What Focus Financial’s earnings say about RIA growth

Focus Financial Partners said revenues increased more than 36% in the first quarter compared with a year ago. But Wall Street is not impressed.  

The New York-based wealth management firm reported Thursday the jump largely came from higher management fees charged to clients and from acquisitions by its partner firms. Such growth is typically regarded as “inorganic” because it comes from buying new businesses, not from growing the operations of existing businesses by attracting new clients and more money from current clients. 

The opposite, organic growth, is coveted evidence that a business prospers over time without buying new firms or entering into joint ventures. Focus’ own definition of organic growth includes revenue gained through acquisitions.

“The organic growth definition has been a bugaboo around this stock ever since the IPO,” said Peter Nesvold, the founder and managing director of Nesvold Capital Partners, a boutique investment bank in New York that invests in advisory firms. Revenues from acquired companies typically aren’t evidence of organic growth, he said.

Shares in publicly traded Focus slipped 2.3% on Thursday. The stock is down nearly 38% this year.

While some advisory firms consider drives to recruit new advisors and their books of business organic growth, the mainstream perception focuses on fresh money from new or existing clients. “The fact that Focus’ definitions are different from what public investors expect” from other companies “is causing some confusion,” Nesvold said.

Highlights from Focus' statement:

• Total revenues of $536.6 million, up $142.4 million, or 36.1%, year over year.
• Of $142.2 million, $87.5 million came from existing partner firms and was mostly driven by higher wealth management fees, “which included the effect of mergers completed by our partner firms.”
• $54.9 million came from firms acquired in the last 12 months.
• “Our year-over-year organic revenue growth rate was 22.0%, above our expected 16% to 19% range for the quarter,” said Rudy Adolf, the founder, CEO and chairman of Focus.
• Focus defines organic growth in revenue as “related to partner firms, including growth related to acquisitions of wealth management practices and customer relationships by our partner firms, including Connectus, and partner firms that have merged.” Connectus Wealth Advisors, a Focus in-house subsidiary, is a consortium of financial advisors.
• 78.2%, or $419.4 million, of total revenues in the quarter were “correlated to the financial markets. Of this amount, 65.8%, or $275.9 million, were generated "from advance billings generally based on market levels in the 2021 fourth quarter.” 
• The remaining 21.8%, or $117.2 million, came from family office-type services, tax advice and fixed fees for investment advice, mostly for high and ultrahigh net worth clients.
• Operating expenses rose to $463.2 million, up from $379.5 million in the year-ago period.

"Our 2022 first quarter results were excellent, reflecting our strong fundamentals and the resiliency of our business despite the challenging macro backdrop," Adolf said in the statement. 

But Jamie McLaughlin, a consultant to the wealth management industry in Darien, Connecticut, said Focus shouldn’t frame acquisitions as driving organic growth. “It’s unbelievable that they’ve socialized analysts on the earnings calls to how they count the beans,” he said. ”It’s poppycock and balderdash.”

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Focus, which has bought 86 independent advisory firms since 2009 — 38 last year alone — has a three-pronged business model: It buys firms and practices led by wealth managers who leave big Wall Street brokerages, such as Bank of America’s Merrill Lynch, and lets them operate independently with their own culture, niche and brand. It gives those “partner” firms access to a war chest to make their own acquisitions. And it provides the firms with client management technology, trading platforms and practice services. Advisors swap a slice of their earnings for upfront cash and stock in Focus.

Last December, Adolf said he wanted to grow the company to $4 billion in annual revenues by 2025, mainly through acquisitions. Partner firms include Buckingham Strategic Wealth and The Colony Group.

The inorganic approach to getting bigger requires money — in the case of Focus, $2.5 billion in debt that it uses to finance acquisitions. The company, which has cash and cash equivalents of $317 million, uses some of its credit line to fund its daily operations. It said that over the next 12 months and in the longer term, it expects to continue that practice. “If our acquisition activity continues at an accelerated pace, or for larger acquisition opportunities, we may decide to issue equity either as consideration or in an offering,” it said in a securities filing. 

Dealmaking for registered independent advisory firms (RIAs) has been on fire in recent years, making inorganic growth through acquisitions the primary way in which firms are expanding. Wealth management practices are fetching top-dollar prices, leading some industry insiders to wonder if there’s a bubble. Despite the trend, nine out of 10 firms expect organic growth (from existing and new clients) to have a greater impact than inorganic growth (from mergers and acquisitions and from new advisors bringing in business), according to Schwab Advisor Services’ 2021 Independent Advisor Outlook Study.