After nearly a decade, Focus Financial Partners’ long-awaited is initial public offering (IPO) is finally coming to market.
A reading of its S-1 filing by several people reveals some very interesting characteristics about the financial realities of one of the advisory world’s leading aggregators. Of particular significance is the use of a new financial metric, "adjusted" EBITDA (Earnings Before Interest And Tax Plus Depreciation And Amortization). In the filing, the company clearly acknowledges that the concept, which adds back certain non-cash charges into cash flow, is not recognized under traditional GAAP accounting methods.
Other aggregators are keenly rooting for the Focus IPO to be a success. Financial Engines and Edelman Financial Services just merged and went private at 19 times traditional EBITDA so private equity investors are clearly willing to pay up for certain RIA companies. If public investors, a different breed, line up to buy Focus shares and the firm performs well financially in its first year as a public company, other aggregators like United Capital and HighTower would feel compelled to at least consider their own IPOs.
But a look at the financial results Focus has posted to date raise several questions at the very least.
Organic Growth
IPO investors typically base their decisions on how they think a company will perform going forward. The recent past is often seen as a good predictive indicator of the future until it isn't.
One interesing piece of information about the Focus filing is its organic revenue growth. Rivals at various other aggregators have long argued that the Focus model, in which it purchases equity stakes of 40 percent to 60 percent in the acquired firms, generates little incentives for the advisors to grow their business after they’ve cashed out most of their equity.
Data from the S-1 filing appear to support that conclusion. One part of the filing says that organic revenue growth in 2017 was 13.4 percent, but that includes growth related to acquisitions of other firms and customer relationships by partner firms and mergers among Focus firms.
Total revenues at its existing firms, not those acquired, is closer to 8.3 percent in 2017 from about $485 million in 2016, according to one expert who tried to strip some of the above-mentioned factors. Revenues in 2017 were $663 million for Focus, but the lion’s share of growth came from acquisitions.
It’s worth remembering that 2017 was a year when the S&P 500 was up more than 19 percent. Furthermore, the U.S. benchmark underperformed most other global equity indexes, so a globally diversified portfolio could have even bested the S&P. Even assuming Focus advisors had older clients with larger fixed-income allocations than most RIA firms, the numbers would appear to indicate that, on average, Focus firms are shrinking, or at least not growing significantly.
There are several possible explanations. Firms affiliated with Focus could have an older client base and these clients could be consuming their capital. Or they could simply be losing more clients than they are onboarding.