Sculptor Capital Management (NYSE:SCU) is a global alternative asset management firm with about $35 billion in assets under management. The company was originally founded by Daniel Ochs in 1994 under the name Och-Ziff or OZ Management.
In the early years, Och-Ziff became a major player in the hedge fund industry by producing solid risk-adjusted performance. But since 2015, the company has gone through a tough period. There was a bribery scandal in 2016 where the company agreed to pay over $400 million to settle the case.
SCU is a publicly traded holding company that owns several operating partnership units. There are various different share classes with different voting rights and economic interests that can make it hard to understand the ownership percentages of the different parties involved. Below is a company diagram from the last 10K report that maps out the various ownership interests:
In recent years, the company has been embroiled in a boardroom fight between Daniel Ochs and the current CEO, Jimmy Levin. The dispute between Ochs and Levin began in 2018 when Levin was appointed CEO of the company. Ochs, who still controls about 12% of the company’s shares, was unhappy with Levin’s compensation level, leadership style and strategic direction. Levin currently controls about 20% of the vote. Note that this percentage gradually increases every year when Levin receives equity compensation awards.
The dispute between Ochs and Levin came to a head in late 2020 when the company’s board voted to extend Levin’s contract for another five years. Ochs, who had been pushing for Levin’s removal, was reportedly furious with the decision and threatened to take legal action against the board.
In October 2022, Ochs sent a letter to the Sculptor board members.
Here are some key excerpts from the letter:
“the Company’s board has failed to discharge its duties by, among other things, enabling and enriching a management team that is more focused on its own compensation than the Company’s future.“
“Last month, several founding partners and I filed a lawsuit seeking increased transparency about the recent activities of the Company. Since the filing, I, as well as other founding partners, have been contacted by several third parties who have asked us whether the Company might be open to a strategic transaction that would not involve current senior management continuing to run the Company. It is not surprising that third parties would see the potential for such a transaction given that outside analysts have previously identified the Company’s management issues and concluded that, at its current trading price, the Company may be worth less than the sum of its parts.“
The boardroom fight between Ochs and Levin has had a significant impact on Sculptor Capital Management’s stock price. Since the dispute began, the company’s shares have fallen by more than 50%, and many investors are concerned about the company’s future.
The Sculptor board responded to Och’s letter, by saying they were always open to third party offers. They formed a committee to investigate some of the following alternatives:
- Sell the whole company to a third party buyer.
- Levin may want to take the whole company private in order to remove Och’s remaining ownership.
- Levin could also sell off part of the business, then take the remainder private.
Because of the high compensation currently paid out, it can be hard to evaluate what the overall business is currently worth. The structure of the company is very confusing. There is a lot of operating leverage, but also very high fixed cost due to the high compensation levels that are paid out.
Levin has said that he thinks about the earnings power of the business in two buckets.
- First bucket: Management fees earned minus fixed expenses. The goal is to grow management fees while reducing fixed expenses. The growth of management fees comes from incoming asset flows and compounding capital within the investment partnerships.
- Second bucket: This includes incentive income for above average performance weighed against the higher variable bonus expense that must be paid out against it.
The Balance Sheet
SCU has a solid balance sheet which is shown below. There is $259 million in cash and about $237 million in shareholder equity in the Class A shares. Compensation paid out in 2022 dropped considerably from 2021 because of the bear market conditions and lower incentive fees.
Levin has estimated that the core earnings potential of the company from just the first bucket is “just shy of $1 earnings per share”. Most of the peer publicly traded alternative asset managers trade at 15 times management fee earnings or higher. Because of the boardroom fighting and past problems, I think a reduced value of 12 times core management fee earnings plus the net assets on the balance sheet make it easy to justify an approximate purchase price in the high teens for SCU, especially if an acquirer could replace Levin and reduce the compensation levels paid out.
A precise valuation of SCU can be very complex. This paper from Houlihan Lokey, “Independent Valuation Insights“, describes the many factors that go into the valuation of an asset manager.
I believe the price of SCU is very cheap now, but there is a time-based risk that an eventual sale of the company may not happen in the near future. Jimmy Levin may prefer to just keep the status quo, which would allow him to gradually increase his ownership of SCU. He could wait several more years before deciding to take the company private or allow a third party to buy the company.
Because of this, I think a good way to invest in SCU stock now is to sell out of the money cash covered puts. That way, you are paid to wait if SCU just trades sideways for several years. At the end of February, I wrote several cash covered SCU $7.50 puts expiring in September 2023 for $1.10. The puts are illiquid and can trade with a large bid-asked spread, so you need to be patient and put out a limit order somewhere between the bid and asked price.
As an example, suppose you are able to sell a cash covered Sept. 2023 $7.50 put today for $0.90. If SCU stays above $7.50 at the expiration date, you would earn a return of $0.90/$6.60 or about 13.6% in five months. If SCU falls below $7.50 at expiration, you would get assigned on the put and would have a cost basis of $6.60 on your SCU shares.