Rating- SELL
12- Month Target Price
$8.00
Company Description
WisdomTree Investments Inc. operates as an ETF sponsor and asset manager. The company offers Equity ETFs, International Hedged Equity ETFs, Currency ETFs, Commodities ETFs and Fixed Income ETFs. It is the ninth largest ETF sponsor globally with AUM of ~$65 billion.
WisdomTree Investments (WETF)
The company is the largest independent ETF manager in the world with ~$65 billion AUM. Net outflows at its two flagship ETFs (DXJ & HEDJ), pricing headwinds, and intensifying competition is likely to weigh on the stock in the near to medium term. Initiating coverage with a SELL rating.
|
52-Week Range |
$8.14 13.41 |
Total Debt (million) |
$30.7 |
|
Shares Outstanding |
151.3 million |
LTD/Equity |
2.1% |
|
Insider/Institutional |
27.7% /94.5% |
ROE (TTM) |
21.2% |
|
Public Float |
120.7 million |
Book Value/Share |
$1.49 |
|
Market Capitalization |
$1.58 billion |
Daily Volume (90 day avg) |
1,663,167 |
|
FYE DEC |
FY2017A |
FY2018E |
FY2019E |
||
|
EPS($) |
ACTUAL |
CURRENT |
PREVIOUS |
CURRENT |
PREVIOUS |
|
Q1 Mar |
$0.05A |
$0.07A |
$0.11E |
||
|
Q2 Jun |
$0.09A |
$0.10E |
$0.11E |
||
|
Q3 Sep |
$0.06A |
$0.10E |
$0.11E |
||
|
Q4 Dec |
$0.03A |
$0.10E |
$0.11E |
||
|
Year* |
$0.20A |
$0.38E |
$0.45E |
||
|
P/E Ratio |
52.2x |
27.8x |
23.3x |
||
|
Change |
4.5% |
87.5% |
19.4% |
||
|
FYE DEC |
FY2017A |
FY2018E |
FY2019E |
||
|
Revenue ($ mil.) |
ACTUAL |
CURRENT |
PREVIOUS |
CURRENT |
PREVIOUS |
|
Q1 Mar |
$54.6A |
$59.6A |
$79.9E |
||
|
Q2 Jun |
$63.4A |
$75.2E |
$76.8E |
||
|
Q3 Sep |
$57.9A |
$76.2E |
$77.8E |
||
|
Q4 Dec |
$61.4A |
$79.8E |
$81.5E |
||
|
Year |
$237.4A |
$290.9E |
$316.1E |
||
|
Change |
8.2% |
22.6% |
8.7% |
||
Numbers may not add up due to rounding. EPS in table are pro-forma. GAAP and pro-forma EPS are in financial statements.
INVESTMENT THESIS WETF is seeing considerable outflows in its US listed ETF AUM while the growth in Europe and Canada AUM has considerably slowed. Year to date, the total net outflows have been $2.2 billion. In particular, WETFs two flagship ETFs (DXJ and HEDJ) which account for ~40% of revenue have been seeing net outflows, thereby putting pressure on advisory fees. The increasing competition in the quantitative-driven ETF space which is WETFs strength is likely to put pressure on margins and fees. The recent acquisition of ETFS has lowered t he probability of the company being acquired in the near-term given the added debt to the balance sheet and time required to integrate the businesses. This is likely to put pressure on stocks 27.8x FY18 P/E which in our view factors in takeout premium. Given the net outflows at its two flagship ETFs (DXJ & HEDJ), pricing headwinds, and intensifying competition, the current valuation looks excessive. We initiate coverage with a SELL rating and a price target of $8.00.
RISKS WETF may improve its net inflows faster than anticipated, in particular by technology-enabled solutions (AdvisorEngine) and new product launches. The company may continue to enjoy takeout premium which could keep the stock price high.
Investment Thesis
The company has given up 14% of its value YTD, and is off more than 21% from its 52 week highs as performance of its two flagship products: DXJ- Japan and HEDJ Europe) continues to remain subdued. WETF is seeing considerable outflows in its US listed ETF AUM while the growth in Europe and Canada AUM has considerably slowed. Year to date, the total net outflows have been $2.2 billion. Of which, DXJ and HEDJ have experienced outflows of ~$3 billion. Wisdom Tree specializes in currency-hedging foreign exchange traded funds, which have given up a lot of ground. The increasing competition in the quantitative-driven ETF space which is WETFs strength is likely to put pressure on margins and fees.
WisdomTree shares currently are selling at 27.8 times the companys expected 12-month forward earnings, well above the price-earnings ratios of competitors such as BlackRock at 18.1x and Invesco at 10x.The average for its peers is 13.4 times forward earnings. We think WETF shares are trading at high multiples partly due to expectations of it being acquired; however, post the recent acquisition of ETFS the probability of the company being acquired in the near-term has dropped in our view. We believe this could further pressure the stocks 27.8x 2018 standalone P/E.
Given the aforementioned issues, we initiate coverage with a SELL rating and a price target of $8.00.
Outflows continue to pressurize AUM and advisory fees. While WETF generated very strong organic growth for its first nine consecutive years (FY07-FY15) as a public company, it saw large outflows in FY16 and has failed to put up strong organic growth numbers since 2015. 2016-17 outflows were driven by its currency hedged suite where WETF has two category leaders (DXJ -Japan, HEDJ – Europe), but the segment has remained out of favor given the weak US dollar. At December 31, 2017, approximately 25% of its US listed ETF AUM was concentrated in the two WisdomTree ETFs, with 11% in WisdomTree Europe Hedged Equity Fund (HEDJ) and 14% in WisdomTree Japan Hedged Equity Fund (DXJ). These two ETFs also accounted for approximately 40% of revenues in 2017.
During 2017, DXJ flows were essentially flat while HEDJ experienced net outflows $2.6 billion. In 2016, HEDJ and DXJ experienced net outflows of $7.8 billion and $5.7 billion, respectively, and through April 30, 2018, these same funds have experienced outflows of $0.8 billion and $2.2 billion, respectively.
The US dollar’s continued decline versus the euro and the yen drove significant outflows from HEDJ and DXJ. We expect that dollar could continue to remain under pressure as escalating US-China trade tensions could exert a toll on the global economy and US growth. The persistent worries over global trade tensions are likely to weigh on the dollar against the yen. Japan has suffered from deflation for decades and Bank of Japan is expecting inflation to return, and with it tighten its loose monetary policies. The recent BOJ meeting left the monetary policy unchanged and also noted that meeting its inflation targets was taking longer than expected. However, speculation about the possibility of the Bank of Japan’s eventual exit from its aggressive monetary easing is also likely to support the yen. A combination of economic recovery in the Eurozone and other external factors are expected to propel the Euro even higher in coming quarters. We believe the appreciation of Euro and Yen relative to dollar would adversely impact companys AUM and thereby advisory fee.
Takeout premium to drop. WETF closed the acquisition of ETF Securities’ European exchange-traded commodity, currency and short and leveraged fund business (ETFS), which includes $17.6 billion in AUM. With the addition of ETFS, WisdomTrees AUM has increased to approximately $63.4 billion globally. The acquisition elevates WisdomTree to the 9th largest ETP sponsor globally and the largest global independent ETP provider based on AUM, with significant scale and presence in the U.S. and Europe, the two largest ETP markets.
While the announced acquisition gives WETF scale and diversifies AUM, we think it would reduce the probability of WETF being acquired in the near term given the added debt to the balance sheet and time required to integrate the businesses.
WETF continues to face challenges amid intensifying competition. ETFs have seen impressive growth over the last decade, thanks to the convenience and transparency they provide investors, in addition to the relatively low fees. Over recent years, competition has intensified with traditional asset managers entering the space with their own ETF products. The intensifying competition among ETF providers has also triggered a price war among incumbents. Certain ETF sponsors have been reducing fees, which has been a trend over the last few years that accelerated meaningfully in 2017. Funds with fees of 20 bps or less attracted approximately 70% of the net flows into U.S. listed ETFs during the year ended December 31, 2017.
According to the Investment Company Institute, expense ratios for U.S. equity ETFs overall dropped by nearly a third between 2009 and 2016, falling 32% to 23 basis points (or 0.23% of assets) on average, from 34 basis points. In June, Morgan Stanley estimated that fees could fall an additional 10% to 15% over the coming three to five years.
The pricing pressure is not just limited to vanilla-ETFs but has extended to smart beta products as well. Smart beta is a category of ETF that sits midway between passive funds, which track an index like the S&P and active funds, where the holdings are individually selected by a portfolio manager. Smart-beta products were generally viewed as a product category which could grow assets without too much sacrifice on revenue.
The price war beyond plain vanilla ETFs into smart-beta ETFs, implies that the industrys higher pricing assumptions for smart-beta products will not hold.
Exhibit : Pricing Pressure on Fees
Source: WisdomTree Investments, Factset
Net margin of the company decreased continuously from FY14 to FY17. Net margins have been on a downward trajectory since 2014 amid pricing pressure due to increasing competition and also due to higher compensation expenses. Compensation expenses of the company include salaries, incentives compensation, and related benefit costs. Compensation expenses are one of the major operating expenses for the company and operating leverage of the company is totally based on it. Compensation expenses increased to $81.5 million (35.78% of revenue) in FY17 as compared to $63.3 million (28.96% of revenue) in FY16. Compensation expenses increased to all time high of 41.9% of revenue in Q4:17, the same was 36.2% of revenue in Q4:16. We expect, the company would keep these expenses high in upcoming years to attract and retain qualified personnel.
Competition. WETF compete directly with other ETF sponsors and mutual fund companies and indirectly against other investment management firms, insurance companies, banks, brokerage firms and other financial institutions that offer products that have similar features and investment objectives. The most significant competition comes from asset management companies such as Blackrock, Vanguard, Nomura Group, Deutsche Bank, UBS etc. These companies boast large AUM and benefit from global presence and cost advantage.
WETF competes based on a number of factors, including name recognition, service, investment performance, product features, breadth of product choices and fees. Some financial institutions operate in a more favorable regulatory environment and/or have proprietary products and distribution channels, which may provide certain competitive advantages to them and their investment products. We believe that competition within the ETF industry will continue to increase as more traditional asset management companies become ETF sponsors.
Guidance and Estimates. For FY2018, the management guides for compensation expense to be in the range of 27%-29% for the US segment, which is down from 32% in FY17. For fund operating cost, WETF gives guidance as gross margin. Historically, gross margin included fund operating cost and third-party revenue sharing. Given the success of the relationships with key decision platforms such as PD and Schwab and marketing arrangement with the Compass Group, WETF no longer includes third-party sharing as part of gross margin, since it’s really a distribution-related cost. Therefore, gross margins going forward will only include advisor fee revenues, less fund operating cost because it’s more accurate to model. Based on current AUM levels WETF expects US segment gross margins to range between 83.5% to 84%.
Third-party sharing costs are expected to be in the range of 2.6% – 3% for FY18. WETF expects to invest $3 million to $5 million on strategic growth initiatives in FY18, which will focus on expanding distribution abilities, specifically around adviser solutions. In addition, the company will continue to invest in product and brand awareness as well as launching 6 to 8 new ETFs in 2018.
For the international segment, losses are improving and WETF expects to have $7 to $10 million of losses in 2018. This excludes contribution from ETF Securities business. Factoring in contribution from ETFS, we expect international segment to be profitable. The ETFS transaction closed on April 11, 2018, adding $17.6 billion to the AUM. The EBITDA contribution from the ETF Securities business is anticipated to be $29.9 million due to the transaction closing in April, instead of March. The management noted that net income from ETFS will be approximately $16 million in 2018 based on the asset levels at closing. There is no change to the synergy target of approximately $5 million. WETF anticipates a $22 million in one-time deal-related expenses and integration costs.
Our FY2018 revenue forecast is $290.9 million and our FY2018 EPS estimate is $0.38. For FY2019, we forecast revenues of $316.1 million and EPS of $0.45.
Risks to the Short Thesis
Product differentiation and innovation could limit fee pressures. WETF continues to leverage its self-indexing license and launch first-to-market products, as it plans to introduce 6 to 8 new ETFs in 2018. Management noted that it wasnt experiencing significant fee pressure in its established product categories, and believes that its differentiated products with deep liquidity and solid performance will continue to attract demand at existing price points. However, we believe both plain vanilla ETFs and smart beta are not immune to the industry fee headwinds, and expect some pricing contraction.
New investments could lead to higher growth. O ver the last two years, WETF has made significant investments in (1) distribution (Europe, Japan, and Canada), (2) product (commodities, fixed income, EM) and (3) technology (AdvisorEngine/Juncture) which could lead to higher organic growth. Juncture has already brought 12,000 financial advisors across 1,500 firms ($600 billion AUM) into WETFs sales effort.
International business could reverse losses following ETFS acquisition. Following its acquisition of ETF Securities’ European business, WETFs own European business is now $20 billion of AUM. The EBITDA contribution from the ETF Securities business is anticipated to be $29.9 million in FY18, while net income from ETFS will be approximately $16 million. The management noted that ETFS acquisition will be accretive to international segment earnings from year one onwards.
Net inflows could improve faster than anticipated. WETFs organic growth could improve as AdvisorEngine gains traction with advisors and enhances WETFs net flows. Also, pressures on WETFs flagship currency hedged ETFS (DXJ and HEDJ) could be short-lived. VALUATION
We forecast WETF revenues to increase about 22.6% in FY2018 to $290.9 million, primarily driven by the acquisition of ETFS which is anticipated to contribute ~$58.5 million to revenues in 2018. We expect EPS of $0.38. We project growth of about 8.7% in FY2019 combined with operating leverage to generate EPS of $0.45. WETF trades at 27.8x our FY2018 EPS estimate.
We value WETF using a blended approach of a 50/50 weighted DCF and P/E multiple methodology. We are valuing WETF using a 25% discount to its current forward multiple of 27.8x (based on our estimate). In our view, the current stock price factors in significant takeout premium. The recent acquisition of ETFS has lowered t he probability of the company being acquired in the near-term given the added debt to the balance sheet and time required to integrate the businesses. This is likely to put pressure on stocks 27.8x FY18 P/E and hence we use a multiple of 20.9x (at 20% discount) to value WETF. We weight this discounted multiple target to equal 50% of our price target. The multiple based target price is $7.84.
We weight the other 50% of our target using our Discounted Cash Flow target. Our DCF model uses our forecasted free cash flow to the firm over the next two years, and then grows EBIT at a 7.5% rate over years 3-8. We apply a weighted average cost of capital of 7.33%. This in turn is a combination of a 7.42% cost of equity and 3.5% pre-tax cost of debt. Thus our DCF produces a value of $8.14.
The combination of $7.84 at 50% and $8.14 at 50% results in a weighted average price target of $7.99, which we round up to $8.00.
Disclosure: I am/we are short WETF.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
