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Focus to offer cash rather than equity in acquisitions, CEO says

Focus Financial has acquired six new partner firms over the past five months with combined base earnings of $35 million, but the firm still lost $7.7 million in the quarter before it went public.

In the New York-based RIA consolidator’s first earnings call on Aug. 29, CEO Rudy Adolf said the firm has “tremendous firepower” in the form of cash on its balance sheet and a revolving loan. He also pledged to buy firms with cash in the future rather than offering prospective RIA partners equity in Focus.

“We really want to use cash for our deals going forward,” Adolf said. “How this plays out over time we are just going to learn, but our sweet spot deals, as much as we can guide it this way, will be heavily geared, if not exclusively geared, towards cash.”

Focus Financial revenue Q2 2018

Analysts had identified non-cash equity compensation expense as a drain on the company’s earnings in the wake of the IPO late last month, which the company says earned net proceeds of $564.8 million. Equity compensation nearly doubled year-over-year in the second quarter to $3.7 million.

On the other hand, the company expanded its count of preferred ownership interests, or so-called partner RIAs, by 17% to 56 advisory firms at the end of June. Its revenue soared by 47% over the year-ago period to $231.4 million, with organic revenue growth of 17% at existing partner RIAs.

Focus doesn’t break out the number of advisors at its RIAs, but the firm now has 2,800 partners and employees. An additional 500 practices in the U.S. would make suitable partners and 5,000 others could tuck into existing ones, Adolf told analysts.

“We are seeing this trend towards independent fiduciary advice all over the world and believe we are well positioned to capitalize on it, in the U.S. and abroad,” Adolf said. “Yet, we believe we have barely scratched the surface of this opportunity.”

While the firm’s loss from continuing operations came in 48% higher than its $5.2 million loss a year ago, changes for nonrecurring expenses turned the bottom line for the second quarter of this year into an adjusted net income of $29 million, or 40 cents per share.

The company’s calculations, which add up to more than $36 million worth of adjustments to net income, pose questions, Matt Crow, president of the research and consulting firm Mercer Capital, said in an email.

“Some of their adjustments are debatable, because they are probably recurring byproducts of an acquisition model that deplete shareholder returns going forward,” Crow says. “The magnitude of some of these adjustments may explain why management now favors funding acquisitions with cash.”

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As for the recent revenue figure, three partners added in the second quarter brought combined acquired base earnings of $23.8 million and three others acquired by Focus since June brought an additional $11.2 million. Adolf also described an upcoming sub-acquisition as one of the largest such deals by a Focus partner ever.

The eight partners purchased by Focus over the 12-month period generated $47.9 million in new revenue for the second quarter, and $26.3 million more came from revenue growth at existing partners.

Since Adolf noted on the call that Focus partners usually carry out a collective 15 to 20 tuck-in deals of their own in a given year, analysts appear interested to know how much of the organic growth is truly same-store growth, according to Crow.

“Focus includes partner level sub-acquisitions in their calculations of organic growth, and I suspect some analysts and investors take issue with that,” he says. “Management was asked pointedly about breaking out sub-acquisitions within organic growth, and the response was clear that they don’t intend to offer that.”

The firm’s revenue topped analysts’ expectations by $4.8 million, and its adjusted EPS surpassed the forecast by 2 cents. The value of its stock increased nearly 3% to $42.13 per share in trading after the earnings announcement.

Adolf, 55, recalled discussing the launch of Focus a dozen years ago at a kitchen table with co-founder Rajini Kodialam. He thanked the firm’s RIA partners at the close of his prepared remarks.

“We could not have accomplished any of this without you and we look forward to continuing to build this great company together,” Adolf said.

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