My older daughter turns sixteen next month. Most parents dread giving their children vehicular independence, but I managed to repress that instinct by concentrating on the more delightful prospect of adding a new car to the family fleet: a Fiat 500. The original 500 (or Quattrocento) came out in 1957, and Fiat sold almost 4 million of them before they discontinued the model in 1975. Since Fiat announced they were returning to the U.S. market and bringing the Italian equivalent of Britain’s Mini or Germany’s Beetle, I wanted one. While I couldn’t make the Quattrocento work for me, I thought the size (big enough for four adults but easy to park), powertrain (peppy but economical), and unique features (like a folding fabric roof) made it perfect for a new driver who appreciates cars like her dad.
Unfortunately, as my daughter’s sixteenth birthday approached, my fantasy of what she should drive had a head-on collision with reality. The Fiat’s small size is handy when you have to wedge your car down Italian city streets (I found one on vacation that was EXACTLY five inches wider than my rented Volvo wagon, with the side mirrors retracted), but not so pragmatic in our town, where every third vehicle is a giant SUV that probably wouldn’t even notice a collision with a 500. I think Fiat may have had the same realization, as their U.S. sales have been far lower than expected, and as a consequence has delayed the reintroduction of Alfa Romeo to the U.S. (a real tragedy). There are at least two lessons to be drawn from this: 1) sometimes bigger is unquestionably better, and 2) some ideas look a lot better on paper than in practice.
I was reflecting on both of these themes last week after word got out that Focus Financial Partners had started preparing documents to file an initial public offering. Because Focus has less than $1 billion in revenue, it can keep details of the offering private until three weeks before the offering, so unfortunately we don’t have an S-1 to review. The Company itself hasn’t said anything about filing.
Focus is another great idea, at least on paper, but has garnered success in a timeline littered with lots of bumps along the way. If they choose to go through with the public offering this time, their S-1 will be a treasure map of information about RIA consolidation, which is probably going to be as painful as it is inevitable.
We have so many questions about the Focus IPO, it’s hard to know where to start. For example:
Focus is a ten year old company that has been headed for IPO since day one. Part of their pitch to prospective RIA targets is enabling them to ride the rise in Focus’s valuation at the offering. Focus previously started the filing process for an IPO last summer. So, in one regard, this isn’t unexpected.
Further, Focus is backed by the VC/PE community, having picked up financing by Summit Partners in 2007 and Centerbridge Partners in 2013. Polaris is also still involved. The timing of those deals is noteworthy, because asset manager multiples were at peak levels in both 2007 and 2013 (so much for booking gains on the buy). We wonder if Centerbridge isn’t looking at the stakes Polaris and Summit have held – for longer than they wanted – and are seeking an exit while they can. We’ll probably never know why Focus didn’t go through with an offering last summer. Compared to a year ago, valuation multiples in the space aren’t any stronger, and the IPO market isn’t any more robust. One would think that Centerbridge, which has been in Focus for three years, would be getting impatient. However, if the stock market coughs and the IPO window closes, it could be some time before Focus is ready to go public again.
About the only two compelling reasons we can come up with for a Focus IPO today is 1) the SEC’s proposed rules on transition planning and 2) scale. With regard to the former, the Focus IPO narrative will undoubtedly feature that it appears the SEC is going to require RIAs to document some kind of ownership exit strategy. Focus is all over this issue, and has the capacity and expertise to offer a pre-packaged solution to this aspect of SEC compliance. As for the matter of scale, Focus may be big enough now to garner a better valuation…
Thinking about valuation may be a little premature, since we haven’t yet seen the S-1. Numbers on the order of $1 billion have been bandied about, but not whether that’s pre-money or post. Focus has plenty of debt and preferred stock (possibly north of $750 million), but since debt is cheap, one wonders if the company is in a hurry to pay it down. What we do know is that Focus currently has run rate revenue on the order of $400 million. If Focus is running an EBITDA margin between 25% and 35%, and the IPO prices at 9x to 12x EBITDA, Focus could deleverage and wind up with a balance sheet that looks a little more like a typical RIA, and/or get their VC and PE investors liquidity. The RIA managers who got stock by selling their shops to Focus will probably have to wait.
Some have suggested that Focus is pulling a stronger EBITDA margin than my range, and could command a higher multiple. We admittedly don’t know enough to comment at length on margin expectations, but the infrastructure necessary to manage a consortium of small to medium size wealth management firms, some of whom are owned outright and some of whom are partially owned, is expensive. As for the multiple, I think it comes down to whether or not the market is ready to accept this business model.
How is This Not a Roll-Up?
More than anything, the Focus IPO will cast some light on what the market really thinks of RIA aggregators. Focus management has been, and will likely remain, defiant that their company is not a roll-up firm – probably because they don’t want to be compared to National Financial Partners. But I just did, and so will the market. A more favorable comparison might be to Affiliated Managers Group, but AMG’s valuation has also struggled recently, and is down by almost a quarter over the past year.
That said, the notion of a national RIA focused on retail clients makes sense. What Focus and other firms like it are trying to assemble looks a lot like the retail side of the old wirehouse firms, absent all the conflicts of interest. But the RIA landscape may be fragmented for a reason, and re-assembling a diaspora of heterogeneous personalities and corporate cultures will undoubtedly prove challenging. I remember a client of mine in a different industry joining a roll-up in the mid-1990s, and being reassured that change would be “evolutionary, not revolutionary.”
That sounds attractive, and Focus has made best efforts to create a platform that allowed acquired RIAs to maintain their individual sense of identity. Trouble is that the RIA industry is highly, and increasingly, regulated. The need for compliance and training and comparable pricing and marketing efficiency will create a gravitational force that will pull the dozens of individual RIAs acquired by Focus toward some regimented similarity.
Nothing wrong with that; but it sounds a lot like a roll-up.