Description

Victory Capital Holdings (ticker: VCTR) is an investment management firm operating a multi-boutique model that is in the process of acquiring the $80B USAA asset management business, a move that will more than double VCTR’s current AUM of $61B. Modeling for cost saves and synergies of $110M within a year of closing, in combination with significant debt refinancing at a pro-forma Debt/EBITDA ratio of 2.9x, suggests a 2020e P/E of 4.6x.

While the recent run-up in the stock reflects both the strong YTD performance of equity markets and the increasing recognition of the attractiveness of the USAA deal, details regarding the margin improvement and the strong cash flows suggest that VCTR has established itself as a force to be reckoned with as industry consolidation continues over the coming decade.

The USAA acquisition is on track to close effective July 1, 2019. Prior to the acquisition, Victory Capital had a diverse client base, composed of 56% Institutional and 44% Retail. U.S. small and mid-cap equities made up 63% of the asset class mix. 75% of AUM has outperformed its benchmark over three and five-year periods, and 90% over a ten-year period.

The USAA Management Company acquisition will change this mix, as USAA is 34% fixed income and 27% solutions. Pro forma, the asset class mix going forward looks like this:

• 38% Domestic Equity  

• 25% Fixed Income

• 19% Solutions (which includes Target Date, Target Risk, Rules Based and Active ETF’s)

• 10% Global / Non-US Equity

• 8% Money Market

The acquisition also brings with it a unique direct member distribution channel, with 13.5 million USAA members, with 1.5 million members owning a USAA investment product. This loyal client base produces high retention rates, with 82% greater than 5 years and 24% of members with mutual funds having automatic investment plans.

VCTR has issued the following annualized pro forma guidance:

• AUM on 3/31/19:                 $138B

• Revenue:                              $856M

• Avg. Fee Rate (bps):             62 bps

• Adjusted EBITDA:                 $394M (~46%)

• Debt / EBITDA:                     2.9x (~$1.14B)

This represents a marked improved in margins, as adjusted EBITDA margins for the various divisions on a segregated pre-synergies basis were 39% for Victory Capital, 28% for USAA, and 35% for Managed Money.

In Q1, VCTR did repurchase a modest amount of shares (123k) at an average price of $10.93 per share, bringing the current share repurchase to 979k shares at an average price of $9.59 per share. There are 72.3M diluted shares outstanding.

VCTR’s origins go back to 1894 and up until 2013 the firm was the investment management division of KeyCorp. At that point, AUM was $17.9B and VCTR employees along with Crestview Capital conducted a management buyout for a total consideration of $246M. The company IPO’d in February, 2018 at $13.00.

Between the time of the MBO and the pending USAA acquisition, VCTR acquired Munder Capital in 10/2014 ($18.1B AUM) and RS Investments from Guardian Life Ins Co in 7/2016 ($16.7B AUM). The USAA acquisition was in fact the second announced acquisition in Q4 last year, with the first being Harvest Volatility Management—a deal which VCTR pulled out of due to deteriorating AUM at Harvest. The steady pace of AUM accumulation along with the protective covenants that allowed VCTR to withdraw from the Harvest deal demonstrates 214VCTR’s appetite for and successful execution of accretive acquisitions.

Victory’s multi boutique model, with currently nine franchises, allows for individualized franchise branding and investment management approaches. By AUM, the most prominent of these franchises are Sycamore Capital ($17.9B AUM), RS Investments ($9.2B AUM) and INCORE Capital Management ($7.4B AUM). Meanwhile, the firm’s sales professionals and centralized support and trading functions serve all the franchises in addition to the Solutions (rules-based) platform.

The USAA acquisition not only represents VCTR’s tenth investment franchise, but it also dramatically increases the firm’s capabilities to onboard additional franchises who don’t have VCTR’s distribution capabilities. The USAA platform and brand loyalty opens up a whole new path for them. VCTR is likely to find suitable and highly accretive acquisitions as consolidation drives the fund management industry, and this has made them that much more attractive to funds seeking a robust partner platform.

A note about debt levels. Clearly, asset managers with significant debt levels face exposure as markets sell-off and AUM decreases. As a result, these managers trade at a discount to their less leveraged peers. Post-IPO, VCTR delevered from 2x down to 1.5x over the course of the year. With the USAA deal bumping leverage up to 2.9x, it is understandable that Victory will go through a deleveraging period before its next series of acquisitions, although their intention is to “use the cash to delever very quickly post the USAA deal”. As the company several weeks ago during its earnings call:

Our projected debt-to-EBITDA run rate after the close is now expected to be 2.9x. Post close, we will be generating substantial free cash flow, and our primary use of this cash will be to delever the balance sheet to give us full flexibility as we continue to pursue shareholder accretive acquisitions. We continuously monitor our capital structure and regularly consider all tools at our disposal for returning capital to shareholders, including share repurchases and potentially initiating a cash dividend at some point in the future, should it make sense.

According to a JPM report, Victory has a track record of cost saves, with VCTR removing 37% of costs from Munder (EBITDA margins went from 45% to 66%) and 48% of costs from RS (margin improvement from 19% to 58%). Victory’s acquired franchises have also demonstrated significant growth, with Sycamore (2013) and RS (7/2016) growth showing 35% CAGR, while the CEMP ETF business has had 141% CAGR (4/2015). While VCTR has had some setbacks, it has led the company to further develop its focus on franchises it feels it can successfully market and for which there exists suitable demand, such as in small and mid-cap strategies.

The acquisition of the USAA distribution channel should open up intriguing possibilities for a firm that has already developed significant sales and product mix success. It should also make them a more attractive destination for asset managers looking to sell to a consolidator. While VCTR utilizes a 100% owned model, it does have a significant revenue sharing incentive structure that creates significant alignment with the managers of its various franchises.

One further thing the recent deals signify is that Victory is an astute acquirer. Not only was the USAA deal greater than 100% accretive, but the purchase price is a bit better than the originally guided 3.8x EBITDA post synergies. On the other end of the spectrum, Victory terminated its planned acquisition of Harvest Volatility Management due to VCTR’s wise inclusion of a termination clause in the purchase agreement protecting against AUM declines.

Going forward, of course, VCTR’s performance is going to have significant correlation at times with the overall market. In addition, management has to be trusted, as public shareholders have less than 3% voting power due to employee/directors, Crestview GP and Reverence Capital having 97% voting interest through its Class B shares.  Plus, there is always the question of what if any overhang Crestview’s 67% ownership of the Class B shares represents.

Layering all of that together, VCTR’s ability to make such a dramatic acquisition as the USAA fund business and the company’s establishment as a force to be reckoned with during industry consolidation, suggests that this is an investment that can be increased opportunistically amidst market volatility and the general cycle of interest and disinterest that accompanies any small cap stock. At a forward P/E of 4.6x, even those opportunities might prove relatively rare.

Catalyst

Increasing recognition of VRTC's strength as an acquirer during industry consolidation.

Staying on path to reduce debt back toward pre-deal levels over the next eighteen months.

Confirmation of post deal EBITDA margins in the mid-forties.