Now that Focus Financial is a public company, what issues will the company have to grapple with in the year ahead, and what questions will investors be asking?
In a post-IPO report, Crow notes Focus reported a net loss of nearly $37 million on $196 million in revenue in this year's first quarter. However, the company's management made adjustments that turned the quarterly loss into a net profit of almost $30 million and EBITDA of over $44 million.
While some nonrecurring expenses are to be expected when taking a company public, Crow highlights the company's decision to add back non-cash equity compensation and the change in fair value of contingent consideration made for acquisitions.
"From the perspective of shareholders, equity compensation is still a drain on earnings because it dilutes existing shareholders' claim on profitability," Crow writes.
If the supposedly extraordinary items are called into question, Focus' already lofty IPO valuation rises to "nosebleed levels," according to Crow.
Indeed, adding back the non-cash (but dilutive) equity compensation expense of $22.4 million, for example, would result in an "other-wordly" implied multiple of 75 on three-month annualized estimated earnings and a similar off-the-charts implied multiple of 32 for three-month annualized estimated EBITDA, Crow says.
Investors will be closely monitoring Focus' multiple of 16 times EBITDA to see how it affects the company's cost of capital, says Brent Brodeski, chief executive officer of Rockford, Ill.-based Savant Capital Management.
If extraordinary items are called into question, Focus' already lofty IPO valuation rises to "nosebleed levels," according to analyst Matt Crow.
"What will Focus’s cost of capital be going forward?" Brodeski asks. "And, will they still have an arbitrage opportunity to buy new firms at a valuation where such deals are accretive given their cost of capital?"
Since Focus is trading at a high multiple, they have a low implied cost of capital, which should make it easier to do accretive deals — that is, buying companies at a valuation that would give them a higher return than the return the market expects on their stock.
But high multiples cut both ways, and acquisition targets may want a similar multiple to Focus', analysts point out.
Nonetheless, Focus' high multiple is hardly unreasonable, says HighTower CEO Elliot Weissbluth.
"Business models such as Focus Financial’s, with reliable, recurring fee-generated revenues, are viewed as more valuable than transaction-based businesses that depend on commission sales," Weissbluth says. "A secular shift in the wealth management industry is underway as investors are drawn to fiduciary-based RIAs and away from the wirehouses."
Investors will also be looking at Focus' highly leveraged balance sheet, says Rush Benton, an RIA M&A pioneer who now senior director of strategic wealth for Captrust, one of the industry's leading RIA acquirers.
"How earnings hold up in a bear market will be closely watched," Benton says.
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The IPO price was lowered, but long-term performance is considered key.
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The aggregator has been buying aggressively since an infusion of private equity cash in April.
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The aggregator has filed with the SEC, and the aftermath of an offering will be closely watched.
May 29
Succession within Focus partner firms is also an issue that will impact earnings, Benton says.
"A key issue related to succession is that the second generation will continue to see a large percentage of earnings sent upstream to corporate in order to cover debt service, yet they received none of the sale proceeds," he explains. "In a personal service business, that can get old pretty quick. So keeping the second generation motivated will be a challenge."
The advancing age of the founders of RIA firms acquired by Focus was a "primary catalyst" in the deals, Benton adds.
"There is still a succession issue to be solved," he says. "Can a hands-off holding company really solve this as well as an integrated one-company firm can? It’s to be determined."
Mariner Wealth Advisors CEO Marty Bicknel, another veteran executive and longtime RIA acquirer, is sanguine about Focus' prospects — and the industry's.
"The firms they have assembled are very good firms," Bicknell says. "Organic growth is the key. At this point, growth through acquisitions has been enough, but I believe you need both. The firms have strong leaders and will figure it out. I am a believer three to four true national [independent] firms will surface. The Focus IPO is a great thing for our business."
