« Home | China Demand for Oil » | Did Google Buy SueTube? » | Google to News Corp: We Won't Eat Your Lunch ... F... » | UTUBE Site Swamped by YouTube Users » | Rags to Riches Story of SunTech Power » | Amazon.com Upgrades Astores Beta » | Is FaceBook Unrealistic with Yahoo? Is Microsoft G... » | Nintendo Wii Pre-Orders Begin on Friday » | The Richest Person in China Is A Woman: Zhang Yin,... » | Bank of America Offers Free Stock Trading - But Is... »

October 13, 2006

Hedge Fund Bubble - Avenue Capital Selling to Morgan Stanley for $2 Billion

posted by MR WAVETHEORY at 10/13/2006 01:18:00 AM



Morgan Stanley (NYSE
MS) is reportedly buying 20% of Avenue Capital for $2 billion. That is a rich price to pay for a hedge fund. Avenue Capital has $12 billion in assets.

Put that into perspective, MWD is paying $1 for every $6 of assets. The price translates into 16% of the assets under management. I don't understand the logic. Someone, please explain to me what I am missing. Don't get me wrong, they are a great fund. But a typical fund earns 2% of assets plus 20% of the return.

To get to 16% return on equity, here's how the math has to look.

Target Return = 16%
Target Return = Fees + Performance

Assume,

Fee = 2% (Industry Standard)
Performance = 14% (20% of the Total Return)

Avenue has to earn 14% from performance. Since the typical fund gets 20% of the total return of assets, that implies Avenue has to generate 70% annualized returns on its $12 billion in assets to generate 16% return on equity. 70% returns are nearly impossible to achieve on an asset base of $12 billion.


Here's another way to look at it. Avenue has 210 employees, so Avenue Capital is being valued at $50 million per employee. Add to that, many of those employees are working in the backoffice, so the value of an investment professional is more than $50 million.

With the reputation of Morgan Stanley, is it that hard to raise $12 billion in assets? Is this a hedge fund bubble?

Previous Posts

3 Comments:

Anonymous Anonymous said...

MrWaveTheory -

I'm confused by your calculations. Not that I disagree, it's just that I don't follow them.

If Avenue Capital generates 10% return on an asset base of $12B, that's $480M (mgmt fee = 2% x 12B, profit = 20% x 10% x 12B). Morgan Stanley's share of that is $480M / 6 = $80M. Assuming a 4% discount rate, the value of an $80M annuity = 2B. So the deal is accretive to MS if AveCap returns > 10%.

Where am I wrong?

4:49 PM  
Blogger MR WAVETHEORY said...

We differ in our assumption of the discount rate. I am assuming that the cost of capital is 100% which I will be the first to admit is higher than most analysts. The cost of capital is likely higher than 4% considering the volatility of the distressed strategy.

With hedge funds as with venture capital, there is no upper bound on the cost of capital. Just ask the investors in Amaranth - who are likely to get very little money back - after years of healthy returns. It only takes one bad spill to end it all. Very few people expected it to happen.

9:01 AM  
Blogger Giuseppe said...

I would evaluate in different way and I'm probably wrong.. If Avenue Capital returns 18% p.a., its average since launch you have 12bn x 2%= 240mm + 14$ (18%-risk free) x20%x12bn = 840mm = 1.080 bn. If we consider the salary and other expenses as 50% of revenues ( not so bad given that it implis 2 mm average per employee anda many are back office..) EBITDA is 540mm. Morgan Stanley is paying 19x EBITDA (2bn / 20% = 10bn / EBITDA = 19).
Now Avenue Capital has 20bn AUM

12:25 AM  

Post a Comment

Links to this post:

Create a Link

<< Home