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What’s driving Focus’ growth?

Acquisitions continue to be Focus Financial Partner’s primary growth engine — a strategy the RIA aggregator intends to employ through 2019.

Focus, which went public last summer, added eight new partner firms last year and closed on 17 mergers for existing partner firms. The holding company now has 58 partner firms altogether.

The emphasis on M&A will continue in 2019, according to Focus CEO Rudy Adolf. The rapid consolidation of the industry “plays to our strength,” he said in a conference call with analysts, following the release of the company's 2018 fourth quarter and full year earnings results.

The M&A market for independent advisors is potentially half of what it could be, he noted, given the industry’s size, fragmentation and large percentage of advisors over 55 years old.

A priority for 2019 will be to “capitalize on the plethora of attractive merger opportunities for many of our partners,” Adolf said. “We’re very active on the deal front.”

Focus 2018  stats

Indeed, Focus has already closed two deals for firms with nearly $9 billion in assets since January and has several more acquisitions pending totaling another $9 billion in assets, Adolf told analysts.

Most M&A deals for RIAs in 2019 will be done an all cash basis, Jim Shanahan, Focus’ chief financial officer, told analysts. The firm typically buys 40% to 60% of a sellers’ cash flow, he said.

Focus will also prioritize buying into high net-worth and ultrahigh net-worth RIAs, particularly those specializing in athletes and entertainment clients, as well as acquiring wealth management firms in Canada, Australia and the United Kingdom.

In 2018, Focus grew its revenue by 37% and neared the $1 billion revenue mark, according to its fourth quarter earnings results. Adjusted net income also soared by 42% last year to $125 million, up from $87 million in 2017.

“What Focus calls ‘same store sales’ at 13% for the period is nice to know, but it is not organic growth,” says industry consultant Jamie McLaughlin.

The firm did, however, report a net income loss of $41 million, $7 million less than it lost in 2017.

Focus continued to stir controversy in the RIA industry by including revenue from acquisitions as part of organic growth. By this metric, the firm’s “organic revenue growth” last year was 13%.

“What Focus calls ‘same store sales’ at 13% for the period is nice to know, but it is not organic growth,” says industry consultant Jamie McLaughlin. "We know their core competency is inorganic growth, but that’s very different from their underlying advisors doing the block and tackling of client acquisition. Another question to ask is ‘What is their normalized sales growth when it excludes any lift outs or tuck-ins and the effect of the market?’”

In fact, “to not make a distinction between inorganic growth, which is their true competency, and true, plain vanilla organic growth may be masking a lost opportunity,” McLaughlin says.

But one top industry executive was more forgiving.

“I think they are being very upfront that growth is growth and believe that the acquisition of relationships is their engine, either at the firm level or at the existing advisor level,” the executive says. “They are being transparent about it. Good for them and the investors.”

"There’s an argument to make that Focus is growing into its valuation," says Matt Crow, president of Mercer Capital.

Indeed, Focus’ stock has recovered from a late year slump and is now near its offering price level of $33.

That recovery, says analyst Matt Crow, president of Mercer Capital, should alleviate concerns about Focus’ valuation “dropping further and interrupting the company’s acquisition momentum.”

Crow believes “there’s an argument to make that Focus is growing into its valuation. If you annualize the fourth quarter, Focus has close to $1 billion in revenue, $200 million in adjusted EBITDA, and $2 per share in adjusted net income.

“That puts them at a little over 3 times revenue, almost 16 times adjusted EBITDA, and about 16 times adjusted net income. Significantly, Focus posted unadjusted quarterly net income for the first time, although the amount, 22 cents, doesn’t correlate with the company’s market valuation.”

Crow also notes that Focus’s adjusted EBITDA multiple is running at a premium to the industry.

“Maybe this is because of Focus’s growth rate, but that growth is accomplished through acquisition activity – the cost of which is largely eliminated from adjusted EBITDA and net income,” he says. “So the economics of their model still seem incongruent with their valuation, even though management has been very forthright about their performance reporting.”

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