should boost the company's revenue. From that perspective, the expected CAGR of 20.3% (aggregate based on 3 analysts' estimations) makes sense.

The company's balance sheet also looks strong. At the end of Q3 2022, the company had a net debt-to-EBITDA ratio of -3.87, while the company's debt-to-equity ratio was 2.7%. I prefer companies with a relatively low debt ratio as it gives them the ability to lever up in case they see good opportunities, and also makes the company relatively safer than one that is highly leveraged.

Valuation

Before investing in a stock, it is important to have a general idea about its valuation. The valuation can serve as a guideline for when to invest in or divest shares of the company. I prefer to use multiple methods which include a DCF model based on a perpetual growth rate and an exit multiple, as well as a multiples analysis.

Discounted cash flows

Whenever I use a DCF model I like to make use of three scenarios, a bull, bear, and base case. I use these scenarios because making a DCF requires a lot of assumptions. By using scenarios, you can see how the inputs would affect the share price. I use revenue growth as estimated by analysts and COGS based on the COGS over the past three years, slightly adjusted based on my expectations. For Patria this leads to the following assumptions:

To get the present value, we need to discount the future cash flows to today. To do this, we use the weighted average cost of capital ((WACC)), which is based on the company's beta, my minimum required rate of return, the treasury rate, the company's cost of equity (based on the CAPM), and cost of debt (based on interest payments and value of debt). This leads to the following WACC estimation:

For the perpetuity growth method, I use a perpetual growth rate of 3%. The reason for this is that a company cannot grow faster than GDP in the long run, and over the past decade, the GDP growth rate has averaged 3%. Do note that I expect the LATAM economies to grow faster, but in order to err on the safe side, we take the average of 3%. This leads to a price of $12.98, slightly lower than the current price.

For the exit multiple, I like to use the average EV/EBITDA of the company. For Patria, I used an exit multiple of 15, which is slightly lower than its average of 18 since going public. I think 15 is a reasonable estimate based on the average 10-year EV/EBITDA of Brookfield Asset Management ( BAM ) and BlackRock ( BLK ), which had an EV/EBITDA of 16.8 and 13.4 respectively. This leads to a price target of $16.06.

Multiples

For the multiples, I like to use the price-to-earnings multiple, as well as the EV/Revenue multiple. In terms of the price-to-earnings multiple, the company has been very volatile, having been above 30 and below 15. The average since going public is 23, but I think that this is slightly too high given the favorable environment that we were in. Based on that, I adjusted it downwards to 20, leading to a price target of $18.00.

If we take a look at the company's EV/Revenue, we see that the average since going public is approximately 10. However, this is also influenced by the elevated multiple when it just went public. If we adjust it to 9, we get a target price of $13.96.

If we combine all the price targets mentioned above, we get a price target of $15.25, which gives an upside of approximately 11%, above the latest closing price.

Catalysts

Having a price target is a good guideline, but there has to be a reason why a stock moves toward the price target. For Patria I have identified two catalysts that could move the stock price closer to my price target:

Growing Market

Patria is active in the asset management business in Latin America or LATAM, and multiple countries are part of the emerging markets index. The EM index consists of countries that have some characteristics of developed countries but does not fully meet its standards. Some countries that are included are Argentina, Brazil, and Mexico. What is also interesting is that the middle class is expected to grow significantly in these countries. This should eventually lead to more people investing in stocks and alternative assets. What is also advantageous for Patria is that the region is currently only 1% of global private markets, while it is 6% of global GDP. I expect that the difference between the two will shrink over time, which is beneficial for the company.

In addition to the region-specific advantages of Patria, we also see an increase in alternative assets. Compared to 2010 the allocation to alternative investments of institutional investors has grown from 14% to 19% in 2020.

Low correlation with G7

An additional reason for investing in Patria is that its investments in LATAM have a low correlation with the G7. The G7 consists of some of the largest economies of the Western world, including the USA, Canada, and Germany. As these countries have some of the largest economies, most people have exposure to them. As the correlation of Patria to these economies is low, it offers great diversification benefits, which could lead to higher demand in the future.

Risks

LATAM governments

Although I expect LATAM to grow faster than most developed countries, their governments aren't the most stable. They also tend to suffer from corruption and nepotism. As an example, both Brazil and Argentina were ranked 96th out of 180 countries on the corruption perception index , while Mexico ranked 124th. Chile on the other hand scored quite well and ranked 27th, the same rank as the United States of America. Corruption and unstable governments make it harder to do business. Furthermore, if things get really bad, governments can decide to seize assets of the company, which would most likely lead to investors pulling their money out of the region and cratering asset prices. Although I do not expect the latter to be likely, corruption could definitely be a problem for the company.

FX risks

Another disadvantage of investing in Patria is that it invests its money in countries with weaker currencies. For example, a significant part of the company's funds is invested in Brazil, whose currency has cratered over the past few years. This can have a significant impact on the profits of the company's funds and therefore also on the fees it receives, such as performance fees.

Conclusion

Patria Investments is an alternative asset manager focusing on the LATAM market. The company has made a few acquisitions since going public, strengthening its platform and boosting growth expectations. At the moment I estimate that the company is undervalued by slightly more than 10% based on a DCF, and multiples analysis. I expect that the growth in the LATAM market and diversification benefits will eventually lead to an upward revision to my estimated fair value. In terms of risks, investors should take into account the governments in the region and the FX risks, as this can extend the time that it takes the stock to reach the estimated fair value.

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