Description

Summary Thesis:

• Victory Capital is a cheap, misunderstood asset manager worth 50%-100% higher than its current price upon a normalized re-rating
• Re-rating should occur as investors appreciate the reduced leverage in the business, a return to organic growth inflows and Victory’s position as a benefit of the shift from “growth to value”
• Victory has a proven track record of value-added M&A that could add even higher upside than the core re-rating thesis
• Victory’s valuation is attractive and misunderstood and management / board is competent and incentivized
• At a normalized valuation of 10x earnings of roughly $4 per share yields a $40 stock = 56% upside

Raf698 wrote up a good long pitch on Victory back in 2019 with an excellent background and information on the USAA acquisition.  The stock has done well since, but still remains mispriced, with improved leverage and scale today. 

Victory Capital is a cheap, misunderstood asset manager worth 50%-100% higher than its current price upon a normalized re-rating

Despite some recent multiple expansion from activist involvement (Trian in Janus Henderson and Invesco) and some M&A (MS buying EV, Macquarie buying WDR), asset managers are still priced rather modestly, with Victory being cheaper than nearly all the others. 

Traditional asset managers are actually a better business than most people think because they are extremely “sticky” assets with steady, recurring, high-margin fee streams, even as the shift from active to passive management and to alternative assets continues.  Once you are tucked into someone’s 401k, it is extremely rare to get kicked out and assets generally go up over time. 

Among public asset managers, valuations range widely but a premium is placed on organic asset inflows (TROW, AB, EV, CNS), then capital returns (APAM and AB pay out most of their earnings as dividends, AB contractually as an MLP) and then various other reasons (SOTP “value” unlock from asset sales at BSIG, perceived ETF M&A target value at WETF, actual good M&A execution at VRTS, etc). 

We think VCTR is the cheapest and most attractive peer:

Re-rating should occur as investors appreciate the reduced leverage in the business, a return to organic growth inflows and Victory’s position as a benefit of the shift from “growth to value”

As we show above, VCTR is far cheaper than its peers.  We won’t argue that it deserves a mid-teens multiple like TROW, but we would argue that it deserves at least as high a multiple as AMG, BEN, JHG and others that are worse positioned.  We think that a re-rating can occur as VCTR:  a) reduces leverage, b) returns to organic growth and c) its exposure to “value” is better appreciated.

For several reasons, VCTR asset flows deteriorated in 2020, including a) the obvious stock market crash from the COVID pandemic and b) some friction with its USAA acquisition and the acquisition of the USAA wealth management business by Charles Schwab at the same time.  We believe that now that the COVID pandemic has largely passed and assets are flowing back into equities, the first headwind has been removed.  Also, since both USAA acquisitions have now largely been integrated and the confusion among customers settled, the second headwind will also abate this year. 

Lastly, Victory has among the highest exposure to the so-called “value” factor amid a potential shift from “growth” to “value” (terms I personally dislike, but one that many asset allocators and financial advisors adhere to).  See BAML notes below

Victory has a proven track record of value-added M&A that could add even higher upside than the core re-rating thesis

I think it is safe to say that most (but not all) asset manager M&A has been disappointing.  While there are some extremely good deals (Blackrock buying Barclays Global Investors before passive/ETF took off), many of the other traditional deals have failed to live up to expectations.  Victory’s acquisition of USAA, however, was as good as promised.  We believe that this deal, along with management’s prior deals while it was private since its management-buyout from KeyBank and subsequent smaller deals, highlights management’s ability to do value-added M&A:

As shown above, unlike Franklin Resources acquisition of Legg Mason, Invesco’s purchase of Oppenheimer or the merger of Janus/Henderson, the USAA deal’s financial accretion was even better than expected.  While the stock has done well, it still remains mispriced in our view.  In addition to the re-rating potential again, management may be able to pull off another good deal now that the company’s leverage has been reduced to a similar level (1.8x) as it was before they did the USAA deal (1.6x). 

Management has also been able to do smaller tuck-in acquisitions at either very reasonable, or even zero-consideration, such as its recent THB acquisition that brought in $435 million of small cap value assets at no consideration. 

Victory’s valuation is attractive and misunderstood and management / board is competent and incentivized

Before Victory bought USAA, it was valued by some sell-side analysts at 10x earnings due to its modest leverage (1.6x as stated) and mixed asset flows.  Now, even though the company has double the scale, the same leverage and similar inflows/outflows, the same analysts use half the multiple to anchor to the current stock price (see below for BAML notes)

In addition, there is a robust M&A market right now for asset managers and we believe those private market multiples justify substantially higher values for Victory.  For example, in the merger proxy for Waddell & Reed (which as we noted above had the single worse outflow track record of the publicly traded asset managers), JP Morgan’s valuation analysis used EBITDA multiples of 5x-9x for public comps and 7x-11x for private comps.  Using these ranges, we can get a value for Victory from $19 per share to $53 per share:

WDR Merger Proxy:  https://www.sec.gov/Archives/edgar/data/1052100/000110465921024645/tm213694-3_defm14a.htm

At the meeting of the Board on December 2, 2020, J.P. Morgan rendered its oral opinion to the Board

Based on the results of this analysis, J.P. Morgan selected multiple reference ranges of 5.0x to 9.0x for Waddell & Reed’s asset management business 

Based on the results of this analysis, J.P. Morgan selected multiple reference ranges of 7.0x to 11.0x for Waddell & Reed’s asset management business 

There are a few interesting things to note:

1. The valuation analysis done by JP Morgan was as of Dec 2, 2020 – and public multiples have expanded a decent amount since
2. We believe that the low end of the public comps (5x) was Victory Capital itself – so if you remove Victory to compare it to the remaining peers, you would argue for a higher multiple
3. We believe that the low end of the private transaction comparables (7x) was the USAA/Victory acquisition – so similarly, you could argue that the right private multiple should be higher

Going back to Raf698’s write-up of Victory from 2019, we believe the merits of the investment are still valid, and perhaps more so due the reduction in leverage:

Why is it still cheap?  I believe that the market today is rewarding simplification, asset sales (BSIG), capital returns (APAM, AB) and inflows (CNS).  VCTR could decide to pay out 100% of earnings as a dividend and I think the stock would double, but they think they can add more value by doing M&A.  Overall, for the reasons mentioned above, I think the company deserves a higher multiple.

At a normalized valuation of 10x earnings of roughly $4 per share yields a $40 stock = 56% upside

Risks: 

Bad M&A:  while I think this risk is limited, it is conceivable that management does a bad deal.  Management announced, but did not close, a transaction with a volatility hedge fund called Harvest that blew up during Volmageddon in 2020. 

Liquidity: the stock is not liquid as the original sponsors (Crestview and Reverence) own a large portion of the Class B shares.  We believe that an orderly decrease of the sponsors’ stake could actually be a positive, as some analysts think that the liquidity of the stock is the only real issue:

Barclays 2019 note: 

Quality of Earnings:  there are a couple of points on the company’s use of adjusted EPS which require comments.  Some are valid, one is not. 

1. The company adds back stock based comp, which I think is not appropriate for any company, but certainly not a traditional asset management.  This is around 15c of EPS
2. Intangible amortization tax benefits:  these are real cash flow benefits, but investors can quibble whether they should be capitalized or accounted for in some sort of NPV analysis instead.  This is around 37c of EPS and stretches out to 2030 (see image at bottom)
3. Contingent consideration / USAA earnout:  as part of the USAA acquisition, the company owes an earnout based on a revenue retention formula (see image at bottom).  The company excludes the change in the contingent consideration in adjusted EPS to the tune of 15c in EPS.  You could argue that this should be included.  I’m fine with that

Net-net:  whether you want to ding the company 15c here or there, I don’t think it changes the thesis much as the multiple goes from 5.8x earnings to 6.2x

Appendix:

Victory Capital Holdings Downgrade by Bank of America / Merrill Lynch Using 5x Multiple “Despite Best Positioned for Shift to Value”

2 year ago – the analyst used a 10x Multiple on Victory despite similar balance sheet, smaller scale and similar asset inflows/outflows

Tax benefits included in adjusted EPS

USAA Earnout

Disclaimer:  I or my firm’s clients may have a position (long or short) in the securities discussed herein and may change such position without further notice.  This is not a recommendation to buy or sell any security

Catalyst

Further accretive M&A

Increased stock liquidity

Debt reduction