Malcolm Gladwell’s Outliers: The Story of Success describes outliers as people who operate outside the normal range of activity, which helps them become successful. Ruediger (Rudy) Adolf, the founder and CEO of Focus Financial Partners, is in his own way an outlier as his company is the first – and only – publicly-traded pure-play RIA aggregator.
Focus Financial, founded in 2004, went public last July, and trades on the Nasdaq under ticker FOCS. The company’s stated mission: “We want to be the partnership of choice for entrepreneurial, growth-oriented, fiduciary, wealth management firms.”
In 2018, Focus reported revenues of $910.9 million, an increase of $248 million, or 37%, from a year earlier.
Focus Financial, which has acquired 63 partner firms, operates like a private equity firm, except it makes long-term investments. The company encourages the firms that it acquires to operate autonomously, with limited meddling, just as Warren Buffett treats companies owned by Berkshire-Hathaway. Adolf has described Focus Financial “as a hybrid of private equity plus a strategic holding company, the Berkshire Hathaway of capital management.”
A February 2017 Harvard Business Review article said Focus Financial’s acquisition strategy was designed to increase the efficiency of acquired firms, and boost access to capital to pursue growth opportunities, while diversifying ownership.
However, Focus Financial has been beset by two vexing issues: debt and a weak stock price. Until it reduces debt, its share price may continue to remain under pressure. In the low-$20s, the stock price is far below its 52-week high of $49.52, and $33 IPO price.
This month, Focus Financial announced that second quarter revenue rose 30% to $301.5 million. The company earned $3.1 million, compared to a $7.6 million loss a year earlier. Fueling the growth was $41.5 million of revenue derived from its partner firms. The company, valued at about $1.5 billion, has $1.1 billion in debt.
Interviewed on the 28th floor of his midtown Manhattan office, Adolf, in a blue-checkered shirt, grey jacket and jeans, looked relaxed and was eager to chat. Born in Innsbruck, Austria, he moved to Munich to work for McKinsey & Co., before moving to the U.S. in 1998 to work for American Express. Below is our discussion, edited for length and clarity.
RIA Intel: Most fiduciary wealth management firms prefer to stay private, but you took Focus Financial public last year. Why?
Adolf: There were three reasons to take the business public. We wanted to have access to public currency. We wanted balance sheet flexibility that you only have with a public company. And we didn’t need it in the U.S, but internationally, it was quite important, the credibility of being a U.S. public company. And now 12 months into the journey, each of these three things has added value to us. There are deals we couldn’t have done without the public currency. For example, we paid $235 million for our acquisition of Loring Ward at the end of last year (which merged with our partner Buckingham Strategic Wealth) based on 50% equity and 50% cash. We would not have been able to do this deal without having the public currency (equity). We could have taken the firm public many years ago and were ready in many respects, including the scale, but I think we picked a pretty good time.
Why was the timing ripe in 2018?
We had tremendous underlying business momentum before we got into the IPO process. Every quarter we announced earnings, we were up well above 30%.
Public companies are under constant pressure to grow and please investors. How does this pressure feel after being private?
If you don’t grow, you die. It’s the world of capitalism. I wouldn’t think there’s any real difference from an overall business perspective. The quarterly is for public companies. As a private company, we could take a longer perspective. We guided the market in the IPO to 20% revenue growth and 20% adjusted for income per share growth. That’s high guidance and we’ve been surpassing it every single quarter since the IPO. I think we are well-positioned to keep growing at very attractive rates.
In the second quarter, revenue spiked 30%. To what do you attribute that?
One is our “same-store” growth for each of our management companies, a portfolio of 63 companies. Ultimately, we’re a holding company for 63 companies. It contributed 18% growth. I attribute it to the fact that we simply have an excellent portfolio of partner firms on their own. Then they tap into the expertise and capability of the holding company and grow the holding company by M&A transactions.
At a recent financial conference, a Focus executive said that there are some 1,000 RIAs that you and your affiliates could conceivably acquire. If that is the case, why hasn’t the stock performance reflected that story?
I think I said that at a conference. The reality is we are operating in an unlimited market. We have done 150 to 170 deals since 2006, but 17,000 RIAs exist in the industry, managing close to $5 trillion in assets. There’s a huge market. Year to date, we’ve done 32 deals. Of which six were large-deal holding companies, and the balance of 26 were merger transactions on behalf of partners. What’s holding the stock price is one concept, and that’s leverage. We use leverage or debt to fund the balance sheet and at this time in the market, it’s more challenging to operate at higher leverage levels. We’re comfortable with it. The market, ultimately, I am convinced, will be comfortable as well.
You’re carrying a debt load of $1.1 billion debt. That’s a lot of money. You seem to downplay it. Why?
The leverage we mentioned in the quarterly earnings was $4.05x. Given the quality of our revenue streams, and structure of protection we have in agreements with our partners, that’s a conservative position of the underlying portfolio. For clients, this is a good number. And when we use cheap capital, and deploy this kind of capital, this results in attractive returns for shareholders. Right now, not everyone agrees.
Focus has characterized its affiliates as laboratories for testing new ideas and practices. How does that work?
Focus is all about partner firms. The ultimate belief is we can help them accelerate growth. The average growth for a partner firm after they join us goes up about 13%, very much at the top of the industry. The value-added program is we have these laboratories and work closely with our partners, observe what’s going on, work with them on projects and deals, and 60% of our partners firms make deals. It’s a two-way interaction. They’ve been running their businesses for many years. We can learn from them. Just because we wrote the check doesn’t mean we’re smarter. We’re adding some parts to the equation, and they add other parts.
Can you name a couple?
Event marketing is very important. We help them with events. Our job is to observe what works. They are at 200 client events a year. This is the type of thing that we do, get better, and do again. We learn how to run these events, how to systematically and professionally follow-up on these events. Some focus groups are as small as 15 to 20 people and some have hundreds. It’s a real skill that this industry quite frankly doesn’t sufficiently have. We also work on large technology migrations. Every time you do one, you learn a lot. We’ve done 80 to 90 of these migrations. Cybersecurity you need to be very focused on and see what the best practices are.
Given that you’re the only public fiduciary wealth management firm, whom do you see as your competitors?
We like to think what attracts 63 partner firms to us is three things. We protect their culture, their entrepreneurial approach and don’t turn them into our brand. Ultimately, we protect their closeness to their clients. We’re a value-added source. And we have a successful track record. If you are a successful RIA and want to protect your culture and want capital, Focus is the only game in town. There is nobody who has this value proposition. If you’re a large firm, you can sell to private equity. But private equity is temporary capital. Ours is permanent capital. So, you’re selling yourself to a PE group and then they sell again. They control it, and you’ve basically lost control of the business.
Given that who are your key competitors?
One would be private equity firms. Next would be intra-industry consolidation: one RIA buying another RIA, usually with equity. The difference here is we have big pockets and operate on a larger scale and have a value-added proposition. They usually have none of that. Third is some aggregator and other initiatives who look to do what we do, but they have different approaches and operate at a fraction of our scale with much less existing capital.
You try to leave the companies you acquire independent and autonomous like Warren Buffett does with his holding company. Why?
When we designed Focus on my kitchen table, we spent a lot of time studying Berkshire Hathaway’s business model. We read their shareholder letters and tried to learn from their approach. I saw Warren Buffett operating when I was at American Express, and when you find the right type of entrepreneur or executive and they have a long track record of success, you can make an attractive investment and job number one is to just get out of the way, as Buffett once said. Unlike Berkshire, because they can invest in any industry, we are focused on one industry. And therefore, our ability to add value to our partners is simply superior. Having said that, the low cost of capital is one of those value components that Buffett brings to his company and we bring to ours. In a humble way, it’s a similar philosophy and investment paradigm.
The whole industry is consolidating. What advantages do you see when they consolidate?
The industry is growing significantly. I never subscribed to this theory that today there are 17,000 firms and ten years from today there will be 500. Scale enables you to do more things but scale in a smart way. The numbers are clear: larger firms are growing faster and operating at a higher margin and serving higher net worth clients. And therefore, what we do when we help our partner firms, we help them get into this billion-dollar or $2 billion size, so you’re operating at a level where benefits of scale can start to kick in. What we don’t do is scale for scale sake. Unless three’s value for being bigger, scale means specialization, and specialization means expertise.
You say you can spur growth when you buy firms. What are the keys to helping them grow their business?
We don’t do turnarounds. We only buy well-run, good firms. In most cases, the infrastructure and how they operate is geared to high single-digit growth, maybe in low double digits, 8%, 10%, 12% growth. Just anyone in this industry can reach those levels. But if you want to go into 15% levels, like ours at 15.4%, and if you want to grow at mid-double digits, you need better infrastructure, better incentive systems, and run this business in a much more systematic and scalable way than you would have to do when you were $500 or $700 million firm. That’s what we can do for them.
Two years from today, where do expect Focus Financial to be?
We will continue on our growth projection of 20% revenue, and 20% adjusted gross income. We’re committed to executing at these levels. If history is any guide, maybe higher. We’ll probably be more international than we are today, not massively, but Canadian and Australian initiatives are going very well. We will have developed our value-added programs on the next level of sophistication. We will take more advantage of our scale. But what will not change is this “Buffettonian” approach to the industry and decentralization. We’ll continue to have the most attractive cost of capital. This is a $5 trillion industry. And that’s just RIAs, who control $1.3 trillion of assets, and the brokerage world is another $1.3 trillion. In the next 10 years, it is likely that almost $2.5 trillion will change advisors. What an unbelievable opportunity and no one is set up to take advantage of it like us.