Weekly Commentary: 15/07/19

Where are the Customers’ Yachts?

The book “Where are the Customers’ Yachts?” by Fred Schwed was written 75 years ago but as we watch the continuing headlines over Woodford it seems as relevant today as then. It has some very useful investing lessons for us. Three of my favourite lines in the book are as relevant today as they were then.

On market reports it says: “One can’t say that figures lie. But figures as used in financial arguments, seem to have the bad habit of expressing a small part of the truth forcibly, and neglecting the other part, as do some people we know.”

On the incentives of brokers, it says “For one thing, customers have an unfortunate habit of asking about the financial future. Now, if you do someone the single honour of asking him a difficult question, you may be assured that you will get a detailed answer. Rarely will it be the most difficult of all answers – “I don’t know”

And on the cyclicality of markets it tells us “When ‘conditions’ are good, the forward-looking investor buys. But when ‘conditions’ are good, stocks are high. Then without anyone having the courtesy to ring a bell, ‘conditions’ get bad.”

Market reporting

Market reporting has certainly developed a codified wording over the years. With brokers now paid by companies in markets that inexplicably change their mood, the public relations industry and the stockbroking industry have become closely related. We once compiled a list of terms for use by new recruits to the industry which is below by way of example of the reporting language used by companies and analysts. In it we described a “parachute” as “landing comfortably after being ejected from corporate HQ by angry shareholders”. A “strategic acquisition” was one that had been overpaid for and a “complimentary acquisition” was because there was no growth in the existing business.

Such cynicism may be borne out of a system where participants are incentivised differently. Management want to keep their jobs; fund managers want shares to go up so they keep their jobs while the broker wants to place shares to earn commission and therefore will encourage acquisitions. This is all ultimately paid by companies who are owned by shareholders. The fund managers, bankers and brokers have highly profitable business models paid for by the customers, which may explain why the city is a popular choice for graduates to seek a career today.

But this model doesn’t only apply to the city. It is usually more profitable to service an asset than to own an asset. It also applies to razors, where blades cost more than razors, printers, where ink costs more than the machine, and lifts, where servicing costs more than the lift. When a customer is asked if he wants his 53-storey elevator servicing this year it is highly unlikely they will decide to give it a miss or even maybe shop around for a cheaper alternative. And so, these service companies have reliable and high returns on capital deployed. These reliable and high return businesses attract stock market capital which is evidenced by high ratings.

Fund Management Sector

This is a factor that fund managers are very aware of. Their own businesses generally perform better than the funds of their customers that they run.

The 5-year share price performance of a sample of quoted active fund managers is shown on the chart below. Impax, the environmental fund manager has appreciated c.450%, Liontrust 210%, and Premier Asset Management by 80%. The FTSE 100 is the red line on the chart and only Jupiter has underperformed the FTSE 100 over the last 5 years.

In stock market terms there is money to be made from transitioning from owning assets to managing assets. As investors it is important to focus on investing in the yacht owners rather than the customers.

Changing Points

Intermediate Capital Group Plc is a good example of the beneficial effect this transition can have on share prices. This listed private equity vehicle used to have years of making poor returns and then high returns as investments matured over the cycle. It is now increasingly running third party mandates for a fee which carries a far higher ROE than owning the assets does. The result has been an increase in the ROE as this transition evolves.

Source: Sharepad

The market has re-rated the shares significantly for this change of strategic direction with the shares appreciating almost 300% over the last 6 years while the profits have increased by 40% since 2013.

Back in 2013 72% of the profits were derived from the investment company and 28% from the fund management company while in the year to March 2019 55% of the profits were derived from fund management and 45% from the investment company.


The property sector has not experienced this shift of value from the asset owner to the asset manager but there are signs it may start to happen. Two companies, Sigma Capital and First Property are starting to move towards asset management which frequently can have a highly beneficial effect on share ratings.

This sector seems to have eluded the servicing/ owner model largely because the sector has been influenced by government interference. Property companies prior to 2007 were managed by operating companies (propco/opco to use the jargon) until Real Estate Investment Trust legislation was introduced. This provided tax benefits as long as 90% of the profits were paid out as dividends (amongst other requirements) and so 80% of the property companies converted to REIT status.

In todays world the services required by commercial property companies are increasingly complex. No longer is just window cleaning and central heating required. Nowadays many services are centralised from shared meeting rooms, guest Wi-Fi, to shared break out areas, as well as free beer in the case of WeWork offices. The design and management of these large offices with vast floorplates needs to be flexible and change more regularly and it noticeable that property companies showcase the strength of their space management capabilities.


WeWork, most recently valued at $47bn while reporting a $1.93bn losses from $1.82bn of revenue in 2018 illustrates the value that can be attached to property companies that get the services right. In the meantime, the UK REIT sector languishes at large discounts to net asset value.

Source: Sharepad

It is my personal view that the arbitrage of valuation will lead to a change in structure of some of these companies. Eyeing the huge gains to be made from managing office environments, companies may end up divesting the property management company or divesting the property to institutional direct property funds. Whatever the outcome the market extremes are huge and ultimately seem likely to result in corporate activity that will move us closer to the old-fashioned world of opco/propco. It is too early to identify exactly which company will be first, but if we could see it the prices would be higher.

This is starting to happen. Sigma Capital is an innovative model in this area.

Sigma Capital

Share Price 110p

Market Cap £98m


The company was founded by Graham Barnet who holds 7% of the company today. It was founded to manage the construction, delivery, financing and letting of new homes in the private rented sector where there is a growing need for quality family homes. Starting out by agreeing framework agreements to ensure land supply, and construction resource the company also has planning expertise in order to deliver the land with planning which it finances with a credit facility with Homes of England, a government body, its own balance sheet and the PRS REIT which raised £700m when it came to market in 2017.

Financial Model

There are 3 revenue streams for the business.

  1. Development Profit Once the homes are completed the PRS REIT acquires the homes from Sigma and Sigma makes a 10% plus margin on the build cost. The REIT is limited to using 30% of its available capital for this.
  2. Development Management fees When the REIT owns and funds the development of the sites Sigma receives a fee of 4% of development cost as development manager. The REIT may use up to 70% of its capital for this.
  3. Asset Management fees – There is a recurring annual asset management fee of 1% of the REIT’s adjusted net assets up to £250m and after that there is a sliding scale down to 0.7% of the REIT’s net assets above £1bn.

With the REIT only raising money in 2017 the returns have only recently started to come through. Planning delays have caused recent share price volatility which is inevitable. However, in 2018 the ROE was above 20%.

Source: Sharepad


The PRS REIT is targeting above £1bn of homes to complete which is c.10k homes at £100k each. So far, the REIT has raised £500m in equity and has debt available of £200m with another £200m debt facility planned which would take the capacity to £900m. If we assumed the REIT stabilises at £500m Sigma would have recurring income of £10.8m per year derived from asset management fees. dividend income from the REIT and Sigma owned properties. If we add to that somewhere between 4% and 10% (depending on how the properties are funded) on building the homes, we can get to substantial revenues. At the end of 2018 Sigma had 3,000 homes under construction which would equate to construction fees of between £12m and £30m.

So, we can envisage revenues of £23-£42m per year while during 2018 the administration costs were £5.7m so we have a potentially high return business here. With the results in April the company announced a new £43m PRS fund backed by the government agency Building Scotland so there may be further upside than just the £500m PRS REIT funding envisaged here.


The house Broker (N+1 Singer) has a strong increase in 2019 revenue but only a 9.2% increase in PBT (Profit before tax) forecast but after that there is no further revenue growth forecast. This could be a concern that the broker doesn’t have the confidence to forecast further growth or it could be prudence.

Source: Sharepad


The share trade at 8X a maxed-out business. Sadly, not enough analysts discuss ROE but I don’t recall many businesses that make a sustainable 20% ROE trading on 8X. My bet would be that further growth will be delivered. The company targets £1bn+ of homes while the forecasts assume only the existing funding of £700m in the REIT. I like single figure PER (PE Ratio) companies with high ROE and sustainable earnings which may possibly grow. I just don’t know how long it will take.


This is one of those rare companies that can generate a high ROE and reinvest its earnings at the same high return. I think that is what Warren Buffet would refer to as a super compounding engine. It seems more likely that customers who own Sigma have more chance of buying a yacht than those who own the PRS REIT.

Another property company at the early stages of changing its operating model is First Property.

First Property

Share Price 48p

Market Cap £54m


This was originally a Polish (now 39% of NAV), Romanian (now 2% of NAV) and UK (now 59% of NAV) property company demerged from the Universities Superannuation scheme. It has transitioned towards becoming more UK centric as well as transitioning from an asset owner to an asset manager over recent years. Today it has £95m of property assets, £56m of debt and net assets per share of £46m (£41p per share) alongside a fund management business with £706m of assets under management.

Changing Point

The change in the company can clearly be illustrated by the segmental analysis in the company’s presentations.

Profit before tax from Group Properties

Source: Company

Fund Management revenue/AUM

Source: Company


This 41p per share net asset value and 48p share price implies that for the fund management business is valued at £8m which last year contributed £3m to profits. The forward PER is 10.3X and the yield is 3.5%


At the moment the fund management business accounts for a small part of the valuation of this company but it is growing while the property business provides a cash generative asset backed base. On a PER this is not priced as a growth company but the asset management business is quietly growing it into a high return business. For the patient investor who can accept Polish property risk in their portfolio this could be a developing asset manager to research.


The City has long been criticised for making more money for itself than it does for its customers. The same as Otis lifts do, and Gillette razors. Asset owning is a lower return business than asset managing which can be an opportunity for investors. The one sector that remains populated by asset owners is the property sector. But there are signs this may start to change driven by some very seductive valuation uplifts available to companies. First Property is a value situation making this shift while Sigma Capital is an innovator in the housebuilding sector. These minnows may cause the large companies to adopt similar innovation to the benefit of investors.

Forthcoming Events

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Source: Companies, RNS