Brave New World of Wealth Management

Transcription

1 Brave New World of Wealth Management Presentation to: Insiders Forum by Mark Hurley September 17,

2 Current U.S. Wealth Management Industry Overview 2

3 How Did the WM Industry Get To Where It Is Today? Almost impossible to fail in late 80s and 90 s Sudden, unanticipated shift from Defined Benefit to Defined Contribution Created vacuum with no natural competitors Beginning of greatest sustained bull market in U.S. history Average annual asset appreciation 14% for ten years No competition w/ lots of young clients Glorified pie eating contest a little more challenging but still easy Upward trending market with two financial corrections Immense opportunity for organic growth Land grab limited by capacity constraints Key decision: reinvest/grow/evolve vs. harvest profits Three primary business models emerged Evolving businesses: Sustainable enterprises with enterprise value Books of Business: Jobs not businesses Tweeners: High profit proprietorships with some enterprise value 3

4 Five Forces Will Reshape Industry Over Next Decade #1 More competition for fewer new clients Pool of prospects w/o advisors growing slowly Spectrem: Still 600K fewer in 2011 vs. 2007; BCG: shrunk by 130K in 2012 Most notable exceptions Silicon Valley & specialty markets Many more large firms; $1B firms commonplace More sophisticated marketing; competition between fee-only firms #2 Average age of existing client bases increasing Gradual demographic shift Constant rate of client addition + long-term relationships Problematic to WM revenue growth in two ways: asset allocation & gross consumption Mirror image of industrys early days #3 Potentially extended period of low nominal returns on lower risk assets Recent Fed pronouncement De minimis Treasury returns lowers all lower risk asset nominal returns Client aging shifts greater percentage of assets in into lower risk asset classes Greater net capital consumption 4

5 Current Supply of Millionaire Households Still Smaller than in 2007 Source: Spectrem Consulting 5

6 Revenue Weighted Client Age Increases With Constant Absolute Growth Example firm has 300 clients and $5 million of annual revenue, with an average client age of 64 years. 6

7 Avg. Age Significantly Increases Over 10 Years Assumes example firm adds 15 new clients per year each paying initial fees of $15 thousand, new clients are evenly distributed between ages 50-60, and that client's assets are liquidated at age 90. 7

8 Five Forces Will Reshape Industry #4 Likely continued high relative rates of cost inflation Currently 5% to 7% on average Supply/demand imbalance for experienced, qualified professionals Russ Allen Prince: 22% of industry participants under 40 More expensive and adversarial regulatory environment Greater expenditures on marketing / differentiation Litigation risk now higher; higher legal costs for protection #5 Founders of wealth managers are getting old Average age late 50s to early 60s Equity in firms often most valuable asset Need to conduct their own financial planning 8

9 No More Easy Money In the Industry Very different future operating environment Individual changes each small; aggregate impact large Slower revenue growth + higher operating costs Will change the economics of every industry participant Degree of evolution as a business determines number of alternatives available More evolved firms will be better able to respond to forces Difficult for owners to fully grasp degree of coming change Kahneman & anchoring For most owners, reference point is last 20 years Consciously recognize change is coming but emotionally unable to accept Un-anchoring requires trajectory analysis Multi-factor models used to conduct multiple scenarios Integrate asset returns, cost structure, client demographics and capital consumption, etc. Quantify impact of choices and changes in variables on outcomes 9

10 Evolving Business Owner Dilemma Relative vs. absolute growth mindset $10M from $4M a decade ago Implies $16M in 10 years & not $25M How much is enough? 5% to 6% earnings growth per year doable; much greater very challenging Attracting & retaining top quality successor professionals Founder ambitions Current trajectory vs. 10 years ago 10% earnings growth vs. effectively flat High profit growth requires immense organic growth Law of large numbers / greater volume each year Growth Conundrum of large wealth managers 15x to 20x resource differential for new vs. established clients Effectively caps capacity for new clients Firm with 400 clients could add 200 established w/only small marginal cost Could not handle 100 new clients at once 10

11 Most Evolving Businesses Had Relatively Young Client Bases 10 Yrs Ago 11

12 Evolving Business WM Trajectory Over Last 10 Years Assumes firm had $4 million of revenue, $2 million of gross profitability, 5% annual low risk asset returns, 5% annual high risk asset returns, annual operating cost inflation of 9.5%, client turnover of 1%, and added 30 new clients per year each with an average initial fee of $15 thousand per annum. 12

13 Average Age Of Clients Has Somewhat Increased Over Time Presented by 13

14 Evolving Business Forward Looking Trajectory Assumes firm has $10 million of revenue, $5 million of gross profitability, 2% annual low risk asset returns, 9% annual high risk asset returns, annual operating cost inflation of 5%, client turnover of 2%, and adds 30 new clients per year each with an average initial fee of $15 thousand per annum. 14

15 Four Alternatives for Addressing Evolving Business Growth Conundrum #1 Slow rate of cost inflation / become more efficient Constant process improvement Cost accounting / time usage #2 Reallocate risk in firm compensation structure Employee outcomes more closely linked to profitability Larger variable components tied to margins Greater sharing of upside Broader ownership #3 Specialization Expertise in solving specific types of extremely complex, important problems Integral part of branding strategy More cost effective marketing & premium pricing #4 Acquisitions Acquire large block of established clients + professional staff Effectively front-end loading five to seven years of organic growth 15

16 Tweener Firm Strategy No Longer Sustainable To date has been brilliant Maximize profitability with minimum of reinvestment Small number of owners capture vast preponderance of economics Have built substantial personal wealth Forces place firms at a tipping point Alternatives available to Evolving Businesses are impractical for most Tweeners Already operate at very high margins Unable to change comp structure w/o altering business model Lack the professional staff to specialize Insufficient infrastructure to support acquisition Three alternatives available for Tweeners: #1 Take necessary steps (reinvestment, broader ownership, etc.) to become Evolving Business #2 Sell the firm #3 Devolve into Book of Business Second option (sell) is not indefinitely available Tied to both attractiveness and materiality of firm to prospective acquirers Both dissipate over time 16

17 Slow Growing Tweener Firm Current Client Profile 17

18 Slow Growing Tweener Firm Client Profile In Five Years 18

19 Slow Growing Tweener Firm Trajectory Assumes firm has $5 million of revenue, $3 million of gross profitability, 2% annual low risk asset returns, 9% annual high risk asset returns, annual operating cost inflation of 7%, client turnover of 3%, and adds 5 new clients per year each with an average initial fee of $15 thousand per annum. 19

20 Books of Businesses Have Limited Options to Address Forces Relatively small firms with limited resources Largely unsustainable proprietorships Already growing very slowly Costs will continue to climb Limited capability to reinvest Owners will likely will work harder for much less money over time Pediatricians of the wealth management industry Will continue in business indefinitely Remuneration will decline in parallel to the increase in the average age of client base De minimis enterprise value potential consideration similar to a referral fee 20

21 FNs Prognostication on Future Shape of the Industry Next ten years will be very different than the industrys first two decades More competition for clients and employees Older clients, less robust asset returns, greater complexity No more easy money but still great opportunity Demand for service unabated Strategy + competent business management will provide competitive advantages Owner demographics will create acquisition opportunities Will result in increased concentration not consolidation 25 to 50 very big ($75M to $150M revenue) Evolving Business wealth managers 125 other Evolving Businesses; larger and more specialized Thousands of Books of Business Most Tweeners will become Books of Business 30 to 50 will become Evolving Businesses 100 to 125 will be acquired 90%+ will devolve into Books of Business 21

22 Future Shape of the Industry Forecast 22

23 Current Market Pricing for Material Wealth Manager M&A Transactions Neither a Buyers or a Sellers market Multiple prospective bidders Evolving businesses; roll-ups Typically only one or two both with the money and culturally attractive Best potential buyers are geographically proximate wealth managers Ability to strip out cost & maximize contribution Need for local successor professionals Efficient Market pricing Confluence of debt and private equity markets vs. cash flow Balance point: acquirer pays full price & still captures sufficient risk-adjusted profitability Locked market Robust upfront consideration Sticker shock Assumption of risk Focus on resulting risk adjusted incremental profitability 23

24 Example Transaction Assumptions General characteristics of seller Fee-only and all revenues from asset-based WM advisory services Attractive client demographics (i.e., revenue weighted avg. age < 64) Non-concentrated client base (i.e. no single client >4% of rev; top 10 <15%; top 30 <25%) Stable & transferrable relationships mostly with individual clients At least four capable & experienced successor professionals As a group have robust relationships with all of the firm s clients Seller financials $4.7M of annual revenue $2.6M of gross profitability $2M EBITDA Buyer profile Evolving business $5M of annual revenue w/ $2.2M of gross profitability Geographically proximate Able to achieve 70% contribution margin from cost savings Highly confident of 98%+ client retention 24

25 Example Current Market Transaction Pricing $10M $5M Up to $10M; tied to growth Closing Payment Year 2-4 Retention Payments Year 5 Earnout 25

26 Acquirer Cash Flow Outcomes With No Organic Growth Total Incremental Cash Flow Over First Five Years $19M Ongoing Incremental Cash Flow In Year Six¹ $4.2M ¹Assumes seller assets 5% w/ 5% incremental cost growth 26