Following leading wealth management services provider Focus Financial Partners’ (FOCS) recent Investor Day event, I am upbeat on the longer-term potential. Supported by ongoing consolidation tailwinds in the RIA space and its competitive advantage in sourcing and winning new deals, FOCS continues to benefit from a meaningful growth runway. In addition, FOCS looks set to maintain its strong cash flow generation, which coupled with its material tax shield should enable it to stay well within its 3.5-4.5x leverage target. Relative to the 20+% revenue growth guidance, the current c. 11x P/E valuation multiple seems undemanding, presenting excellent value for investors.
“Focus 2025” Targets Revised Upward
Despite not offering any significant changes in its strategy, FOCS raised its fiscal 2025 revenue target to $5 billion – this was significantly above its prior target of $3.5 billion and the $1.65 billion reported at its quarterly result. Notably, this revenue target also implies an impressive 23% CAGR, a step up from the c. 20% CAGR outlined previously. Base firm organic growth is guided to contribute $1 billion of the $2.2 billion additional revenue needed to hit the medium-term target, with merger activities of existing partner and new partner firms contributing the remaining $800 million and $700 million, respectively. These targets also imply base organic revenue growth contribution of c. 10%pts of the 23% revenue CAGR, followed by new partner firms at 7%pts and merger activities by existing firms at 6%pts.
Source: Focus Financial Partners Investor Day Presentation Slides
FOCS also projects growth in adjusted EBITDA to $1.1 billion (well above the prior $840 million) and EBITDA margins to 28% (up from c. 24% previously) while maintaining leverage levels within the 3.5-4.5x target range. I view the top and bottom-line growth numbers positively, especially with the expected revenue contributions from M&A looking conservative (note M&A has historically been the key growth driver). Also notable was FOCS’ transparency around real organic growth across its portfolio of partner firms – at c. 10% CAGR globally and c. 11% domestically, the growth numbers were in line with the domestic RIA industry’s expected growth of c. 10% over the next five years. I think this new disclosure will be well-received by investors and should provide comfort on the relative quality of acquired firms and its offering of value-added services.
Robust M&A Pipeline Presents Upside to Growth Targets
Encouragingly, FOCS’ funnel of potential RIA M&A opportunities appears robust, with an expected $3.0-$4.5 trillion of assets expected to be in motion in the upcoming years. Assuming a relatively conservative 50bps fee rate, this implies a significant $15-22.5 billion potential revenue opportunity. Coupled with the fact that FOCS’ share of US RIA industry acquired revenues stood at c. 15% in fiscal 2021, I see plenty of upside to the medium-term target of $1.2 billion from new deals. Not only would this only require FOCS to acquire 6.5% of revenue-in-motion at the midpoint, but it also excludes non-RIA and international acquisitions, both of which represent incremental sources of inorganic growth.
Management also noted its pricing discipline on the M&A front, an especially positive sign considering new consolidators are entering the market. Looking ahead, there remain plenty of opportunities for more deals – FOCS believes it would take $60–$100 billion in total capital for the industry to complete the consolidation of the remaining 50% of US RIAs where the principals are at or above retirement age (equivalent to c. $3 trillion in assets). Another key positive is the fact that FOCS has sustained a 25+% weighted-average leveraged IRR from the 64 partner firms that have been part of FOCS for the last two years, with over 90% of these transactions delivering 20+% leveraged IRRs. Should this performance continue into the medium-term as well, I see plenty of upside to the current revenue growth target.
Connectus and New Value-Added Services Widen Addressable Marker Opportunities
Thus far, FOCS has successfully added new capabilities that have proven invaluable to partners, including Recruiting, Trust, Family Office Offerings, and Valuation Services. This has helped FOCS gain share within an industry expected to grow to $30.4 trillion by fiscal 2024 in the US (up from $22.7 trillion in fiscal 2019). From the 13.7% FOCS held in market share over the last three years for acquired RIAs in the United States, that percentage has increased to 14.6%. A key driver of this growth is the success of Connectus, which provides prospective clients an alternative option to retain their “look and feel” while also leveraging the shared services of the platform. Impressively, Connectus has already achieved an encouraging pace with 12 acquisitions in its first twelve months, and I expect more of the same in the upcoming years. Finally, with FOCS planning to expand globally into new and higher-growth markets like Singapore and other countries in the EU, I see plenty of upside to the longer-term growth targets.
The COVID-19 pandemic may have been a speed bump on the long-term road to achieving its targets, but FOCS has since re-accelerated on the back of an exceptionally strong market performance and successful M&A. And with FOCS still well-positioned to address a multibillion-dollar revenue TAM due to its best-in-class value proposition, the increased top-line and margin targets seem well within reach. Overall, I continue to view FOCS as one of the most compelling growth stories in the financial services industry – not only is this a quality cash generator exposed to secular growth trends, but its valuation at c. 11x P/E also screens very favorably relative to the 20+% growth guidance.