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Focus Financial Tries to Calm Nerves After Reporting Heightened Leverage

Second-quarter revenue surged 30%, but the serial acquirer of RIAs said it needs more cash than it expected to take advantage of M&A opportunities this year.

Focus Financial Partners, the serial acquirer of RIAs that went public last summer, attempted to calm the nerves of investors and analysts Thursday after reporting that its leverage ratio rose in the second quarter.

The company is growing rapidly as its 63 partner firms, which Focus takes an equity stake in, are doing more mergers and acquisitions themselves. Revenue in the second quarter jumped 30.3%, year-over-year, to $301.5 million, and fee-based and recurring revenues have nearly doubled since a year ago.

Focus posted a loss of $41 million in 2018 but it has been modestly profitable so far this year. It reported net income of $247,000 through June 30. 

Non-GAAP net income of $41.2 million was 42.1% higher year-over-year in the second quarter. Adjusted net income per share increased 37.5% to $0.55.

The market initially cheered results. The stock, which closed Wednesday at $24.93, opened sharply higher, trading as high as $28.07 in early trading. It then quickly surrendered those gains and closed 2.9% lower. 

Rudy Adolf, Focus Financial Partners’ founder, CEO and chairman, said during Thursday’s analyst call that revenue is currently the most valuable measure of the company’s performance. But the company’s leverage ratio – its borrowings outstanding relative to cash and equivalents – creeped above four times in the second quarter and piqued the interest of analysts.

At the end of July, Focus said it took advantage of a positive credit environment and closed on an oversubscribed, incremental $350 million term loan, raising $50 million more than it announced it was originally seeking. The loan will be used to pay down the company’s revolver and give it more “dry powder” to continue to pursue attractive deals at will.

“Is there any level that you guys are uncomfortable at?” Michael Carrier, an analyst at Bank of America’s Merrill Lynch, asked about the leverage ratio.

Executives did not declare a specific leverage ratio that would cause discomfort but Focus CFO Jim Shanahan reminded listeners the increased leverage was “accretive” and necessary to fully capitalize on opportunities. The “benefits of pursuing unprecedented M&A opportunities outweigh [the] drawback of increase in leverage above 4x” the company wrote in its earnings presentation.

“We’re very comfortable where we are,” Adolf said. “We feel that we are in a good spot and very much sustainable spot. Clearly we generate a lot of cash flow.”

Focus and its partner firms have 32 pending or completed transactions year-to-date in 2019, already beating the 25 total deals made in 2018. The company primarily uses cash to pay for other firms and said it has no plans to issue equity in the near future, unless in connection with M&A transactions.

Shanahan and Focus Chief Operating Officer Rajini Kodialam said at the Capital Markets Financial Technology Conference in June that the company estimates there are 1,000 more potential partner firms in the market. Focus has not pegged that objective to any timeline but exudes the confidence that it will get there.

“Our model, and we firmly believe the results are demonstrating it, is clearly superior,” Adolf said Thursday. “Quite frankly, we firmly believe that we are the only game in town. There is no one else that can do what we do.”