My favorite investments are companies with lots of moving pieces that are hard to analyze. Whenever I come across the Berkshire Hathaway's (NYSE:BRK.B) of the world, I rub my hands with glee because I know they will be more involved than just crunching the numbers. Finding the gems within a holding company structure is half the fun, and nowhere is that more apparent than studying the inner workings of Compass Diversified Holdings (NYSE:CODI), a Connecticut-based small-cap holding company with interests in several different industries. I liked this company when I first came across it in 2010 when it was trading at $16.28, and I like it even better today with it trading around $12.60. Here's why.

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Moving Pieces

Compass defines itself as "an acquirer, owner and manager of high cash flow, niche leading middle market businesses operating in attractive industries." It currently owns eight businesses, down from nine after selling HALO, a promotional products company, for a total enterprise value of $76.5 million. Compass acquired the company in March 2007 for $62.5 million. A 22% return on its investment (not including accumulated earnings) over five years isn't spectacular, but it's more than adequate. It rightly suggested in its May 2 press release announcing the deal that it was putting the proceeds to better use. The remaining eight businesses generated $195.3 million in revenue and $16.3 million in operating income in the first quarter ended March 31. Of the eight businesses, its Fox mountain-bike and off-road suspension products' business generated the most revenue at $45.7 million while its CamelBak business is the most profitable at $7.1 million.

How It's Managed

Compass Diversified Holdings is managed by Compass Group Management LLC ("CGM"). Like any asset manager, CGM is paid an annual fee equal to 2% of CODI's adjusted net assets to manage the day-to-day operations of the business. In 2011, those fees amounted to $16.8 million and they are to be paid before any distributions to shareholders. In addition, CGM is entitled to profits from the sale of CODI subsidiaries. In October 2011, CODI sold its Staffmark employment agency for $295 million achieving an $88.6 million gain on the transaction. CGM earned $13.7 million or 15.5% of that gain. While it probably seems high, it's no different from what a hedge fund or private equity firm might charge. At the end of the day, CODI has no employees and although its CEO and CFO are employed by CGM, they report to CODI's board of directors. The operating expenses you see on its income statement are those of its consolidated businesses and not the company itself, which is a trust.

How Shareholders Win

CODI has paid out $7.80 a share in distributions since its initial public offering (IPO) in 2006. Its current quarterly distribution is 36 cents, yielding 11.1% as of May 16, 2012. Over the past five years, its stock's achieved an annual total return of 3.6%, 377 and 332 basis points higher than the S&P 500 and Russell 2000, respectively. CODI succeeds by first being careful not to overpay for its platform acquisitions. The businesses must be basic in nature serving some niche purpose that's not facing obsolescence. It then works with each company's management to grow revenues and make them more efficient. By doing so, it's able to significantly increase cash flow, which helps ensure it meets its distribution plan in the near term, and delivers realized gains in the future from the sale of each of the businesses. Of the original businesses owned at the time of its IPO in 2006, only Advanced Circuits is still around. Since 2006, it has sold five businesses for an approximate gain of $198 million. Like every successful fund, it's had its good calls and its bad ones. Long-term, the proof is in the pudding.

The Bottom Line

If you look at Compass Diversified Holdings' asset manager peers, whether it be larger businesses like Blackstone Group (NYSE:BX) and Oaktree Capital Management (NYSE:OAK) or smaller companies like Virtus Investment Partners (Nasdaq:VRTS), one thing is clear CODI is definitely the most undervalued of the bunch. At these prices, it's definitely worth owning.

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At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.

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