FOCS - Focus Financial

[walkie518]

Focus Financial looks pretty interesting here.

 

The stock came out the gate around $33/sh and is now trading at $21/sh. 

 

I understand the negativity to be surrounding higher leverage ratios than previously expected.  Market started selling on this news as mgmt provided some insight into revenues. 

 

I also believe the stock was wrongly bucketed as a "financial," and the pain in that sector is weighing down FOCS. 

 

That said, 70% of revenues are market based (think fee on AUM)

 

The 70% is billed a quarter in advance... in this way, fees are paid on the previous qtr performance (or lack thereof).

 

My sense is the market doesn't appreciate how limited risk might be in this scenario, and while mgmt tried to provide guidance, I don't think they fleshed it out in full on the last call.

 

I make 4 points:

 

First, not every RIA is going to have clients 100% in stocks.  It's likely that a 20% decline in say the S&P won't become a 20% decline in AUM, but it seems the market trades as such.

 

Consequently, I believe the 20% illustration was the drop in AUM during the financial crisis on a diversified basis. 

 

Second, if a client loses money, Focus doesn't lose money.  The downside is that Focus makes less money.  I thinkt this only jeopardizes Focus when it comes to its interest coverage and if Focus loses its client-base, which is much stickier than ppl realize given the inertia of high-net-worth and ultra-high-net-worth clients. 

 

Third, the secular trend is moving away from the big brokerages. 

 

Fourth, Focus is in a highly fragmented market.  The rate of tuck-ins do not need to stop if the currency to acquire is there.  30% growth y/y is where we're starting at the end of 1H2019. 

 

The obvious problem I see is that if the stock price falls, it's harder to do a deal in stock...

 

And this might be one of the bigger risks? 

 

I get the feeling that mgmt doesn't care much about the short-term movement of the stock.  Sure, I appreciate long-term vision, but disregard of partners can lead to lawsuits and distraction.

 

That the market hates the stock can't help the consolidation effort.  You don't see this w/TDG over time...

 

At the same time, it's clear that mgmt cares about building the business.  And in time, interests should align?  Not a reason to own something this inexpensive given its cash flow profile?

 

Anything else I'm missing?

[Broeb22]

Your point about FOCS not losing money even if it’s clients lose money ignores the high operating leverage of the asset management business. If you start out with $100 of revenue on 10,000 in AUM and have $70 of expenses, you have operating profits of $30. If your AUM declines 20%, revenue declines to $80, while your expenses remain mostly fixed. Maybe you stop paying for some research you didn’t really need and maybe you let a relationship mgr. go who was underperforming anyways, but absent any of those changes, you’re looking at a 66% decline in operating profit on a 20% decline in revenue.

 

There’s plenty of people on here who have run Asset mgmt. businesses. What happens to your financials when you lose clients?

[walkie518]

Your point about FOCS not losing money even if it’s clients lose money ignores the high operating leverage of the asset management business. If you start out with $100 of revenue on 10,000 in AUM and have $70 of expenses, you have operating profits of $30. If your AUM declines 20%, revenue declines to $80, while your expenses remain mostly fixed. Maybe you stop paying for some research you didn’t really need and maybe you let a relationship mgr. go who was underperforming anyways, but absent any of those changes, you’re looking at a 66% decline in operating profit on a 20% decline in revenue.

 

There’s plenty of people on here who have run Asset mgmt. businesses. What happens to your financials when you lose clients?

yes, there are levers to pull and a recession will hurt any/the business

 

in response though, I would say that even though the company only recently came public, they operated in the financial recession

 

what mgmt learned was that b/c the RIAs aren't catering to retail investors and tend to have different relationships to clients than say a hedge fund manager might, the dynamic in the downturn was favorable

 

also, the partner firms keep skin in the game where AUM fees are sold while the new partner retains carry to cover costs ... certainly, deals will look different depending on who does the deals within Focus, but this should not be overlooked either since some admin gets consolidated but not all of the costs are Focus'

 

and the numbers you note also assume not net growth of AUM in face of a market decline ... if hnw and uhnw RIAs continue to partner w/focus, the figures on the downside can change pretty quickly

 

so yes there is a fair amount of leverage, but what is the probable downside risk if the equity markets decline 20%? 

 

I think Focus loses 14% on a 20% portfolio decline not a 20% market decline...

[Broeb22]

You may be correct that FOCS AUM will decline only 14% in a market decline vs an equity market decline.

 

What matters to investors in FOCS stock is how much their income will decline, which is the example I was showing. The low valuation relative to earnings may reflect some bearishness on the part of investors with how much this business will earn with current leverage and significantly reduced earnings in a downturn.

[walkie518]

You may be correct that FOCS AUM will decline only 14% in a market decline vs an equity market decline.

 

What matters to investors in FOCS stock is how much their income will decline, which is the example I was showing. The low valuation relative to earnings may reflect some bearishness on the part of investors with how much this business will earn with current leverage and significantly reduced earnings in a downturn.

agreed

 

mgmt also noted that they will be on the higher end of the proposed leverage range

 

this speaks to pace of deal activity as much as the risk that mgmt perceives in the markets in which it participates

 

I tend to believe that b/c of how there aren't many (if any?) companies like Focus that are out there, the model is thought of akin to that of any other money mgmt business, which I think is the opportunity in the trade

 

also, I believe that at current pricing, private equity sponsors will start squeezing since the market is trading pretty close to what I believe is cost of entry in private markets

 

moreover, those who brought FOCS public are solid and understand the underwriting risk they took upon investing

 

maybe they botched the IPO, maybe mgmt is too aggressive with its strategy ... but what's interesting is that the lenders, who have material inside information regarding business activities well beyond the filings and immediate access to mgmt, just increased the size of the term loan FOCS can use to acquire other RIAs, while the public market simply doesn't like more debt...

 

a $100 problem is your problem, but a $650m problem is the bank's ;)

[wolverine890]

I am in the RIA/independent FA aggregation business and I am not too impressed with FF anymore. These guys were the talk of the industry for a while.

Their business model was:

 

1) offer a lot of cash to a bunch of RIAs, getting them a higher buyout price then if they were to sell to Joe Shmoe jr. adviser. I believe the deal was something like: 1x revenue upfront and 1x revenue worth of stock then a 50% payout but the RIA doesn’t own their book anymore. If you are an RIA that takes in $1M of revenue per year. FF would pay you $1M to join up with them, $1M worth of restricted stock and $500k/year in compensation.

 

2) Try to unload the upside to the public equity markets and sell the company for more than 2x revenue. Then partners are better off (they are currently at 1.5ish last year’s revenue).

 

3) Take on a good bit of debt along the way because free cash flow doesn’t pay for it. But if our public offering goes well then it will be worth it.

 

I would not be surprised if there is a 1-2 year lead time for their 70 person acquisition team to acquire new RIAs. If this is true, the continued revenue growth is from what was already in their pipeline. Therefore, my guess is you would see this growth rate fall off starting towards the middle or end of next year.

 

I would echo what Broeb said, these guys have a lot of fixed expenses. Yes, they made it through 2008/2009 but they hadn't gone public yet. they still had the carrot of an IPO they were offering RIAs. I can't emphasize enough that I believe that was their business model and I am not sure it worked. Additionally, they now have a 70+ person acquisition team that I would guess has compensation tied to on-boarding new RIAs. Therefore, there is a good chance they haven't paid for the additional growth yet.

 

Sorry if this was convoluted. My TLDR would be, these guys ejaculated once they touched Mrs. Market's boob and now, she is not satisfied. Their refractory period better be quick or it’s not going to end well.

 

If you want an example of who is doing a great job, at least on paper, look up Stratos wealth partners, and check out Michael Kites podcast.

[chrispy]

FWIW Chuck Akres fund had owned high single digits of FOCS since IPO and this past quarter sold the entire position

[walkie518]

I am in the RIA/independent FA aggregation business and I am not too impressed with FF anymore. These guys were the talk of the industry for a while.

Their business model was:

 

1) offer a lot of cash to a bunch of RIAs, getting them a higher buyout price then if they were to sell to Joe Shmoe jr. adviser. I believe the deal was something like: 1x revenue upfront and 1x revenue worth of stock then a 50% payout but the RIA doesn’t own their book anymore. If you are an RIA that takes in $1M of revenue per year. FF would pay you $1M to join up with them, $1M worth of restricted stock and $500k/year in compensation.

 

2) Try to unload the upside to the public equity markets and sell the company for more than 2x revenue. Then partners are better off (they are currently at 1.5ish last year’s revenue).

 

3) Take on a good bit of debt along the way because free cash flow doesn’t pay for it. But if our public offering goes well then it will be worth it.

 

I would not be surprised if there is a 1-2 year lead time for their 70 person acquisition team to acquire new RIAs. If this is true, the continued revenue growth is from what was already in their pipeline. Therefore, my guess is you would see this growth rate fall off starting towards the middle or end of next year.

 

I would echo what Broeb said, these guys have a lot of fixed expenses. Yes, they made it through 2008/2009 but they hadn't gone public yet. they still had the carrot of an IPO they were offering RIAs. I can't emphasize enough that I believe that was their business model and I am not sure it worked. Additionally, they now have a 70+ person acquisition team that I would guess has compensation tied to on-boarding new RIAs. Therefore, there is a good chance they haven't paid for the additional growth yet.

 

Sorry if this was convoluted. My TLDR would be, these guys ejaculated once they touched Mrs. Market's boob and now, she is not satisfied. Their refractory period better be quick or it’s not going to end well.

 

If you want an example of who is doing a great job, at least on paper, look up Stratos wealth partners, and check out Michael Kites podcast.

 

funds raised from the ipo didn't go to private equity LPs who own the bulk of the business (KKR / Stone Point) ... the money went to build the business

 

are you implying that they've destroyed value by partnering at too high of a price?  ie, the partnering RIAs were overpaid and FF didn't know what they got for the money?

 

deals are still getting done, are you implying that the growth ends end of next year based on loss of currency/mcap?

 

my guess is the moment the deals stop, the profile of fixed costs look better from continued rationalization?

 

[wolverine890]

 

funds raised from the ipo didn't go to private equity LPs who own the bulk of the business (KKR / Stone Point) ... the money went to build the business

 

are you implying that they've destroyed value by partnering at too high of a price?  ie, the partnering RIAs were overpaid and FF didn't know what they got for the money?

 

deals are still getting done, are you implying that the growth ends end of next year based on loss of currency/mcap?

 

my guess is the moment the deals stop, the profile of fixed costs look better from continued rationalization?

 

 

I might be wrong but i thought the common understanding in the industry was when focus financial acquired an RIA they did so with a equity, cash and salary deal. Are you saying this is wrong?

 

When mentioned the IPO i was talking about the value that unlocked for RIAs not KKR or stone point.

 

I, personally, would not pay 2x cash/equity upfront for a financial advisory book, not to mention keeping the partners on at a 50% production payout. Have they destroyed value... very difficult question to answer given that they have only been public for about a year (their value proposition to RIAs IMO, was the large upfront payout). My guess is that they have transferred value from equity holders to the RIA partners more than destroyed value.

 

My other thesis would be, in order for something like this to work the consolidator would need to create value for the end customer (the FA's client). I don't see evidence of this value creation at this time.

 

Of course deals are still getting done. It takes forever to go from the initial conversation with an RIA to closing the deal. Then you need to on board the RIA... its a very slow process. i would assume, given their numbers, that one person from the acquisition team closes one RIA per year? Each of those sales people have been working these relationships for years, i would guess.  It will be really interesting to me what happens to the company if their, as you said currency, stays depressed. I mean one interesting strategy would be buy long dated options on them. If i am right they shouldn't last too long. if i am wrong, they are undervalued. i don't see an in-between.

 

On your last point i am not sure. this would be a question of how management pivots when the first phase of their business plan stops. You could be right. they could cut their acquisition team and try to add value with the cards they already have. But they could also overpay even more to make it look like deals are still happening.

 

 

 

[chrispy]

https://riabiz.com/a/2019/9/2/focus-financial-files-a-shelf-registration-as-debt-swells-above-critical-4x-level-then-its-shares-dropped-to-new-low-in-after-hours

[walkie518]

 

funds raised from the ipo didn't go to private equity LPs who own the bulk of the business (KKR / Stone Point) ... the money went to build the business

 

are you implying that they've destroyed value by partnering at too high of a price?  ie, the partnering RIAs were overpaid and FF didn't know what they got for the money?

 

deals are still getting done, are you implying that the growth ends end of next year based on loss of currency/mcap?

 

my guess is the moment the deals stop, the profile of fixed costs look better from continued rationalization?

 

 

I might be wrong but i thought the common understanding in the industry was when focus financial acquired an RIA they did so with a equity, cash and salary deal. Are you saying this is wrong?

 

When mentioned the IPO i was talking about the value that unlocked for RIAs not KKR or stone point.

 

I, personally, would not pay 2x cash/equity upfront for a financial advisory book, not to mention keeping the partners on at a 50% production payout. Have they destroyed value... very difficult question to answer given that they have only been public for about a year (their value proposition to RIAs IMO, was the large upfront payout). My guess is that they have transferred value from equity holders to the RIA partners more than destroyed value.

 

My other thesis would be, in order for something like this to work the consolidator would need to create value for the end customer (the FA's client). I don't see evidence of this value creation at this time.

 

Of course deals are still getting done. It takes forever to go from the initial conversation with an RIA to closing the deal. Then you need to on board the RIA... its a very slow process. i would assume, given their numbers, that one person from the acquisition team closes one RIA per year? Each of those sales people have been working these relationships for years, i would guess.  It will be really interesting to me what happens to the company if their, as you said currency, stays depressed. I mean one interesting strategy would be buy long dated options on them. If i am right they shouldn't last too long. if i am wrong, they are undervalued. i don't see an in-between.

 

On your last point i am not sure. this would be a question of how management pivots when the first phase of their business plan stops. You could be right. they could cut their acquisition team and try to add value with the cards they already have. But they could also overpay even more to make it look like deals are still happening.

the shelf registration is not good but provides mgmt some room should shares appreciate

 

I don't think FOCS will sell shares at current prices... this would be a sign that mgmt recognizes it has destroyed partner and shareholder value

 

the market doesn't like leverage, but rates are going down, not up, as far as I can tell

 

this should favor a consolidator since they buy until they run out of capital then begin the deleveraging process, which might be prescient to add leverage as rates fall (now) and delever when rates rise (some time in the future)

 

I think RIAs create value for clients by being 3rd parties ... they also create value for clients by not losing money.  I don't see droves of UHNW and HNW clients leaving the partner firms? would there be a way to tell?

 

rather than act, I think waiting to see what next Q looks like might be the best move, but if they have a good quarter, I think the stock is pretty cheap here