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Warburg-Kestra deal signals challenges ahead for IBD sector

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It may have a track record in wealth management, but Warbug Pincus is entering the independent broker-dealer sector at a challenging time.

Stone Point Capital has agreed to sell a majority stake in Kestra Financial to the global private equity firm roughly three years after buying the ownership position, the firms announced on Feb. 25. The parties didn’t disclose the terms of the deal, but reports have said it may value Kestra at as much as $800 million — or 8 to 10 times its EBITDA.

Beyond regulatory approval, the agreement must win over the 2,300 advisors who would balk at disruption to their practices at Kestra and subsidiaries Kestra Private Wealth and H. Beck. The deal also comes after the Dow hit record highs 15 times in 2018 and equity markets saw major fourth-quarter volatility.

The agreement, which is expected to close in the second quarter, put questions to rest about the possibility that Kestra was seeking a new capital structure after tapping Goldman Sachs for the effort. The same Goldman team advised Cetera Financial Group in its sale for a reported $1.7 billion last year.

Warburg has a portfolio of 180 companies and $43 billion in assets under management and boasts more experience in wealth management than other PE firms fueling record M&A. Warburg’s paper trail in the industry extends to some notable M&A deals shaping the industry in recent years. Its investments include startup Facet Wealth and past positions in The Mutual Fund Store, Financial Engines and Yodlee.

Experts predict Warburg will finance growth while allowing CEO James Poer and other executives the space they need to run the firm. However, Warburg has taken about 100 firms public, and the wealth management industry has changed since Yodlee and Mutual Fund sold for a combined $1.2 billion about three years ago.

In September, Warburg led a Series A funding of Facet which raised $33 million. The company buys smaller-account clients from RIA firms to service them and offer them back to the RIAs if the accounts amass $1 million or more.

Warburg “made out like bandits” with Yodlee, says consultant Tim Welsh of Nexus Strategy. Envestnet purchased the firm in 2015 for $660 million, a few months before Financial Engines closed the $560-million acquisition of Mutual Fund. Warburg offered its remaining shares in Financial Engines in 2017.

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PE investment into the IBD space in recent years has coincided with a shrinking number of firms and tightening margins. The equity environment and requirements for publicly traded firms make an IPO unlikely for Kestra, says Carolyn Armitage, a managing director with consulting firm Echelon Partners.

“I would expect very good things from Warburg Pincus. I don’t think going IPO is as attractive a route as it used to be, say maybe 10 years ago, considering the cost not only of the initial public offering but the ongoing requirements,” Armitage says.

“There's so much private equity money available at attractive terms,” she continues, “that I don’t think the IPO road is something that should automatically be assumed for success going forward.”

Indeed, Poer has called any talk of an IPO “premature” while citing the benefits of being private for the Austin, Texas-based firm and its advisors. Management and more than 60 advisors have shares in the firm, with opportunities for others to pick up stock after the close of the transaction, Poer says.

The deal “is intended to make sure we have the cash flow necessary to fuel growth and invest in the ideal value stack” for advisors, he says.

NFP, the insurance firm that sold Kestra to Stone Point in 2016, and Securian Financial, which sold H. Beck to Kestra in 2017, would no longer have minority stakeholder positions after the acquisition is finalized. The funds managed by Stone Point would keep a minority stake in Kestra under the deal, however.

“We are incredibly proud of [Kestra’s] success,” Fayez Muhtadie, a Stone Point senior principal, said in a statement. “We firmly believe in their growth prospects and look forward to our continued partnership with James and the rest of the talented management team, as well as with Warburg Pincus.”

Neither Stone Point nor Warburg were available for further comment, but Warburg Managing Directors Jeff Stein and Arjun Thimmaya issued statements expressing excitement about the deal and pledging to help advisors’ success.

The data aggregation software firm Yodlee — now a subsidiary of Envestnet — and current Mutual Fund RIA parent Edelman Financial Engines declined to discuss Warburg’s tenure as an investor. Baltimore-based Facet didn’t respond to an inquiry about Warburg.

Stein and Thimmaya serve in Warburg’s financial services practice, which lists 23 staff members on its website at offices in New York, San Francisco, London, São Paulo, Shanghai and Hong Kong. With 13 total offices in nine countries, Warburg’s 17 funds have invested more than $73 billion in 855 companies.

Longtime co-CEOs Joseph Landy and Charles Kaye lead the private equity firm. They hired ex-Treasury Secretary Timothy Geithner to serve as president when he stepped down from government service in 2013. Poer hasn’t met with Geithner about the Kestra deal, he says.

Asked who from Warburg will oversee its investment and sit on the IBD’s board, Kestra spokeswoman Jen Diehl said in an email that the firm expects to “work on all of these details between now and close.” Stone Point would retain its board seat as well.

“We’ve had such a great 2 1/2 years that it just made sense from a board standpoint that Stone Point [would] consider taking a partial gain,” Poer says. “We want to make sure that we have the ideal capital structure — that includes making sure that we're keeping a fresh perspective and bringing fresh capital and views.”

The PE firm has acted as the lead investor in almost 100 IPOs on the Nasdaq and NYSE, according to a Harvard Business School case study published in 2008 and revised in 2012. The lesson examines Warburg’s decision to take a Norwegian energy firm public on the country’s exchange.

The Business School states that case studies are not endorsements or definitive research but rather “a simplified summary of a company's business challenges, written only for teaching and classroom discussion purposes.” However, the study provides a brief glimpse into Warburg’s approach.

In it, then-Warburg Managing Director Jeffrey Harris compares Warburg’s quarterly meetings to the United Nations because they have “a lot of different languages and cultures represented.” He credits founding partner John Vogelstein for coming up with a decentralized method of deal approval.

“He was the senior partner and you’d sit down and walk him through a deal,” Harris says. “But you never spoke only with him and then wrote the check; you would have had a number of earlier conversations with others in the firm. Essentially it’s sensitivity testing and a quality control process, ensuring that you haven’t missed anything important in evaluating the risks of the deal.”

Welsh sees Warburg’s investment as a “good outcome” for Kestra while bringing “a ton of risk into the picture” for the acquiring firm. The falling margins at IBDs and equity market highs, along with the dearth of “prime assets” like Yodlee and those in the full RIA channel, display the challenge, Welsh says.

“Any normal investor would really be worried about the fundamental economics of independent broker-dealers, which are not good,” says Welsh, arguing Kestra should now acquire more IBDs. “If you're a private equity firm, you've got cash. You can actually get the capital to go out and buy these companies and really take advantage. To me, that's really the only strategic route that makes sense.”

Welsh and IBD recruiter Jon Henschen note Warburg’s global record of investing for growth in its portfolio as a positive. Stone Point and representatives with stock would make substantial money on the deal, according to Henschen, who says he heard the selling firm would receive double its investment.

While announcing the deal, Kestra pledged it would have “no impact to Kestra Financial’s employees and advisors.” Henschen expects Kestra to maintain the same staffing, technology and ratio of team members to representatives, he says, citing earlier PE deals as “non-events” for advisors.

“They're known for high-quality service and they attract high-quality advisors. I don't see that changing,” Henschen says. “The thing I've liked with Kestra is that, whatever private equity firm that's been involved with them, it's been financial support, otherwise hands off. They let the management do what they do, because that's not their area of expertise.”

Former Kestra advisor Lee Rawiszer of Westport, Connecticut-based Paradigm Financial Partners, who left the firm in 2018 after 15 years to launch an independent RIA, has spoken with three advisors at his former IBD after the deal, he says. None were “worried or shook up” about it, he says.

Poer’s promise to advisors at the firm’s annual conference in February that any buyer would “invest money back into the company to make Kestra even stronger,” helped set them at ease, according to Rawiszer. They’re also confident Warburg won’t try to alter the firm’s payout to advisors, he says.

“That's the first thing that goes through an advisor’s mind,” says Rawiszer. “They're not worried about it, they'll take a wait-and-see. They're not planning on going anywhere."

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