OM Asset Management's (OMAM) CEO Peter Bain on Q2 2016 Results - Earnings Call Transcript

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OM Asset Management (NYSE:OMAM)

Q2 2016 Earnings Conference Call

August 4, 2016 10:00 ET

Executives

Brett Perryman - Head, Investor Relations

Peter Bain - President and Chief Executive Officer

Steve Belgrad - Chief Financial Officer

Analysts

Craig Siegenthaler - Credit Suisse

Bill Katz - Citi

Michael Carrier - Bank of America/Merrill Lynch

Robert Lee - KBW

Michael Cyprus - Morgan Stanley

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the OMAM Earnings Conference Call and Webcast for the Second Quarter 2016. [Operator Instructions] Please note that this call is being recorded today, August 4 at 10 o’clock Eastern Time. I would now like to turn the meeting over to Brett Perryman, Head of Investor Relations. Please go ahead, Brett.

Brett Perryman

Thank you. Good morning and welcome to OMAM’s conference call to discuss our results for the second quarter of 2016. Before we get started, I would like to note that certain comments made on this call may constitute forward-looking statements for the purposes of the Safe Harbor provision under the Private Securities Litigation Reform Act of 1995. Forward-looking statements are identified by words such as expect, anticipate, may, intends, believes, estimate, project and other similar expressions. Such statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially from these forward-looking statements. These factors include, but are not limited to, the factors described in OMAM’s filings made with the Securities and Exchange Commission, including our most recent Annual Report on Form 10-K filed with the SEC on March 15, 2016, under the heading Risk Factors and on the company’s current report on Form 8-K filed with the Securities and Exchange Commission on July 20, 2016.

Any forward-looking statements that we make on this call are based on assumptions as of today and we undertake no obligation to update these statements as a result of new information or future events. We urge you not to place undue reliance on any forward-looking statements. During this call, we will discuss non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today’s earnings press release, which is available in the Investor Relations section of our website, where you will also find the slides that we will use as part of our discussion this morning.

Today’s call will be led by Peter Bain, our President and Chief Executive Officer and Steve Belgrad, our Chief Financial Officer. I will now turn the call over to Peter.

Peter Bain

Thank you, Brett. Good morning, everyone. Thanks for joining us on the call today. I will make some opening observations and then I will ask Steve to walk you through the financial results in a little more detail. And then as always, we will look forward to Q&A with you to talk about the business.

Turning to the presentation that we have provided, if you start with the overview on Slide 3, I think what I will observe is that we are in what was a very challenging operating environment. We are very pleased to have delivered the solid results that we have. This has been an interesting macro-driven market. I will try and make it through the entire call without saying the word Brexit. I don’t know that I will be successful in that, but it is an interesting market environment we are in.

Importantly, we accomplished a couple of very meaningful strategic objectives that those of you who have spent time with us know we are focused on, in announcing the acquisition of Landmark Partners and our 60% equity position in that affiliate going forward as well as completing a $400 million bond offering. Those two strategic accomplishments are material to our business strategy and to our growth going forward. We are very pleased to be able to execute on those this quarter.

On the straight financial results front, our second quarter ENI per share of $0.30 is down about 6% from Q2 ‘15 and that was really driven by a decrease in our management fee revenue. Our second quarter GAAP EPS of $0.30 was a 26% decline from Q2 ‘15, but as you will remember, our Q2 ‘15 GAAP results included a $48 million nonrecurring performance fee. On a sequential basis, our ENI per share was actually up 11% quarter-over-quarter and our GAAP EPS is actually up 15% in the second quarter this year relative to the first quarter. So, we like the trending progression we have been able to accomplish.

Our net flows in terms of AUM turned negative in the second quarter. We were $2.9 billion down after having been $2.4 billion up in the first quarter. The revenue impact, however, was only $3.4 million negative in the quarter. That’s a result of our having reversed successfully the trend of basis point fees on assets coming in relative to basis point fees on assets going out. As you will remember in the first quarter, the fees on assets going out were actually a little higher than the fees on assets coming in, principally because we realized a number of hard asset disposals in the first quarter.

Here in the second quarter, we have reversed that trend back to our historical delivery, where the fees on assets coming in were 46 basis points and the fees on assets going out were only 32. As a result of that, year-to-date, while we are slightly negative in terms of AUM flow, we are still generating $4 million of organic revenue growth year-to-date and the change in the flow really was purely a function of sales in the quarter interestingly and we will talk about that as we go forward.

Our total AUM were just under $219 billion, which is down 3.4% from Q2 ‘15, up 3% year-to-date and up a little under 0.5% from March 31. On the performance front, our long-term performance remains strong with 63% and 72% of our revenues being generated by strategies that are beating benchmark on a 3-year and 5-year basis, respectively. But the environment we are operating in is reflected in the short-term performance numbers where active management has been challenged by the benchmarks and we see that coming through in our 1-year number, where 36% of our revenues are now coming from strategies that are beating benchmark on that 1 year basis.

As I mentioned at the beginning on the strategic front, we are delighted to have announced our new affiliation with Landmark Partners. We announced that on June 14, that is now on track to close later this month and that closing process have been very smooth. And related to that, but not entirely connected is our successful placement of $400 million of investment grade debt in two tranches, which we closed just a few days ago, $275 million in a 10-year fixed rate offering at 4.8% and another $125 million in a 15-year fixed rate offering at 5.8%. So, we were pleased to be able to ladder our liquidity in the way that we did and at the rates we are able to achieve in the market.

And then the last opening general observation is on the repurchase front, we were able to repurchase over 620,000 shares in the open market during the quarter at weighted average price of $13.52 a share. And I think from our perspective and thinking about the buyback going forward, our basic view is that we think we have a about $150 million of capacity to do further buybacks this year.

When you switch to Slide 4, this is the pyramid of growth. We consistently include this because we want to remind all of you and ourselves of our business model and growth strategy. We think the model itself supports a diversified growth strategy. And interestingly, this quarter it did kick in, in a way that’s very, in our view mindful of the reason we built the model the way we have. In the sense that, if you look at core affiliate growth, in the first quarter you had very strong reflection of that through the flow numbers and in this quarter, you see the reflection of the headwinds in the active management segment of the market this quarter. So the core affiliate growth was a little challenged. Our collaborative organic growth is all long-term investing in our affiliates to build and diversify and improve their platform. So those initiatives continue to ongoing.

Global distribution operates in a relatively benign and/or challenging world, but it will always be engaged. And this quarter it continues to do that work. And global distribution has generated north of $1 billion of sales this year year-to-date. So we continue to be pleased with the way it’s operating. But it’s the fourth one at the top that kicked in this quarter, which is the new partnership front. So again we would remind the market that in this business model, it’s designed strategically to have multiple avenues of growth generation. And in a quarter where the traditional organic growth is challenged, we were able to generate inorganic growth through the landmark transaction.

And when you go to Slide 5, it provides you a little bit of an overview of Landmark. The business itself is one of the longest standing and leading secondary private equity managers in the industry. They have been around since ‘89, over the course of their history, they have raised and invested a total of $15.5 billion of committed capital. Their most recent fundraising cycle was in 2013 and ‘14. They raised over $5 billion in a new private equity fund, a new real estate fund and they recently closed their first real asset fund. So they have been a good job of diversifying their expertise in the market. They have got a very strong management team with depth and they have got a very differentiated investment process. So, as – they are exactly the kind of leading platform business in an alternative asset class that we think improves the overall quality of OMAM in meaningful strategic ways as well as economic. And the transaction itself is described on the right side of this slide. We are acquiring 60% of the equity of Landmark. Management is retaining 40% of the equity. The closing payment will be approximately $240 million in cash, which we anticipate making later this month when it closes. And that obviously is clearly funded – more than funded by the successful debt offering.

There is a potential true up 2 years after the closing after their next round of fundraising is completed. And it can be up to an additional $225 million. The actual amount will be purely a function of the success and magnitude of the fundraising cycle that they go through. Net-net at the end of it all, we think that the transaction will result in an overall ENI multiple in the transaction of between 8x to 10x. And we have based the transaction structure solely on the management fee generated by Landmark. The performance fee, carried interest and co-investment capital components the relationship are going to be structured outside of the purchase transaction, which we think is the right way to do that both for Landmark, its clients and our shareholders. The transaction will be accretive to our ENI per share from the day we close going forward.

Slide 6 provides you a catch up on both the trailing 12-month and also sequential quarter basis of AUM. On top left, you can see that trailing 12-month from the market peak at the second quarter of ‘15 of $226 billion to the $218.8 billion at June 30 this year composed both of market depreciation and trailing 12 months net AUM outflow. The bottom left shows sequential quarter, where you can see the assets going from $218 billion up to $218.8 billion, reflecting the turn in the market in the quarter and also the absorption of the AUM net flow outs. And on the bottom right of this page in the AUM mix, you can see that we continue to be pleased with our diversification across asset classes, where U.S. equity is only 36% of our AUM. And then when you look at our positions in international equity, global equity and our alternatives businesses, each of those classes is in the mid to high-teens with our emerging markets equity position just under 10%.

Slide 7 provides a little more detail on both the AUM flow and the revenue flow that we talked about at the beginning. Here on the left, in the AUM graph, you can see in Q1 and Q2 this year, the flip from the $2.4 billion positive in Q1 to the $2.9 billion negative in Q2. And then if you follow that across to the revenue side, this is where you can see the impact of our having successfully reversed the flow trend on assets in and assets out. If you look at the line items at the bottom of that revenue impact graph on the right, the line items headed bps on inflows and basis points on outflows and followed across to Q1 and Q2 this year, You can see that in Q1 the fees on inflows were 38 basis points, while the fees on the outflows were 40. That has now reversed itself again to their historical trend of bringing in assets at substantially higher fees on the assets that are going out, which is why on a $2.4 billion plus in Q1, we can generate over $7 million of new revenue, whereas on the 2.9 AUM out in the second quarter, we actually only absorbed $3.4 million of revenue diminution that leaves us on a positive basis for the year of that $4 million of organic revenue growth.

If you go to Slide 8, you get a little more of the underlying detail in how that revenue generation is created. And here what we have done this quarter is something that’s new for you all, which we think is relevant. We have added a new segment here which is we have broken out of the alternative outflows, hard asset disposals. Those are, as we have discussed with you in the past, when one of our alternative managers, principally real estate and/or timber with Heitman and/or Campbell Global, when they actually harvest an investment for a client and sell a hard asset and then distribute the proceeds to the clients, that is an outflow, but it’s a good event for the client. It’s a value-creation event. And there’s new category you can see in the kind of brown box on the down flow side. And you can see the Q1 and Q2 impact of the hard asset disposals. And we thought that’s just a useful piece going forward. And again, you can see the switch on how when we bring in alternative assets and non-U.S. equity assets on Q2, they come in at 44 basis points and 42 basis points respectively substantially higher than the sub-advisory and U.S. equity and fixed income assets that flow out and that generates the positive revenue delta that we were able to deliver in the quarter.

Slide 9 is just a little more on investment performance. And here again you can see that on a 3-year and a 5-year basis, we continued to deliver competitive performance both in terms of revenues generated by strategies beating benchmark as well as our equal-weighted measure, which is that number of our strategies that are at scale and therefore marketable that are beating their benchmarks as well as AUM weighted. But on a 1-year basis, you see the kicking in impact of the macro-driven market we have been operating in. What you will – I mean, you have all seen this and looking at the overall industry, but this is a market where the benchmark results based on the analytics we have been able to do here, really have been driven by a very narrow range of the components in the benchmarks. And those narrow components have been dominated by defensive stocks, commodity driven stocks and effectively bond proxy equities like REITs. And those securities have delivered the predominance of the impact on Benchmark movement. And the reality is while each of our affiliates has its own very distinct discipline, there are some common threads and those common threads tend to run along the themes of real valuation discipline, a genuine focus on deliverable earnings as well as dividend growth as distinct from simple yield characteristics as well as the quality of that earnings and the quality of that growth.

And as a result, the kind of portfolios that our managers are constructing have not held a number of the securities that have dominated the benchmark returns because those securities now are operating at PE levels that are simply unsustainable and they won’t be in the portfolios. So that has a carry-on impact in our current positioning in the 1-year. And our view is as markets return to fundamental, less correlation, security driven capability to value create that will happen. The other piece is it’s important to remember, in the institutional world that we inhabit our affiliates are hired to generate alpha over full market cycles through very specific and well understood disciplines. And we continue to focus on that as to our affiliates. And we think that’s the right thing to do.

So I think, with that as a backdrop, I will turn it over to Steve and he can walk you through the financials and we can then look forward to Q&A.

Steve Belgrad

Great. Thanks Peter and good morning. While the second quarter of 2016 was challenging in several respects, the business performed well financially and we made significant progress in positioning the company to drive growth in 2017 and beyond. If you think about the operating environment in the second quarter of 2015, markets have peaked and AUM was at the cyclical high. That makes for a challenging quarter-over-quarter comparison. However, if we consider both the operating dynamics of our business as well as the financial progress made relative to the first quarter of this year, the prospect is more positive.

Please note that in my comments all ENI comparisons to 2Q ‘15 exclude the impact of $48.1 million extraordinary performance fee we received in the second quarter of last year, which we have consistently excluded from our core ENI results. Comparing Q2 ‘16 to Q2 ‘15, economic net income was down 4.7% quarter-over-quarter to $36.2 million or $0.30 per share, driven by a $7.8 million reduction in revenue and generally flat operating expenses, which increased only 1% to $61.8 million. While market declines and outflows resulted in a 5.4% fall in average assets from the year ago quarter, excluding equity accounted affiliates.

Our continued shift in asset mix towards higher fee products enabled us to limit management fee contraction to only 4.7% during this period. Revenue was also impacted by the volatility driven lower performance fees, similar to what we saw in the first quarter. As net performance fees were actually negative at $0.8 million due to management fee rebates on sub-advised accounts in Q2 ‘16 compared to positive $0.5 million in Q2 ‘15. Combined operating expenses and variable comp decreased 1.9% year-over-year driven by lower variable compensation. However, this was not enough to offset 4.6% overall revenue impact caused by the decline in management and performance fees. As a result, the ENI operating margin fell from 37.5% in Q2 ‘15 to 35.8% in Q2 ‘16. About half of this decline was related to the difference in performance fees over the period. In line with earnings, our adjusted EBITDA declined 7.5% to $50.3 million for the second quarter of ‘16 compared to Q2 ‘15.

Looking at the rest of the year with respect to performance fees, it’s really too soon to predict with uncertainty the ultimate level of these fees. However, given the level of performance of certain key products as well as the fee rebates on large cap values of advisory accounts, we are currently expecting performance fees to remain modest through 2016 and there could be less than half of last year’s levels on an annual basis.

Comparing the first of results of 2016 to the first half of ‘15, ENI income is down 9.4% to $68.2 million. Clearly, we have ground to make up. We continue to focus on expense control while investing selectively for future growth. And in the third quarter, we expect to see the financial benefits of the Landmark investment flow through once that transaction closes later this month. These benefits should accelerate in 2017 as Landmark moves forward with its next round of fundraising. I will speak more about Landmark and our expectations for how this transaction will impact our key ratios and financials as we go through this presentation. In July, we also made progress in our balance sheet management as we received investment grade ratings of BAA2 and BBB- from Moody’s and S&P respectively. By accessing both the institutional and retail markets, we are able to raise $400 million of long-term capital. These bonds will allow us to fund the Landmark transaction and other financial obligations in a long-term cost effective manner.

Slide 11 gives a better perspective of our financial trends over the last five quarters as well as the financial improvement between the first and second quarters of 2016. For each period, we show the core earnings power of the business by breaking out the impact of performance fees and we are relevant to show the change in the metric on an annual quarter-over-quarter and sequential quarter-over-quarter basis. As you can see, total average assets peaked in the second quarter of 2015 and then pulled back primarily due to market movement reaching a low point in Q1 ‘16. While average assets, including equity-accounted affiliates, declined 3.5% during the period from Q2 ‘15 to Q2 ‘16, the increase in fee rates from 34.3 basis points to 35 basis points partially offset this reduction. These increasing average fee rates reflect the ongoing impact of higher fees earned on new asset sales primarily into alternatives and non-U.S. equities. Relative to the lower fees earned on outflows, which are primarily U.S. sub-advised and fixed income.

While this trend reversed in the first quarter of this year, in the second quarter was again evident as fees on inflows of 46 basis points exceeded fees on outflows of 32 basis points. Once the Landmark transaction closes, we would expect our average fee rate to increase by approximately 2 basis points as a result of the increased mix of alternatives earning Landmark’s higher fee rates. While many of the annual quarter-over-quarter trends on this chart are negative due to lower average assets and revenue, there is a market improvement comparing the sequential quarters of Q1 ‘16 and Q2 ‘16. The 4% increase in average AUM during this period driven by market improvement and strong first quarter flows resulted in a 5% increase in revenue and a 2% increase in operating margin from 34% to 36%.

ENI earnings per share also improved strongly on a sequential basis by about 11% as EPS grew from $0.27 to $0.30 per share. On the right side of this chart, you can see pre-tax ENI and after-tax ENI per share. Our 24.4% effective tax rate in the second quarter benefited by our UK domicile and intercompany interest was lower than the 27% we typically planned for. In a declining earnings environment, the fixed nature of our tax benefit acts as a cushion on earnings volatility through a reduced effective tax rate. Once Landmark is completed, I would expect additional intercompany interest and the amortization of intangible assets for tax purposes to further improve our effective tax rate. On a full year basis, including the addition of Landmark from mid-August, I would expect the tax rate to be in the 24% to 25% range for 2016.

Slide 12 provides insight into the drivers that impacted management fees and revenue from Q2 ‘15 to Q2 ‘16. The overall trend during this period was the continuation of the positive mix shift towards higher fee assets. On a combined basis, our average fee rate increased by close to 1 basis point to 35 basis points in Q2 ‘16 from 34.3 basis points in Q2 ‘15. In the left box, you can see average assets for Q2 ‘15 and ‘16 split out by our four key asset classes. The box on the right provides the gross management fee revenue generated by these average assets and basis points of fees, also broken out by asset class. On an overall basis, average assets were down 3.5% period-over-period and gross management fees including equity accounted affiliates were down 2.5% or 2.1% actually quarter-over-quarter.

As you recall, our different asset classes have very different fee rates. Global non-U.S. equities and alternatives have average management fee rates of 42 basis points and 44 basis points, respectively. While U.S. equities and fixed income have averaged management fee rates of 25 basis points and 20 basis points, respectively. Between Q2 ‘15 and Q2 ‘16, the average fee rate on U.S. equity increased by 1 basis point as outflows occurred in lowest fee mandates and alternatives increased by 1 basis point as the alternative mix shifted towards real estate. Fixed income decreased by 2 basis points.

During this period, the combined share of high fee global non-U.S. equity and alternative assets went up by 3% to 58% of our average assets, while the share of U.S. equity decreased approximately 2% to 36% of average assets. Alternatives were the only asset class to experience absolute growth during this period, primarily from real estate. Our average assets and gross fees in these bar charts represent all assets managed by our affiliates, including the equity accounted affiliates, Heitman and ICM. To tie back to ENI revenue, you need to subtract the average assets and management fees associated with the equity accounted affiliates which we have below each bar.

Slide 13 provides additional perspective regarding ENI operating expenses for the three months and six months ended June 30, 2016 and 2015, and breaks out several of our key expense items. In a volatile first half market environment, we and the affiliates have sought to manage expense growth while investing in the business. Total ENI operating expenses grew by only 1% between Q2 ‘15 and Q2 ‘16 for a total of $61.8 million for the quarter. We were helped by lower commissions and G&A expenses, in part due to favorable currency movements. However, these benefits were partially offset by hiring at several of our affiliates, in some cases related to new growth initiatives.

Technology spending and an affiliate office move drove the increase in D&A from $1.6 million in Q2 ‘15 the $2.3 million in Q2 ‘16. At the holding company, including global distribution, expenses were flat over this period. On an aggregate basis, you can see that the ratio of operating expenses to management fees grew from 37% in Q2 ‘15 to a more normal 39.3% in Q2 ‘16. Most of the period-over-period increase in this ratio was the result of the 4.7% decrease in management fees over this timeframe. On a sequential quarterly basis, the operating expense ratio fell by approximately 350 basis points from 42.8% in Q1 ‘16 as operating expenses fell 3.4% from seasonal highs and management fee revenue increased 5%.

On a full year basis, we continue to expect the ratio of operating expenses to management fees to be in the range of 40% to 42%, including the impact of Landmark, which has a positive scale impact relative to our standalone results. The next key driver of profitability is variable compensation shown in more detail on Slide 14. The table at the bottom of the slide divides total variable compensation into its two components; cash variable comp and equity amortization. In this exhibit, you can see the benefit of the profit share model, which links to variable compensation to profitability. Variable comps declined 6% quarter-over-quarter to $41 million, generally proportionate to earnings before variable comp, which fell 8%. Cash variable comp decreased even further, declining 9% quarter-over-quarter. As performance fee payouts in the prior year did not occur in Q2 ‘16. We have also calculated the ratio of total variable compensation to earnings before variable comp, which we refer to as the variable compensation ratio. This ratio increased 79 basis points quarter-over-quarter to 41.8% from 41%, primarily due to the increase in non-cash equity award amortization.

For full year 2016, assuming stable equity markets and including Landmark, we would expect the variable compensation ratio to be slightly improved in the range of 41% to 42%, reflecting the additional scale achieved with Landmark. Affiliate key employee distributions for the three months and six months ended June 30, ‘16 and ‘15 are shown on Slide 15. Distributions represent the share of affiliate profits owned by the affiliate key employees. Between Q2 ‘15 and Q2 ‘16, distributions fell 10% from $10.2 million to $9.2 million, while operating earnings or earnings after variable comp were down a comparable 9% quarter-over-quarter. Given the proportionate decline in affiliate key employee distributions in operating earnings, the distribution ratio was flat at 16%. Following the acquisition of Landmark, this ratio will increase given the 40% ownership stake retained by Landmark management. Combined with Landmark, this ratio would be closer to 19% to 20%, and for the full year 2016, we would expect the blended ratio to be around 17% to 18%.

Turning now to the balance sheet and capital on Slide 16, we have said previously that we believe our balance sheet provides multiple opportunities to increase shareholder value. Since the end of March, we have made significant progress positioning our balance sheet to support our growth strategy while improving our capital allocation. In anticipation of the Landmark closing and other financing needs, in July, we issued $400 million of bonds, including $275 million of 4.8% 10-year bonds in the institutional market and $125 million of 5% and 8%, 5-year non-call 3 bonds in the retail market. While we are satisfied with the cash coupons on these financings totaling $19.7 million per year, the all-in annual cost of these financings, including non-cash amortization of fees and losses related to an interest rate hedge will be higher at approximately $23.7 million per year. With the $400 million capital raise and our $350 million revolving credit facility, which had only $50 million drawn as of June 30, our balance sheet retains significant financial flexibility to meet our financial obligations while executing on our growth strategy and allocating capital to enhance shareholder value. Assuming $400 million of debt, our debt-to-EBITDA ratio, including Landmark, will move closer to our target level of 1.75x to 2.25x debt-to-EBITDA.

We also continue to actively manage our capital. On September 30, we will pay our quarterly dividend of $0.08 per share to shareholders of record on September ‘16. This dividend rate reflects our standard 25% payout ratio. Likewise, as of June 30, we repurchased a total of 921,740 shares in the open market at an average price of $13.22 per share. We continue to believe that we have the financial capacity to buy up to an additional $150 million of shares in 2016. Given our lower public trading volumes as well as the opportunity created by our parent’s managed separation exit strategy, we are more likely to use this buyback capacity to repurchase shares directly from our parent under the terms approved at April’s Annual General Meeting. This directed buyback strategy will enable us to put more of this money to work in a more efficient manner, but obviously depends on our parent’s timing and objectives and cannot be guaranteed.

Also, related to the expected separation from our parent, in June, we adjusted the seed capital and DTA agreements that have been in place since our IPO. As a result of these revised agreements, we will bring approximately $35 million of seed capital on balance sheet at the end of August and up to another $100 million on balance sheet in June 2017. With our recent financings and revolving credit facility, we clearly have the liquidity to fund all necessary seed and co-investments in our business. We will continue to work with our bank to determine the most efficient means to finance these seed investments as June 2017 approaches.

We have also adjusted the current DTA agreement with our parent. Under the original agreement, from late 2014 through 2019, we agreed to pass-through realized tax benefits to our parent related to certain deferred tax assets. In 2020, we were supposed to repurchase any remaining DTA benefits. Under the revised agreement, the pass-through will continue through year end ‘16, at which point we would value the remaining expected DTA payments from 2017 to 2020 at 8.5% discount rate and pay for these assets in June 2017, December 2017 and June 2018. The final cost of the DTA repurchase will depend on our usage through the rest of 2016, but we are expecting our total 2017 and ‘18 payments to range from $135 million to $145 million. Our parent has indemnified us for any changes in tax law or audit risk related to these DTAs. So this transaction is entirely a financing arrangement, where payments made in 2017 and ‘18 will come back to us in cash tax savings in later years, either the seed arrangement nor the DTA arrangement is expected to have a meaningful impact on our ENI results.

Finally, I would like to give a bit more perspective on the financial impact of the Landmark transaction. As I have discussed our key metrics, I have tried to indicate the impact of this investment on our business. At the time we announced Landmark on June 14, we indicated that we expected the transaction to be up to 12% accretive to 2017 standalone EPS. The ultimate impact and level of accretion will be driven by future fundraising at Landmark, which we expect to begin this fall following the closing of the transaction later this month.

Based on Landmarks’ financials today, before any additional fundraising, the transaction should deliver about half of the maximum targeted accretion levels or approximately 6%. A fundraiser in line with past 2013 to ‘14 levels would achieve most of the 12% accretion level in 2017 with an increased level of fundraising generating even higher earnings pickup. This accretion can be decreased by about 1% to 2% once the net cost of the earn-out is factored in at the 2-year anniversary in 2018. The full earn-out would require 2016 to ‘18 fundraising, meaningfully higher than previous levels. Of course, it’s difficult to predict the results of future fundraising, but we would hope that 2016 to ‘18 fundraising to meet or exceed prior levels. With respect operating margin, we are expecting Landmark to have a neutral and slightly positive impact for 2016, but depending on fundraising, this investment could improve margin by 100 basis points to 200 basis points in 2017 compared to standalone.

Now I would like to turn the call back to the operator. And Peter and I are happy to answer any questions you have.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Craig Siegenthaler of Credit Suisse. Your line is open.

Craig Siegenthaler

Thanks. Good morning.

Peter Bain

Good morning Craig.

Craig Siegenthaler

So just trying to run the numbers during the call, but over the next 2 years, it looks like you need about $515 million to fund the seed portfolio repurchase, the deferred tax agreement and then also the Landmark acquisition and then you raised about $400 million of extra cash just from the recent debt deals, what I am wondering is, are you going to need to do another debt raise or some other financing for this and then also how should we think about free cash flow after dividends over the next few years going through its buyback, so I am just trying to weigh all these things together?

Peter Bain

Yes. I will do the quick fundraising. Steve can talk about cash flow with you Craig. But from our perspective, we have got the $4 million in the bank. We have got all of our operating cash flow after dividend, which is substantial because as you know, our dividend payout ratio is only 25% and we have $350 million of incremental capacity on the revolver. So from our perspective, just accepting the numbers that you laid out, the five and change, we have got more than enough liquidity to cover it, so we are not troubled by it. We might go into the market and do financing activities we felt that were favorable. But we are well positioned to cover everything we need to do.

Steve Belgrad

I think the other element here and that’s what I referenced in talking about seed capital is that the – even if you assume seed capital at $135 million, that doesn’t need to be financed entirely on balance sheet. There is a potential to finance that off-balance sheet on the non-recourse basis, which would significantly decrease the actual cash and leverage related to that funding. So, we have that as well. I think as usual and as we have done from where we are right now the decision of buyback versus other uses of cash is really based on where the stock price is and what alternatives we have. I think, we continue to explore and try to build out new affiliates and that clearly – I wouldn’t expect anything for the remainder of this year in that front. I think as we move into next year, we are continuing to build up dialogue. And I would think it would really be in connection with another strategic investment that we would be more likely to think about other financings to finance that. And that could be depending on what our leverage ratio was at the time and the size of that transaction that could be debt or it could be some combination of equity credit and debt. But that would be a fact-based decision we would make on the basis of the capital markets at the time as well as the economic value of the particular acquisition we have been talking about. So, our sense is the market will understand that at that point.

Craig Siegenthaler

Got it. Very helpful. And then just a follow-up on modeling question on interest expense, you raised both bond deals just recently, but the retail bond I believe is going to start accruing interest in the third quarter and it’s a quarterly basis going forward, the institutional bond is semiannual and I think that’s probably December and then again in the June quarter of next year. So, you are going to have a situation where interest expense is stepping up in the fourth quarter stepping down in the first quarter and then sort of sell on, right?

Steve Belgrad

No, I mean, I think we are just accruing it. From a financial point of view, we are just accruing it from when we borrow the money.

Peter Bain

So, it won’t be related to the cash out, Craig.

Craig Siegenthaler

Got it, got it. So, it’s just steady, okay.

Peter Bain

Yes.

Craig Siegenthaler

Alright. Very helpful. Thanks, guys.

Steve Belgrad

Yes.

Peter Bain

Okay, sure.

Operator

Your next question comes from Bill Katz from Citi. Please go ahead. Your line is open.

Bill Katz

Okay, thanks. Good morning, everyone. What I normally say is I really do appreciate the nice structure to your calls, it’s very helpful. First question I have is just on the hard asset disposal, as you look out over the next 12 to 24 months, any sense of any large distributions you would anticipate many of the big funds, just trying to get a sense of the pace as we look out over the next few quarters?

Peter Bain

Yes, it’s a good one. I will break it into the two principal components of our hard asset businesses, Bill, which are timber and real estate. I think as we look out over the next couple of years, certainly based on our discussions with Campbell Global, we don’t have kind of on the calendar, any aggressive or active disposition targets in terms of out of the ordinary hard asset disposals there. There maybe some restructuring of some of their forestry holdings, but that really is going to be a function of their conversations with the clients who are the participants in that particular forestry holding. And on the real estate side, I don’t see substantial uptick in dispositions. Having said that in the discussions we have with Heitman, I think there is a general view that valuations in the property markets currently are pretty high, there maybe strategic reasons to harvest and realize value in some of their holdings if they think its the right time to sell the property. And if they do that, that will get reflected in a hard asset disposal. So, I think if there is anywhere where you might see some disposal activity, it’s probably on the real estate side, but I don’t see it being disproportionate jumps from where we are now.

Bill Katz

Okay, that’s helpful. And then you mentioned maybe the flows that Q1 was particularly strong and Brexit towards the end of the quarter and then perhaps maybe all the sort of discussion around the acquisitions and takeover also impacted sales trends. Can you give us a sense as you look into third quarter, anyone give specific numbers, obviously, maybe qualitatively, how RFP or general dialogue is going with investors as we think about sort of gross sales as we look ahead?

Peter Bain

Yes, it’s interesting, because I didn’t hit this detail in the conversation earlier, but I will hit it with you now to give you a little more feel for it. Steve touched on the point that our outflows tend to be relatively stable and they tend to run in that kind of 3% to 3.5% beginning of period AUM on an annual basis. The variability that you therefore see in our net numbers really tends to be a function of sales. And if you remember and I know you will Bill, but if you remember, when we announced the first quarter results and the $2.4 billion net positive, it was the result principally of the best sales quarter we have had in over a decade. We had $9.5 billion of sales in the quarter. And in the second quarter again, we had about $7 billion therefore of outflow. In the second quarter, we had exactly the same $7 billion of outflow. But the sales dropped to like four and change we had thought in the first quarter, essentially we had to some degree, accelerated some sales and the inflow activity into the quarter and that would probably eat into the second quarter pipeline, that’s certainly is what happened. Now looking at the third quarter, we don’t see either of those, what I would say uncharacteristic levels either on the up on the downside. So I think we are seeing normalized, where I will be cautious in terms of sales this quarter, is the impact of the high correlation of benchmark returns, the challenges that active managers have had delivering in the short-term benchmark beating performance and the overall global concerns. And I swear I wouldn’t say it, but I guess I will say Brexit one more time here. So the – I am sorry, let me correct myself, the 3% to 3.5% on gross outflow tends to be a quarterly number, not an annual, just that you got the number right.

Bill Katz

Okay. And then just one final question and maybe this is just equaling and you did say quantified by saying, hey, it’s all to the parent, but you were very specific that the $150 million this year, is there any reason to think that the dialogue with the parent has advanced at this point, I know they have been disposing other perhaps more difficult assets on their own side and they have a sort of 2018 timeline to bring down their ownership in OMAM, is there any sort of shift in the discussion with them that gives you a little more visibility that maybe will be 2016 revenues more open end to next couple of years dynamic?

Peter Bain

No. I would tell you that the conversation among – between us and Plc is kind of steady and consistent. I think that I mean they are working on the managed separation and they have net bank in OMAM and OM Wealth and us to deal with and they are working on all of that correctly and with discipline and kind of with the all due deliberate speed. But we had our Board meetings in London in July and we had ongoing discussions with our colleagues there. I don’t see any shift in what Plc has said. And I believe they said in their interims that their view is, they anticipate a phase to sell down of us and that could include buyback. But I don’t think our mentioning $150 million represents a change, honestly. And it’s a brilliant function of kind of how they look at the stock, it’s not a unilateral discussion, it’s really a conversation between us is that at what level we think it makes sense to buy back and at what level they are willing to do it.

Bill Katz

Well, that talent dropping looks even better, alright. Thanks so much.

Peter Bain

Yes. I mean you are right, Bill, that’s correct and everybody is cognizant of that.

Bill Katz

Thank you very much.

Peter Bain

Yes. Thanks Bill.

Operator

Your next question comes from Michael Carrier of Bank of America/Merrill Lynch. Please go ahead. Your line is open.

Michael Carrier

Hi. Thanks guys. Just on the DTA, you mentioned and we had the updated timeline, just given the acceleration, but there is also the benefits that you get from that, so I don’t know if you can frame that because I think there is one is the cash flow that you will need to do that transaction but then there is the longer term benefit, so I don’t know if there is a way to just give us any color on that?

Peter Bain

Yes. I mean it is a – it’s one of these items that from a – I just want to make sure we are clear, while there are benefits in terms of the fact we have discounted at 8.5%, so that’s a financing effectively of how the returns will come through. Those will primarily not be seen from an ENI point of view, you would really just see it on the cash flow statement. There will be – we will give more clarity next quarter, but I would anticipate that there obviously will be some financing costs related to the purchase and there will be some offsetting or partially offsetting amortization benefit of that. But from an ENI point of view, it’s not going to be that visible. So, it’s really going to be over the next sort of 5 to 7 years the usage of those cash benefits that will then come back through from a pure cash flow statement perspective.

Michael Carrier

Got it. Okay, that makes sense. And then just on the flow side, I think when we look at this quarter, it will make sense what you said in terms of the first quarter, in terms of the sales. Anything when you look at around Brexit that there are any potential things that funded that maybe slowed down in the month of June? And then probably more importantly just when I look at the buckets of whether it’s the U.S. equity, the international alternatives, when you had the conversations with the affiliates, are there certain ones where like the short-term performance is more of the way on kind of the RFP activity versus what you mentioned in terms of just some of the active versus passive impacting the industry. I mean, it seems like it’s not as impactful just given institutional money and thinking about it longer term, but I just wanted to get an update given the short-term pressure?

Peter Bain

Yes, that’s fair, Michael. Look, I would absolutely tell you that the world, the institutional world kind of paused and took a breath in June and July thinking through Brexit. I mean, everyone sort of thinks about and maybe it’s just because we spent so much time in Europe and the UK, but everyone seems to think about Brexit as having started on June 23. It’s important to remember that this is a big issue in the European markets well before June 23. And then when the vote actually came, that triggered as everybody knows an extreme response, which on the large cap side, to some degree, has been clawed back. If you really look at where small caps are relative to that, they still haven’t recovered. So yes, the uncertainty created by how European economic relationships need to reformulate themselves, that’s a part of it. It’s hit the margin, but it’s there. I would tell you on in terms of our affiliates and their conversations with their client bases and their consultants, certainly, everyone is aware of near-term performance. But as I said earlier, the kind of strategies that our affiliates have built over years of discipline, the kind of relationships that they have built with their clients and the consultant community and the very specific mandates for which they are hired, really are designed to deliver alpha over a full market cycle. And it’s an occupational hazard that I get on the phone with you guys once every quarter, because the securities laws require it. But it really isn’t how we run the business, it isn’t how our affiliates manage client portfolios and it isn’t the way the clients and the consultants think about performance. So, we have that funky kind of mismatch that we just have to live with. But as a genuine business matter, no, I am not troubled by this number on a 1-year basis because we know exactly why it exists.

And actually when you look at the performance of affiliates are delivering and look at the broader market, I got some interesting statistics that just came through on Callan’s database based on the 6 months year-to-date through June 30 in asset class segments. And if you look at it in small cap, for example, or in mid cap value or in large cap value, the number of managers who are actually beating benchmark on large cap are 11%, mid cap are 20%, small cap are 33%. This is just a very anomalous market situation where you have benchmark performance ending up looking high, but really being a function of small components of it. So, that’s the operating environment this quarter kind of trailing four quarters, that’s not the way our affiliates manage money and it’s not how they are hired, but it’s the reality of this market. And actually, I will get on the soapbox for a second, I don’t know how many you all have read the corporate governance paper put out by diamond and thinking those guys, it’s worth taking a look at it, because they are very clear in it that those of us who run public companies, we shouldn’t be giving earnings guidance, we don’t which I think is right and they are very much focused on the issue of how can we try and build long-term value for our shareholders in the context of this quarterly exercise. And we are going to keep doing it and we are going to keep having the quarterly conversation as well and we will try and do the best we can to provide you all with the balance between the quarterly conversation and the way we are trying to build the business.

Steve Belgrad

I think the other element when you look at the performance is one of the good things about having an institutional discussion with your clients is I think when you look at, particularly when you are talking with new clients, when they look at how the portfolios are positioned at this point, I don’t think it’s a hard stretch to see where the value is going to come from in the future because you are not going to have an environment where recent utilities go up endlessly forever and financials stay low, at least I think I hope that’s the case.

Peter Bain

Well, it’s true. Again, if you look at that market data Michael, the Wilshire REIT index for the first six months was up almost 12%, right. And the Barclay’s global Ag fixed income was up almost 9% over six months in an environment where the Russell 2000 growth was almost 2%, MSCI EAFE was down 4.5%. That is not a sustainable environment, those relationships will revert. Our Affiliates during that reversion will meaningfully over perform and we know that. I guess there is one more fact point or empirical data I will share with you, which is if we look through our $218 billion worth of client franchise relationships. Lastly, we look at it our sort of weighted average relationship duration with the client is over 7 years, that’s entirely logical because if you think through market cycle durations, that’s where they tend to be. So if you are talking about a business that has on average 7 year relationships with clients, you are going to have a different perspective on 1 year performance numbers and we do.

Michael Carrier

That makes sense. Thanks.

Peter Bain

And that really is how we look at the business.

Operator

Your next question comes from Robert Lee of KBW. Please go ahead. Your line is open.

Robert Lee

Thanks. Good morning guys.

Peter Bain

Hey Rob.

Robert Lee

Hi, I actually had a question, doesn’t give much talked about too much, but the fixed income assets, I mean if you look back a few years ago, it was a nice incremental contributor at least the asset growth, in the last couple of years, it’s kind of been a modest outflow. Although, if you look around kind of broadly in the industry, it seems like fixed income certainly have been getting some flows, so can you maybe update us a little bit on that initiative, which I guess was mainly a Barrow, Hanley kind of what do you think has been kind of some of the headwinds there has been performance just kind of where the types of strategies they offer?

Peter Bain

Their performance in the fixed income side is perfectly competitive, Rob. So, it’s a fair question. It’s a good one. I don’t know that I have a great answer for you other than their focus has to some degree been on LDI and LDI is a very tailored, very client specific portfolio construction discipline. And I think when you look at the way the velocity has moved in the fixed income markets generally, it has been into pretty straightforward asset classes, not LDI, so if I have any answer for you on it, probably that’s may best one.

Robert Lee

Okay, fair enough. And then maybe as a follow-up, I was just curious I mean I saw in the press release you mentioned that I guess the Plc exercise, it’s right to add a couple of more executives to the Board, so I don’t know, I mean given what they have announced or looking to do, is there any implication or anything that we should you think we should be reading into there increasing the Board size and adding more executives to the Board?

Peter Bain

Right. Ingrid and Russell, actually you should read into it, which is it’s consistent with the managed separation. There are a lot of moving parts. And we spend a lot of time making sure that we are coordinating with London. And I think we and London agreed look, rather than having this constant kind of dual track communication, when we are working with our Board and briefing them and having normal governance. And then we sort to have to replicate it to make sure that London is in the loop on everything. Ingrid is the FD she is talking to Steve all the time, Russell is Council, he is working through the legal implications of separation questions, it’s just so much more efficient for them to be on the Board, so that everyone is in one room and we can just get this done right. That is absolutely what’s driving it, what you should read into it, it’s just to do this better.

Robert Lee

Okay, great. And then maybe just one last question or actually I have one or two last questions, but on Landmark, I know you have talked about them kind of entering their next fundraising cycle and I know there is a limit you could talk about that. But their existing funds, are those largely fully invested, so that once you kind of close and may get started, it should be relatively quickly that they kind of raise the assets and kind of turn them on and start generating fees or they have kind of first starting the fundraising then it’s kind of another year or so before you could start turning on fees?

Peter Bain

Yes, it’s good question. The most recent cycle of fundraising was completed and those funds are well deployed. So, your first premise is correct, Rob. And then the way these funds are structured, when you have the closings, you start collecting fees on committed capital immediately. So, the issue of deployment is actually not relevant to the way it will impact our economics. Those fees will start flowing through revenue immediately upon the closings. And without – and I appreciate you are caveating for me in advance, without falling into the trap of offering securities on this call, which I am not doing, yes, they are well positioned to start that fundraising cycle promptly upon closing.

Robert Lee

Great. Then one last question for Steve, if you make the – and I am sure you hope you do, if you make the follow-on payments to Landmark in a couple of years, so those will also generate some incremental tax benefits those follow-on payments?

Peter Bain

Yes, they would. You would have the same 15-year amortization of the intangibles as well as the potential to re-lever some of the intercompany debt which creates tax benefits.

Robert Lee

Okay, great. Thanks for taking my questions.

Peter Bain

Yes.

Operator

Our last question comes from the line of Michael Cyprus of Morgan Stanley. Your line is open.

Michael Cyprus

Great, thanks. Hi, guys. Just curious how you are thinking about your cadence of M&A as you are thinking about it, should we expect one sizable deal every couple of years, just trying to understand the likelihood of you guys transacting every say 1 to 2 years as we think about earnings and growth coming through?

Peter Bain

I think, on balance, Michael, we certainly would as a core strategic component of our growth like to be in the market on an ongoing basis and we would like to see that generate a transaction and it’s interesting. I would actually tell you I think if I heard your question, right. Your question was would we like to generate a transaction every couple of years, I would almost like to flip that and say we would like to generate a transaction or so every year. Now, currently, we have got Landmark, which is fantastic. We now do need to work through getting that successfully closed this month and then having it integrated and working correctly. And we also have managed separation to manage through and other things at the moment, but in a steady-state ongoing basis, yes, I think we would like to be in the market and get something done every year.

Michael Cyprus

Great. Now, private credit is an area, I know you have spoken about in the past in terms of an area of interest, is there any color you could share with us in terms of the properties that you see out there, are there lots on the box for sale, a lot on the sidelines, how those conversations are going, just anything you could share with us about that space, because it does seem like you are not the only ones that want to get involved?

Peter Bain

Yes, I think that – I think there are good firms in the space. I don’t know that many of them are for sale. I don’t know that we are particularly interested in buying one that’s for sale. I think we like firms that aren’t for sale that decide it makes sense to partner with us. That certainly drives our thinking on it. And look to the extent, there has been some activity. I would point you toward the collateralized loan obligation space, the CLO space. And I think that’s really driven by changes in regulatory framework. There have been implemented some essentially what are some capital employments, some co-investment capital requirements in the CLO business. And I think that has led some privately owned CLO managers to seek out partners who provide the kind of balance sheet backdrop to support the new regulatory environment for CLO business. But other than that, I wouldn’t tell you that I think that there are necessarily a number of firms actively for sale.

Michael Cyprus

Okay, great. If I could ask just one last question, given you have more of an institutional band with your business, just curious how you are thinking about the growth overall in the industry on the institutional side? There have been some reports that suggest that actually most of the growth over the next decade could be perhaps more likely on the retail side, just curious how you are thinking about sizing the institutional market and how you are thinking about the key drivers over the next 5 years, 10 years organic versus share shift etcetera?

Peter Bain

I think that there will be – in the institutional segment, I think there will be substantial growth. And as you carve it up, I think that we believe there would be greater growth in the non-traditional asset class categories, which is I think a part why we are so interested, which is why we are so pleased to be partnered with Landmark to state the obvious. But I think that there are more opportunities in those alternative asset classes in the institutional space, because I think the institutional world is going to need to find ways to generate meaningful outflow in non-correlated asset classes to hit their funding requirements. I think that it will be more likely in the traditional long only classes where you see the money and motion being principally, but not exclusively replacement searches. That’s how I kind of carve up the institutional space, Michael.

Michael Cyprus

Super. Thank you.

Peter Bain

Yes.

Operator

This concludes our question-and-answer session. I would like to turn the conference call back over to Peter Bain.

Peter Bain

Thank you. That’s really what we have this quarter. It’s an interesting environment to be running a long-term business and we will continue to run a long-term business. Thanks for joining us and we look forward to seeing you over the next few weeks in meetings. Goodbye.

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