I am surprised to see Invesco Ltd. (IVZ) is currently trading at around $20, as despite the company’s generous dividend policy, the share price has now lost more than 30% since my previous article just over 3 years ago. The share price fell from $32.50 at the time of publishing the previous article to just $20.60 now. Even after taking the option premium I received on writing a put option for April 2016 into consideration, I’m sitting on a substantial loss.
Fortunately, Invesco is paying a generous dividend ($1.20 per year), and this does soften the blow somewhat. But how sustainable is the 6.1% dividend yield? Let’s find out.
The share price is still weak, as Q3 didn't meet expectations
Invesco’s Q3 results were somewhat disappointing, as the total revenue increased by just 0.3%, which is a much lower growth rate than in the first half of the year. It’s also interesting to see the lower investment management fees (-2%), while the service and distribution fee revenue increased by almost 14%. On top of that, the total revenue from performance fees nosedived (-81%), so I’m not too impressed with the company’s revenue in Q3.
(Source: SEC filings)
To make things even worse, its operating expenses did increase by approximately 4%, and this resulted in a 10% lower operating income. Again, a very disappointing performance considering Invesco’s total operating income increased by 13% in the first half of this year. The only thing that allowed Invesco to post a higher net income and EPS was the much lower tax bill. The company had to pay just $61 million in corporate taxes, compared to $123 million in the same quarter last year. This resulted in an attributable net income of almost $270 million, or $0.65 per share. A decent result, but definitely not impressive, and the lower corporate tax rate is the only reason why the reported EPS didn’t decrease by a double-digit percentage.
(Source: SEC filings)
Invesco’s operating cash flow was $662 million in the first nine months of the year, but after removing the changes in operating assets and liabilities from the equation, its adjusted operating cash flow was approximately $999 million. After deducting the $68 million in capital expenditures, the company’s free cash flow result was roughly $930 million, or approximately $2.15/share. That’s approximately 15% higher than the reported net income, and the majority of this difference could be explained by the lower capex (compared to the depreciation charges) as well as the rather substantial $124.5 million stock-based compensation.
The company has announced a $1.2 billion share repurchase program, and the existing (and incremental cash flows from the OppenheimerFunds transaction) should be sufficient to cover the cost of the buyback program. The total cost of the dividend is approximately $495 million per year, so there’s plenty of money left on the table to fund the share repurchase.
The Oppenheimer acquisition will add even more value
A few months ago, Invesco said it was planning to acquire OppenheimerFunds for approximately $5 billion. Seeking Alpha Contributor Financial Alphas provided his first look on this acquisition, and now that there’s more information available, I do agree this move could be a game-changer for Invesco.
During the Q3 conference call, the company confirmed that the purchase will "rapidly advance the strategy," as the OppenheimerFunds are a very resilient and robust business. Additionally, the strong relationship with MassMutual will perhaps open new potential markets for Invesco’s products to be distributed.
The transaction does come at a steep price though. Invesco will issue 81.9 million new shares ($1.65 billion), as well as $4 billion in perpetual preferred shares (non-cumulative) with a 5.9% coupon. The company will not be able to "call" these preferred shares within the first 21 years after issuing them.
(Source: Company presentation)
It’s an interesting funding strategy, as it means that: A) MassMutual wants to have a meaningful relationship with Invesco by taking stock and preferred stock rather than hard cash; and B) although paying 5.9% seems to be high, one should keep in mind the preferred shares are perpetual in nature and non-cumulative. So, for Invesco, it’s an interesting way to add long-term funding to its balance sheet at a cost of less than $250 million per year.
But what does Invesco receive in return? It will take the reins of a $250 billion AUM fund manager and expects this deal to be immediately accretive after closing. The company is expecting an impact of $0.38 on its EPS in 2019 (based on OppenheimerFunds starting to contribute to Invesco from April 1 on) and $0.80 from 2020 on. I would assume these calculations include the cost of the preferred dividends.
The company is expecting to incur $450 million in non-recurring expenses related to integrating OppenheimerFunds into its existing corporate structure, but as it also expects to generate $475 million in annual synergy advantages from the third year on, this deal makes sense on all levels. The $475 million in synergy benefits will push the total expected incremental EBITDA to $1 billion, which makes the acquisition a pretty good one. Invesco is paying almost 11 times the pre-synergy EBITDA but just 5.5 times the post-synergy EBITDA, and that’s a very fair price.
Q3 wasn’t good for Invesco, but I’m very optimistic about the recent acquisition of the OppenheimerFunds. I don’t necessarily agree with issuing 5.9% preferred shares, as a straight debt-funded cash payment would have been cheaper, but the perpetual nature of the preferreds is a clear positive for Invesco’s long-term funding mix.
And due to the lack of cash outflow related to the OppenheimerFunds deal, Invesco can now repurchase $1.2 billion worth of stock over the next two years. This represents approximately 55-60 million shares at the current share price, and even after taking the 81.9 million shares to be issued to MassMutual into consideration, the total post-repurchase and post-transaction share count will be just 435 million shares. This means that, should the $1 billion in annual post-synergy EBITDA guidance be met, Invesco will generate about $6/share in EBITDA. Considering the company’s net debt (at the corporate level) is just $1.2 billion, its Enterprise Value will be just over 4 times its anticipated EBITDA. That being said, the AUM decline in October could mark a new trend, and this could have a major impact on Invesco’s performance.
I’m sitting on a 30% loss, but I’m confident in Invesco’s future, so I will add to my position. I may combine an open-market purchase with writing put options, although I’m leaning towards writing a few in-the-money and out-of-the-money put options, as the option premiums are quite attractive.
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Disclosure: I am/we are long IVZ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.