Clarington IPO
Reasons for advisors to be careful
NOTE: This article was written in late 2003 about a secondary
offering then planned (and later pulled) by Clarington Corp. We have
neither reviewed nor written about the Clarington IPO completed in
March 2005.
Clarington Corporation recently announced its intention to go
public. The firm owns Clarington Funds, which is one of the country's
fastest growing fund companies which has had strong net sales in an
environment where the colour red is commonplace in the industry's
monthly net sales reports. An IPO by such a successful firm may seem
like a no-brainer investment but advisors should be careful about
jumping head first into this puppy.
The IPO
I admit that I did not read closely enough the initial press release
announcing this IPO. Unlike most IPOs, this one clearly differs in a
way that should grab the attention of any interested investor.
It states that the IPO is being implemented by way of a secondary
offering. The company will not receive any of the proceeds from the
IPO though is footing some of the costs to go public. (Clarington will
only receive proceeds from the offering if the underwriters exercise
their over-allotment option - i.e. if they want to buy more shares
than existing shareholders are selling.) In short, this offering is a
liquidity vehicle for a number of insiders and other shareholders
wanting to cash out. They can only cash out if others are willing to
buy. In this case, liquidity is being provided by a number of
brokerage firms that, presumably, will look to sell part or all the
shares they buy (as underwriters) to retail investors.
Of course it's prudent to diversify one's personal wealth, which
presumably is what company insiders are doing. But this isn't
necessarily a good deal for advisors and other investors. Think about
it, if they're selling - even if it's for diversification purposes -
they're unlikely to do so at a low price. For valuation and
diversification reasons, advisors would do well to proceed with their
eyes wide open.
Clarington's fortunes generally rise and fall with those of Canadian
stock market performance - since so much of their assets under
management (AUM) are invested therein. This is not unlike the income
and business value of many of this country's financial advisors. While
advisors tend to invest in what they know best, it's often best to
keep actual investments in such sectors quite limited for
diversification reasons. See more about this in a past article
entitled Big Picture Investing.
Despite Clarington's strong net sales during the worst bear market of
our generation, there are fundamental factors of which to be aware
before getting overly excited about this offering.
Manager risk
Of every $6 in AUM, $5 are managed by one firm - Halifax based Seamark
Asset Management Ltd. While Seamark has posted very strong
performance, every manager hits occasional rough patches. Clarington's
sales have begun to broaden beyond its Canadian Income fund and other
Seamark-managed funds, but the concentration remains. Also, while I'm
not one to dump (or stop recommending) a manager just because they hit
a very normal slump, history has shown us time and time again that
most advisors stop supporting (and often yank money from)
managers/funds in such slumps. Trimark in the late 1990s was the most
glaring example in memory. Hence, until AUM are sufficiently
diversified, this remains a notable risk to the firm's net sales and,
in turn, to the company's top and bottom lines.
Financing costs
Judging by recent financials (included in the prospectus) net profit
margins are low - i.e. they've been between 2 and 4 percent. Of every
$9 in management fees charged to its funds, Clarington keeps about
$2. There are two causes.
First, Clarington's financing arrangement with respect to its
commission payments to dealers requires them to share a piece of their
management fee revenues for a period ranging from two years (for low
load funds) to twelve years (for deferred sales charge funds). It has
also waived rights to redemption fees on units whose sales commissions
were funded by this third party. Over the past few years, this cost
has amounted to a little under $3 out of every $9 in gross management
fees. Trailers cost them about the same amount.
Second, the firm relies entirely on external money management firms,
which is more costly than handling these functions in house. This eats
up about $1 of every $9 in management fees.
That leaves relatively little to pay other general and administrative
costs. The upside for Clarington is, at the margin, they'll be able
to keep a larger chunk of management fees. They will self-finance low
load commissions starting next year - increasingly the choice of
advisors who sell funds. Plus, fees to subadvisors will shrink
slightly as assets pile up.
However, this remains little more than a bulk sale by insiders at a
price that meets their satisfaction - and that rarely proves to be a
good price for buyers.