LPL Investment Holdings Inc. (NASDAQ:LPLA)
Morgan Stanley Financials Conference Transcript
June 13, 2012 8:00 AM ET
Mark Casady – Chief Executive Officer
Thomas Allen – Morgan Stanley
Thomas Allen – Morgan Stanley
So I’m Thomas Allen. I’m the lead analyst on LPL Investment Holdings. It’s my pleasure to introduce a company. I’m sure you all know their story, but they are leading independent broker dealer. They service about 17,000 financial advisors that benefiting from the trend two independents from traditional firms.
They service both fee and commission based assets for the key differentiator. Today we are lucky to have Mark Casady, the CEO. He has been CEO since 2005. Mark has done a great job managing the company through a number of acquisitions. He sits on the Board of FINRA and we are very happy to have him. So thank you Mark.
Good morning, everyone. Nice to see you here this morning. I want to go through a presentation and happy to take questions as we go through. Oops, I want to go through the Safe Harbor quickly, that’s usual disclosures related to forward-looking statements and such for the company.
Let start with an overview of LPL, basically we are on a mission to make sure that advisors are well-positioned to provide financial advise that unbiased and conflict free to basically middle income consumers. It’s a wide range of consumers they serve, well, majority as middle income, we do range from the mass market up to high-net-worth individuals.
We think the advisor as our customer and we are the largest independent broker dealer, that’s our legal structure for how we serve those advisors. The next competitor is 40% our size and the next one after that is 20% our size. So we are a dominate market leader within the independent broker dealer space with over $350 billion of client assets that we oversee.
We are the number one provider to banks and credit unions of white label brokerage services, meaning that we go into the bank and employees the bank use our brokerage capabilities and advisory capabilities to serve the banks clients, but they are employees of the bank and we have oversight for their activities. There is nearly 700 banks in credit unions that we serve today.
We are also leader in defined contribution space with something like 25,000 plans, roughly 2 million participants at about 60 billion of assets, that’s outside our 350 billion of consumer retail assets with some additional 60 billion of 401(k) that’s been a part of our story of serving those who consult to 401(k) plans.
I think it sometimes easier to understand LPL little bit by what we don’t do as much as by what we do. So we use this slide to just differentiate ourselves from other competitors in the marketplace, who are providing financial advise to consumers and you can see that from our perspective, we don’t create any products, we basically have no investment banking activities, no market making securities, whether its fixed income or equities, we don’t compete with our advisor by having direct-to-consumer businesses, we fully support those who are independent in this business, there is not an employee model within our business, fully open architecture, literally thousands and thousands of products that our consumer -- an advisor can use to provide advise to the consumers that they operate with.
And more recently since the end of 2008 we’ve provided the only integrated registered investment advisory and retial brokerage platform in the country. So basically for the same fee that you would pay to a custodian, we will essentially outsource the work for you to integrate that information for your clients to be successful.
So you can see that’s competitively distinctive against the others who are in the market, who have a range of conflicts from making proprietary products to an investment banking when it comes to retail financial advise.
We think the consumer understands this better and better since 2009 market break and we see more and more situations for consumers are saying to their advisors who had employee model firm, I’d like to make a change, they understand the conflicts quite well and want their advisors to make the change to independent where they can be better served.
We think LPL has a unique growth story. We are going to talk about each of these issues individually on the next few slides. But I want to pause here and talk about the very last bullet point which relates to our management team.
We did announced about two weeks ago, the appointment of Dan Arnold as our CFO, Robert Moore who was our CFO has become our President and COO, and essentially he is moving into more revenue producing opportunities as an executive for the company and continue to broaden his reach and his capabilities, and helping us grow the firm.
Dan Arnold was the Head of UVEST, which is the company that we acquired in 2007. He built that business from nothing to quite a sizable competitor in the marketplace and then basically joined us through the acquisition and let a series of acquisitions to create a very large business and now the market leader serving banks and credit unions. So Dan has incredible strategic sense, really wonderful business capabilities, certainly know account, but we have wonderful accountants who work for him that will be part of the finance team and do a great job. So we are very pleased with Dan’s appointment to CFO that we announced just a couple weeks ago.
Let’s talk about some of the growth trends that we see as real tailwinds for the business kind of despite the market turmoil of today or last week or last month, the reality is there is incredible tailwinds that propel the business forward at LPL.
Number one, huge need for help by retail investors whether its baby boomers, generation -- wire generation acts who are starting to accumulate wealth as there is a tremendous need to be served for those retail advisors. And they are seeing that and that’s what we hear from them is very positive as they are seeing lots of opportunity to provided by in their particular markets.
That we see growth from those clients in a range of investment vehicles they are not after just one thing, particular stock, or mutual fund or an annuity, thereafter entire and comprehensive plan which fits very well with what it is that our advisors do in providing financial advise on an unbiased basis.
We also know the middle market is a wonderful market and that the competition is a little bit less. It’s a market that generally has been abundant by most retail brokerage firms and a number of large banks, which we think is a good thing, and there is 40 million households who were there and have an incredible amount of wealth in aggregate for us to serve. And we serve about 6 million of those households today basically 4 million through our retail brokerage platform and 2 million through our 401(k) consulting business that I mentioned before.
We also see wonderful tailwind in the form of advisors going independent. You can see this real chart on this page that talks about the market share of independent advisors going from 37% to 44% over the next several years.
Since we are the market leaders what happens when somebody decides to go independent is they are going to talk to us. So we both facilitate the action of making this happen, people going independent and we also benefit from just the trend line of individual advisors deciding to make the lead independence with their practice.
We are, as said before, leading independent broker dealer, but we are also quite sizable relative to our competition in the retail advise space, but yet, we still have relatively small market share about 4% in overall retail and just over 10% in the independent space. There is plenty of room for us to grow. There is no natural barriers for our growth in terms of number of advisors that we can serve. So you see lots of opportunity in terms of what we are doing.
We said before that we are competitively distinctive in this line up in the left hand side of the chart, because we don’t offer proprietary products. We don’t make markets. We are not an investment banking. So having that unbiased conflict remodel is unique among those top 10 players in America that’s the first thing to know.
We are also unique among independent broker dealers and then other than Raymond James no one else self clears their business for their independent broker dealer. Self clearance is really critically importance because it allows to control the quality and the cost of what it is we do for advisors and we’ll talk a little bit later about the competitive advantage that gives us in creating value for those advisors.
On the right hand side is the growth of numbers of advisors overtime, you can see it’s relatively consistent. The jump in 2007 based on the number of acquisitions that we did in that year but over this time period about 78% of our growth has been organic which I think is important to understand that the company story of growth is really much more about organic than acquisition lead.
I think the last thing I touch on is we do recruit from a number of different types of business models, over 200 different broker dealer since we like to say contribute their brokers to our independent model in any given year and those broker dealers are from a variety of business types, insurance companies, banks, wirehouses, regional firms and so forth.
So we are able to really recruit and one area is slow and there is not as many people moving from say the insurance sector that typically is the year in which the wirehouses might be moving quite a bit stronger. So it allows us to be as we think about an all weather recruiter able to move advisors into the platform consistently overtime.
We are looking our value proposition of firm. We put the four pillars up which are the way that we think about our business in the areas we invest heavily as a firm and variety of ways for marketing programs, the technology, to business consulting and essentially a whole range of services that allows to help that advisor can rate a very successful practice both when they first go independent and then 10 years later they think about their model and they want to continue to improve it.
If we look at the range of things we do including marketing and technology, we also do independent research with over 40 investment professionals that cover a wide range of products, mutual funds and annuities to whole range of alternative investments that they do.
The other thing that we are known for and a very strong in the compliance, we have a very large compliance team and its important part of we think running a very good business in this area.
So one of the reasons that I’m going to appoint a government for FINRA is because of our compliance track record as a firm and our ability to really do well by our clients, which is a good business practice and certainly helps overall in running the business from a risk management standpoint.
And how does that measure my view as a CEO of the company is in the lower left-hand box in this chart, which shows that our advisor is using something called net promoter score greatest to the 54%. That would be among the very highest in the industry. There is really three firms including LPL that are there.
The other two are quite a bit smaller than we are and that tell us that advisor’s rate is very high and they’ll recommend us to other advisors who we’re thinking are going independent and that’s what we’re after.
We started the net promoter score review in 2007. Back then we scored in the middle of pack. What we said to our clients was we will get ourselves in service, technology and capabilities to a point in which you will put us to very highest measures in the net promoter score in the brokerage industry and we've gotten there in a little less than five years. So we continue to push on that satisfaction measure.
The second measure that’s there is the in-client measuring their experience with their advisor. You can see we came in at number two in the J.D. Power’s customer satisfaction survey around the relationship that the retail consumer has with their advisor. So very good scores, the advisor to us and the client to the advisor and that’s what we’re after.
On the right-hand side of this chart is the competitive advantage when someone joins us. If you are an employee model, you can basically take home twice as much pay by going to an definitive model and that overcomes a lot of upfront money that we’ll see have, excuse me, for people who move their practices because economically it’s a better decision to take a higher payout and then build the business that you could sell several years later as a result of making changes.
This is why someone joins LPL. I think the real secret for us is the lower right-hand box which is at the end of the day, are we adding value in those four pillars that were doing for practice. Are we really making the differentiated offer?
We asked PricewaterhouseCoopers to look at that question in 2010 as part of our going to market process for the IPO. And their conclusion was that an LPL practice is 18% more profitable than any other choice that an advisor could make for affiliation of their practice. That’s a significant market lead, a significant differentiator for the firm. It’s the reason that we are able to be successful in both retaining our advisors having to be happy and been able to bring new ones on board.
We have many, many years of history as a firm. These 11 that are on left hand side really tell us two stories. One is that we’ve had very consistent top line growth, right-hand side very consistent profit growth.
The other story that’s here is if you look at 2009, we all remember that vividly. We had a 12% drop in revenues but if you look on the profit side, we have 2% increase in profits. So over 11 years, we’ve had two down years of revenues and never a down year profitability. So we’ve very consistent producer profits, very consistent producer returns over time for investors and one of it is not volatile because we’re out of the businesses that add volatility.
Investment banking, market making, product manufacturing tend to have very volatile revenues and earnings. We don't have that and therefore our business produces much more like a financial technology company that it would with typical broker-dealer.
If we look at the other point on this chart is if you look at the black line on the right-hand side that's our margin over time and that’s basically taken total revenues to profits there in the bottom. You can see that there are different times in history. We have made decision so essentially that margins erode that our actual profits increase.
We made decisions to have relatively flat years of margin. The margin shows up over time with (inaudible) consistently there year-in and year-out. And 2012, we’re certainly shaping up to be one of those years in which we’ll have, we think very little margin expansion not at all because we've done a number of things that allows us to invest forward.
So we’re a company that always wants to think about growth opportunities. We bought a number of companies in just the last year. Those companies generally have come to us with either no profits or losing a bit of money and we’re going to take a year or two to basically invest in them and turn them into kind of profit-making organization we think they can be for just most recent example of that.
It takes a couple of years to basically take that from zero profits to making some money. So you’re going to see continued pressure on margin for the business based on those acquisitions, which essentially is investing ahead of our business and let us think about new growth opportunities.
Just based on the number of calls that we received inbound some transaction, the number of proposals that we’re putting out for cross-selling between Fortigent and LPL, we know that over time that will create a very profitable and very good growth stream for us, just that could be in 2012 as we think about the business.
Secondly, when we look at this, we look at a very healthy pipeline for new advisors. You'll recall that it was about three years ago that the wirehouses in particular put essentially golden handcuffs on their advisors through a fairly significant amount of retention money about one and half times their revenues during the crisis of 2009.
At year three, that tends to start to get to a point where advisors can get up out of their chairs and leave. So we start to see a build up on our pipeline of people inquiring about moving to LPL for the definitive model. If they move that causes us to have an increased transition assistance. We’re happy to do that.
As shareholders, we’d all want to be able to spend as much as possible on [TA]. If it results in good movement of business onto the platform, we do think the shares are going to be a good movement of business for the firm. We saw that since the beginning of the year and we contended to see the pipeline building since then.
And then the final part of it, as the rising production expense. We are seeing larger branches grow faster. We talked about that in the first quarter of earnings call. That has not changed as we’ve gone forward here. They have some advantages in terms of what they do in marketing and sales that let them grow a bit faster. They also recruit more in and out of themselves. So therefore they have growth from that as well.
Larger branches tend to take more production bonus but they offer us G&A synergies that allow us to have little bit lower cost profile overtime. We’re little of sync with that right now. In my view, we’ve got a little more G&A expense against those branches growing a little larger.
We’re going to sync that up in a number of ways over the next few months as a firm. So we’ll -- we certainly acknowledge that’s there. I don’t see there is anything that we can’t overcome. It’s just part of the process of managing the business quarter-after-quarter and year-after-year.
The next slide talks about the drivers of growth. We feel very good about our 20% EPS growth number over time. We’ve delivered more than that since we’ve gone public. Again, this may be a year in which we have little bit less than 20% growth but we would certainly made it up year after that as part of our typical profile for the business overtime.
The organic growth of business for us are same-store sales which we consider to be strong in 2012 in the first quarter. So we’ve seen a nice recovery in sales then. We'll see where the market crisis extends. If there is crisis in Europe extends for another several months, we will certainly see some impact to regional consumers at some point but wouldn't say that we see it yet today in our business.
Other areas that support our new stores. So we’ve talked about before and continued new programs to sell existing advisors, new capabilities, growing a number of new software this year, open a number of new services that advisors can subscribe to and we have a really wonderful rollover service for 401(k) plan that allows basically the plan sponsor to hit a button and there participants rolls into a retail account automatically, saves an incredible amount of time, makes the process much easier, rolling out in-plan advice for 401(k) plans later this year.
Those are all things that we’ve invested in but haven't yet shown up earning that will be significant advantages over time in times of our profit growth that we see on the slide. Then we certainly see the connectivity, we will add more than that in terms of growth over time. And of course, interest rates with the low-end of the [alb] we hope in terms of win rates are.
We certainly face plenty of headwinds on relative rates, say last year to this year as it does feel that we start to get a little bit of bump back from where we're today. Overall, it’s certainly a very attractive financial model in terms of high recurring revenue, about 63%.
Our expenses tend to be much more variable. Sometimes the fixed gets little bit in there but we again are very active managers making sure that we manage those fixed cost expenses and don't take on variable expenses if we see any headwinds building in the business at all.
As I mentioned before, this is really where having our own self-clearing platform lets us control margin and continue to increase the margin of the business over time. And if you look at the business on a gross margin basis to earning, you will see that we’re an excess of 40% margins, which compares by favorably to custodians who are public in this business as well.
The last point I make is that we have strong cash flow generation as a firm. We've announced and paid our special dividend. We have an ongoing dividend that should yield roughly 1.5% per year. So we feel very good about refinancing that we've done, the dividend policies that we have and the share buybacks we announced about three weeks ago that the board authorized us an additional $75 million for share buyback.
So we will use capital to basically either take their share count, pay our dividends to shareholders but really manage that capital aggressively to get returns for shareholders. So very good about the organic growth of the business to support that.
So in conclusion, we certainly think that the greatest opportunities for growth lie ahead of us. We see a transformation in the industry towards the independent model that we’ll benefit from and the demand by consumers for independent advisors only growing and getting much, much larger and we’re very, very well positioned to take advantage of those trends.
I’m going to stop there and take questions. Thomas, you’re going to go first.
Thomas Allen – Morgan Stanley
Mark, you’ve been broadening your management team. So you didn’t mention was you had two external -- recently that you announced. And you have also suddenly or not so suddenly been growing in RIAs retirement and now you have this new venture that I think is going after younger more appellant, you have been pretty big. That’s but I think on the -- could you just talk about where you think you will be in five years, how you will envision LPL down the road?
Thank you. So I think the first part of it, from my perspective is we have to make sure the management team is fit for purpose that in a company that grows at the level we grow, you really can’t expect everyone to make the journey to the next stop. And that was really a key part of what we’ve done over the last year is making assessment of the team. I have the team members make a self assessment, some made decisions to retire, some made decisions to move to new opportunities, and some situations we decided we needed to have different talent in place.
The two key outside hires are Sallie Larsen, who comes to us with 30 years of experience in human capital, fantastic executive, there was a month and it feels like she has been with us forever. She is just great.
Joan Khoury, another wonderful executive came from a major wirehouse. She has a really wonderful understanding of the end consumer, which is something we traditionally have not had. She is our Chief Marketing Officer. She is going to do a lot of great work for us particularly around brand building, understanding, how to build brand a little bit different that we’ve done before.
So, the team is in really good shape now. That has been a frankly a fairly exhaustive part of my work for the last 8 to 12 months. As we made those assessments, probably did 50 different interviews of outside candidates in order to settle on this team and make the decisions we’ve made. So it’s a very good about where we are.
But I look forward into multiple years from now. Certainly, what I see in the business that they are much bigger business than we have today. That’s why we needed to assess the management team. And I think we are going to see multiple sources of new advisors coming on board.
One is recruiting which has always been strong and will be. But the other one is the new venture, where we will be learning to train advisors and do that for a profit. I think we have lots of exciting things to come in that area for that business. We asked Esther Stearns, she was one of the best (inaudible) managers I ever met to run that venture for us.
So she stepdown as President of LPL to become the CEO of our new venture and I hold a lot of promise for that venture in producing advisors who are trained in the second career to provide financial advice in growing demand that’s out there.
And then the core business, that I see is that the fundamental has been as good today, as they’ve ever been, been with the firm for 10 years. And I think we are still in the early innings of growth for the fundamentals of end consumer demand and advisors wanted to build on independent practice. And our ability to capitalize on that in a wide range of ways that we provide services to those practices.
Thomas Allen – Morgan Stanley
Okay. Then another from me. (Inaudible) Bachus’ bill to those of you to don’t know, it would require an SRO for financial advisor’s thoughts on it, and how it could impact the industry?
So we are very strong supporters of Bachus’ bill and house has already passed a bill that’s very similar to Bachus. We would like to gets senate to pass this one. And then we do think they are supporting the White House for this bill. And basically, what it does is does force an SRO.
We think that a consumer is best protected by having one entity that overseas all retail advice giving. Today, it’s bifurcated or [trifurcated] if there is such a word. The State overseas are some RIAs, the SEC overseas some RIAs, and federal overseas, securities license brokers.
In the end, the consumer does not understand the difference between what one -- how one is licensed and the discussion that they are having. So we think we need to have one SRO that overseas all of that and that’s essentially what the Bachus Bill asked for. So we have been heavy supporters of that, spend a lot of time on the health and a lot of time with the White House on supporting that bill. So we think that [levelizes] the industry in terms of having similar protections in place.
One simple fact, I will give you is if you look at E&O insurance, which essentially insurance that a consumer would draw upon. If there was wrong doing inside of an RIA or inside of a broker dealer, as a broker dealer I have to carry E&O insurance and everyone is protected as a result.
But in RIA, it’s optional and only 43% of RIAs carry E&O insurance. That’s means they self insured, which means the consumer is going to -- if there is fraud that’s at RIA. We think it’s a horrible public problem and this bill would really help solve things like that.
Hi. Could you talk about your past acquisitions from National Retirement to Concord and now Fortigent? Can you explain where you are in a process of integration of those two earlier ones and then what you get from -- you’re getting the type of return that you expected. And then Fortigent, what kind of -- how do you plan to grow that? How can that be revenue derivative?
So let’s start with the oldest first, which is National Retirement Partners we bought at the end of 2010. That was a broker-dealer that brought us about 200 advisors, we -- all the metrics we had for the movement integration came just as we planned. We then planned on -- giving us an advantage in recruiting, which we’ve thought, we’ve recruited about -- that when we bought, excuse me, about $40 million, $45 million worth of revenues out of that company. Again, which was very close to the model that we had at the time.
We predicted that we would get decent recruit in the second year 2011. We ended up recruiting over $40 million of new advisors on the retirement platform as a retirement partner. So we’re significantly better in recruiting than we had planned. And in 2012, when we only got one quarter behind us and we are seeing some more results. So we think that business, which was designed to do three things for monetization, one is bring new advisors of the charts here.
Number two, was to basically take our existing advisors of LPL and have them pay about $5600 fee per year to join the partners and then get special conferences, special technologies and special support. We now have something north of 400 advisors, who moved on to the retirement partner’s platforms so by the plan just slightly over what we expected so that one before.
And then third one, we don’t know yet. That’s a one where we rolling out the retail rollover and rolling out in-plan advice and that’s this year that we are doing it. We’ve seen good early results. They were about $600 million of plans that are under the retail rollover program, which is faster than we predicted but we haven’t yet seen enough to measure the rollover itself in terms of opening the retail accounts in retention of those. It will take us another year to know the third leg of that stool.
For Concord and Fortigent, what we are trying to do there, as I like the sky is being winded upstairs. In the bank today, if you think about just the physical location of the bank, the first floor is typically where the brokerage unit is and the tellers are there and all the normal things you see in the bank. And we did a great job of covering that first four today.
What happens is our clients say to us that I have a Trust Company that’s up in the third floor. We’re up on the 54 derivatives and they need exactly the same tools you have for broker dealers. But it’s a trust entities, so it requires a different technologies. And we bought Concord and Fortigent for those capabilities.
Could have built them, but it would have taken years to build them and they already have existing clients and about they can total $40 billion or $50 billion of trust assets today just easier to buy.
What we are doing now is Integrating Concord and Fortigent today under Andy Putterman. Andy is the CEO of Fortigent, great executive. He is going to really do, I think fine job in bringing together our bank trusted partner capabilities and then rolling that in.
So too early to see whether those of there concord just closed middle of last year Fortigent in April. But I feel good about the management team, which is where it starts, I feel very good about the customer feedback and what we’ve seen in our piece that are coming in that business.
And then the final piece of Fortigent’s acquisition is the high network space. They service about $40 billion of high net worth assets through their technology and through their content that’s there. And it’s content we didn’t have on our research department related to hedge funds and our alternative investments that are highly liquid, but are unique and require special skills to analyze. So we picked up a really wonderful content provider through that acquisition.
We’re already planning on rolling out in September, Fortigent in our centralized wealth management program for advisory. So we’ll specialize in the program that’s just alternative investments for our existing advisors to use. We think that will raise a significant amount of assets overtime.
So it’s still too early to tell, the financial impact that early indications are good that we can do that well. Mostly, but I am realize that we are the 26 largest manager of high network households in America, which I will tell you surprise me, when I saw the banker, the balance list you are the large, I didn’t think we acquired this larger work.
And one of the things I wanted to do is over the years, we’ve looked for opportunities to bring new capabilities into that space and again acquiring just a faster way to go there. And acquisitions are very subject to somebody wanting to sell. So we had a nice opportunity to Fortigent decided to sell, not too long after Concord so that -- that’s why we did those transactions.
Thomas Allen – Morgan Stanley
I think we running out of time, so.
Sorry about that.
Thomas Allen – Morgan Stanley
So, any other questions you can ask Mark upstairs. Thank you.
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