Focus Financial Partners reported strong revenue growth and improved margins during the third quarter, despite the market correction, and the firm continued to see momentum in its M&A activity.
Focus closed on nine RIA transactions during the third quarter, including two new partner firms and seven mergers on behalf of partner firms. Year-to-date, the firm has either closed or announced 24 deals, including five new partners and 19 mergers.
“Our experience is that M&A in this business is secular not cyclical because the primary catalysts of consolidation—succession and the need for scale—are not market dependent,” Focus CEO Rudy Adolf said on an analyst call Thursday morning. “Even extreme market volatility—like what we saw in ’08 and 2020—tends to only delay transactions leading to catch-up periods of high deal activity. This industry continues to under-consolidate, which is amplified by current conditions. We remain beneficiaries of these dynamics, which is evidenced by our transaction volumes year-to-date. This year will be one of our strongest for M&A activity overall, as well as one of our most active years for mergers on behalf of our partner firms.”
Overall, industry transaction volumes remain at high levels, but Adolf said they are seeing a softening in multiples and more flexibility in structuring the transactions. Last year was an unusual year for M&A activity, but there are signs it’s getting back to normal, he added.
“Sometimes I call it ‘amateur hour’ because there were some very aggressive competitors,” he said. “They’re all gone from what we can tell, and we now see a more rational and more kind of constructive market from an M&A perspective.”
Looking into next year, he said it will likely be a solid M&A market.
Focus is particularly well positioned to take advantage of a larger industry trend; specifically, while year-to-date sales of $1 billion-plus RIAs have moderated, M&A activity among RIAs with less than $1 billion has increased 54% year-over-year, Adolf said, citing research from DeVoe & Company.
“The flexibility of our model, which enables us to acquire on a direct basis on behalf of our partner firms in the form of mergers, positions us to benefit not only from strong industry volumes, but also from changing seller dynamics,” he said.
In an interview with WealthManagement.com, Adolf said about two-thirds of the firm’s 87 partners are interested having smaller firms join them.
“Partners join us because they want to tap into our M&A expertise and into our capital, to do these merger transactions,” he said. “It’s really something we’ve invented in this industry. We can really take advantage of this dynamic in a very powerful way.
“Focus has a solution for just about anybody in this industry because we have such a diversified set of partner firms that all can tap into our capital and M&A expertise,” Adolf said. “When you’re a much smaller entity, you only can have a fit with a limited set of partners. We have such a broad set-up that we really have a solution for anybody who is qualified to fit into our business models.”
When asked about the market impact on Focus’s business, Adolf said it’s during volatile market conditions when fiduciary advice is most needed. He also cited research from Cerulli Associates that show RIAs outperform in post-crisis periods, increasing industry managed asset growth rates by 60%-70% versus their compound annual growth rate of approximately 10% per year in normalized markets.
He said he expects the markets to remain volatile for the next several quarters at least, but Focus will use it as an opportunity to position itself to accelerate growth as markets recover.
“Our decentralized approach to partnering with entrepreneurs enables us to remain nimble in how we manage our business, and positions us and our partners to take advantage of the opportunities on the horizon,” he said.
Matthew Crow, president of Mercer Capital, a business valuation and financial advisory services firm, said M&A in the RIA space is both secular and cyclical.
“Adolf is right that certain consolidation pressures persist despite a challenging environment,” Crow said. “But there are alternatives. Sellers can do a minority transaction to ameliorate near term issues and buy time to wait for a better time to sell out entirely.
“Maybe ‘amateur hour’ is over, but there’s still plenty of competition for good targets,” he added.
Overall, Focus reported third quarter revenue of $519.9 million, up 14% year-over-year, which beat analyst expectations by $16.45 million. The firm estimates that about 76% of total revenue was correlated to the markets. Adjusted net income excluding tax adjustments per share was $0.86, up 2.4% from a year ago. Focus had an organic revenue growth rate of 3.4% year-over-year. Adjusted EBITDA was $128.7 million, up about 13% from a year ago.
