Invesco Ltd (IVZ) — Q3 2018 Earnings Call Transcript

This presentation and comments made in the associated conference call today may include forward-looking statements. Forward-looking statements include information concerning future results of our operations, expenses, earnings, liquidity, cash flow and capital expenditures, industry or market conditions, AUM, geopolitical events and their potential impact on the company, acquisitions and divestitures, debt and our ability to obtain additional financing or make payments, regulatory developments, demand for and pricing of our products, and other aspects of our business or general economic conditions. In addition, words such as believes, expects, anticipates, intends, plans, estimates, projects, forecasts and future conditional verbs such as, will, may, could, should, and would as well as any other statement that necessarily depends on future events are intended to identify forward-looking statements. Forward-looking statements are not guarantees, and they involve risks, uncertainties and assumptions. There can be no assurance that actual results will not differ materially from our expectations. We caution investors not to rely unduly on any forward-looking statements and urge you to carefully consider the risks described in our most recent Form 10-K and subsequent Forms 10-Q filed with the SEC. You may obtain these reports from the SEC's website at www.sec.gov. We expressly disclaim any obligation to update the information in any public disclosure if any forward-looking statements later turned out to be inaccurate.

Thank you and thank you everybody for joining us. I appreciate you changing your schedule so quickly. Some very good news, we're going to talk about the transaction between ourselves, Oppenheimer and MassMutual and also go over the third quarter results. If you're so inclined, the presentations are on our website if you want to follow along. There has been quite a bit of news in the market about this combination for a period of time, but before we get into the third quarter results, I really want to clarify some very important key points. The combination will result in Invesco being the thirteenth largest global asset manager in the world and the sixth largest manager in the US retail channel, both are very important when you think of the importance of scale and client relevance as we look forward. The financial returns are extraordinarily compelling. For the partial year 2019, we're expecting 18% accretion, in the full year 2020, 27% accretion and post synergies, we anticipate an additional billion dollars of cash flow for the combined company, so really quite extraordinary. We're also very excited that MassMutual can be a long-term strategic shareholder of 15.5% equity stake in the $4 billion of preferred, but Loren will get into details in a few minutes. What's really important is that MassMutual is not selling or taking every dollar, all the proceeds to the backing of the combined institution, showing their commitment and excitement for the opportunity in front of us. The other point I want to make is that we're going to initiate today a $1.2 billion stock buyback, which is also an important part of the discussion that we'll be having today. So with that, Loren, you can talk through the financials.

Thank you very much, Marty. On Slide 7 you'll see a summary of the results for the third quarter. We've continued to demonstrate strong long-term investment performance with 63% and 67% actively managed assets in the top half of peers over the three and five years. Our year-to-date gross sales are up 16.7% versus prior year. Market dynamics and some near-term performance challenges continue to impact redemption, leading to total long-term net outflows of 11.2 billion for the quarter. Adjusted net operating income was 358 million for the quarter, down from 377 million in the prior quarter, driven by a lower revenue yield resulting from a change in AUM mix, the negative impact of foreign exchange, and the impact of lower transaction fees. In terms of expenses, we saw some elevated marketing and technology expenses this quarter. These items also impacted our adjusted operating margin, which decreased to 37% from 38.7% in the prior quarter. We returned 124 million to shareholders during the quarter in dividends and we've made good progress in paying down the balance on our credit revolver in early October. We expect to have our leverage ratios buffer in line with our previous Guggenheim acquisition levels by the end of the fourth quarter. Moving on to slide eight, we highlight more in terms of investment performance for the quarter over one, three, and five years. As we've noted in past conversations, our investment processes and approach are focused on generating performance over a full market cycle, so we typically see fluctuations between quarters. The current market cycle is impacting the relative performance of a number of large value-based equity investment approaches, which represent more than 10% of included AUM, but some of their recent market volatility and favorable market conditions. However, the teams have seen near-term improvement as you would expect. An example being diversified dividend is now in the top decile on a quarter-to-date basis, as well as our UK equity portfolios and international growth portfolios, which are in the top quartile. Let's turn to flows on slide eight. While gross sales have been robust for the quarter, up more than 17% year-to-date for 2017, we did see net negative flows during the third quarter as market dynamics weighed on redemptions and net results. We have pockets of strength within ETFs, with nearly 1.5 billion of inflows in US ETFs, and nearly 0.5 billion of flows into our bullet share franchise, which closed to nearly 1 billion. Commodity ETFs in Europe and the U.S. were weaker in line with industry trends, which led to modestly negative paths for ETF flows for the quarter. On the active side, outflows were largest in the U.S. and U.K. retail equity products, which continue to face some challenges. Additionally, on the institutional side, we saw two sovereign wealth fund outflows totaling nearly 2.5 billion. We also saw varying outflows from an Asian client in our bank loan strategies, and there was a $1 billion real estate outflow, which we mentioned on the previous quarter call, contributing to negative flow this quarter. Despite these one-time outflows in our institutional outflows, our institutional pipeline is, in fact, at an all-time high in terms of both AUM and revenues, with AUM in the pipeline, which is funded up more than 35% versus the prior quarter, and up over 30% versus the prior year. Also, we did see very strong flows in our Great Wall JV money market product with nearly 5 billion in inflows for this quarter, and that's a trend we expect to continue into Q4.

Thanks, Loren. Now let’s turn to the transaction. We're very excited about it; it's 100% consistent with our strategy and rapidly advances the strategy that we've been talking about with all of you. On page 11, importantly, you really want to know the facts about Oppenheimer Funds, which is often not understood: the strength of that organization and how it aligns with the strategy we've discussed. The first thing we're really excited about is the strength of the organization. They have $250 billion in assets under management; 75% of those assets are hard to replicate differentiated active and alternative strategies. They have exceptional investment talent generating very good consistent long-term performance; 59% of assets are in four and five-star rated funds, and the business is financially robust with net annual revenues of $1.4 billion, a net revenue yield of 56 basis points, and an operating margin of 40%, all of which is accretive to Invesco. On page 12, I want to make it clear that our strategy is unchanged. We continue to focus on strengthening our leadership in our core markets while executing high growth areas, which we believe are necessary for future success. If you do both of these very well, you will generate a set of lead capabilities for the benefit of both clients and shareholders. What we truly believe is unique about Invesco is the combination of our leadership in core markets and our investments in high growth areas. The combination with Oppenheimer, along with our relationship with MassMutual, will meaningfully expand our leadership in the U.S. wealth management industry while also strengthening our ability to execute in several of these high growth areas. This transaction rapidly advances our growth strategy and is fully aligned with our clients' needs. A final point I want to make is that, from a context point of view, the $87 trillion in assets under management in the industry sees the U.S. wealth management segment as the largest segment, comprising 23% of global assets under management, and that segment will continue to grow. It's clear to all that it will grow, but it's important to note it will be concentrated in fewer investment managers' hands in the years ahead. The ability to have client relevance to scale is an absolute necessity. The combination itself creates a $1.2 trillion global asset manager. The vision of Oppenheimer Funds provides several benefits to our tenants, our business, and shareholders by representing a strong strategic and cultural fit for both organizations. The power really comes from four different areas: scale and client relevance, differentiated investment capabilities, compelling financial returns, and the strategic relationship with MassMutual. If you take a look at client scale and relevance, as I mentioned, we will be the 13th largest global investment manager in the world, providing the necessary skills to compete and invest on behalf of our clients and our shareholders; importantly, the immediate impact of the combination creates a clear leader in the U.S. retail market, with Invesco becoming the sixth largest U.S. investment manager with $680 billion in client assets. Another aspect of client relevance involves our relationships with the top 10 U.S. wealth management organizations. Our relationships will be meaningfully more important, as you can see, with these key platforms; post-close, we will have five relationships with more than $30 billion in assets under management. When we look at the investment capabilities of the combined organization, they are incredibly compelling. Invesco's and Oppenheimer's strengths are very complementary, broadening our comprehensive range of investment capabilities, which will benefit both the U.S. retail market and institutional markets both domestically and internationally. Importantly, 85% of Oppenheimer Funds are in high-demand alpha persistent asset classes, such as international equities, emerging markets, global equities, and crucially important income-focused alternatives like high yield, munis, bank loans, etc. The combined rankings post-transaction are incredibly compelling. Again, the investment performance profiles of the two firms are highly complementary. They generally serve as a counterbalance to one another, which is great news for our clients and serves as a business benefit simultaneously. So I truly believe this is an incredibly powerful combination that will immediately benefit our clients, our shareholders, and both organizations, and we couldn't be more excited about it. I'll now turn it over to Loren to go into more depth regarding the financial results of the combination.

Thanks, Marty. In addition to a very compelling strategic rationale for the combination that Marty just outlined, we expect the transaction to provide strong returns for our shareholders in line with our previously stated financial criteria for acquisitions. For those following along, I'm now on Slide 20. Excluding the impact of incremental intangible amortization and one-time integration charges, our pro forma EPS accretion is approximately $0.38 or 18% in the year of closing, and this is projected to increase to about $0.80 or 27% EPS accretion in 2020 with the full benefit of cost synergies in place. As a result of the combination and including the expected run rate synergies of $475 million, we expect to add nearly $1 billion in incremental EBITDA, and by 2020, we project to have an operating margin well in excess of 45% and a combined annual EBITDA of more than $3 billion. The purchase price will be satisfied with a combination of roughly 81.9 million common shares and $4 billion in non-cumulative perpetual preferred shares that have a 21-year non-call period and a fixed rate coupon of 5.9%. Based on our current stock price, this translates into a total consideration value of approximately $5.7 billion. In addition, MassMutual will become a long-term shareholder and our largest shareholder with 15.5%. MassMutual intends to be a long-term strategic partner and shareholder of Invesco, entering into a two-year lock-up on the common shares. They have indicated that they do not intend to sell their common shares after this lock-up period expires. The transaction is a tax-free reorganization for them and it's highly tax efficient for MassMutual, so any sale of shares in the future could trigger a sizable taxable event for them, which incentivizes them to continue holding their shares long-term. Reflecting the financial strength of the combined business, and the additional cash flow resulting from this combination, as Marty mentioned, we are announcing a $1.2 billion common share buyback program to be completed within the next two years. Importantly, this will be funded through operating cash, and we do not intend to take on any additional leverage to support it. Moving to the next page, we expect to add nearly $1 billion in incremental EBITDA after synergies; for your modeling, we've included some assumptions of breakage and we’ve projected AUM growth of about 4% in 2019, with a modest level of organic growth in future years. We have modeled modest fee reductions of approximately $45 million in future periods and plan to capture about $475 million in cost synergies within the combined organization, which represents approximately 14% of our combined expense base. We have high confidence in achieving our synergy target, partly due to our past successes with prior acquisitions. The savings will come from scale benefits and platform synergies, primarily in the middle and back office areas, including streamlining operational technology platforms and leveraging preferred vendors and rate cards across the combined organization. The transaction, which has been approved by the Board of Directors of both companies, is expected to close in the second quarter of 2019.

Thanks, Loren. I want to return to our history of success in making these combinations work. Many of you have followed us for years and we have a proven track record of success in delivering benefits to clients and shareholders as we've discussed and laid out here. If you look at what has happened with PowerShares, which started with $6 billion in assets under management and, through organic growth and subsequent acquisitions, now stands at $230 billion in assets under management today, taking the number two position in smart beta and the number four position in ETFs is quite compelling. The Morgan Stanley Van Kampen track record was also an incredible success for our organization and our shareholders. So when we look at our history, we have consistently delivered and I have tremendous confidence in our abilities to do so again. This combination will create an exceptional organization, providing a better client experience and generating significant results for our shareholders, and we will achieve this alongside our new colleagues at Oppenheimer, which we couldn't be more excited about.

Okay, thank you very much from Citi Group. Thank you for taking the question this morning. I'd like to come back to the savings opportunity for a moment. You've highlighted $475 million, and Loren just gave a little bit more detail on your comments here. Can we break that down a little bit more in terms of how much is coming from the standalone Invesco platform versus the legacy Oppenheimer footprint? Can you break it down maybe by line item, between compensation versus non-comp? Just trying to get a sense of the savings here. You're running at about 45% margin round numbers and they're running at 40%. I'm surprised by the amount of redundancy that you’ve identified.

Thanks, Bill. I appreciate the question and you should be surprised. What has been presented here is part of a broader conversation amongst the industry regarding the benefits of scale. If you think about the Oppenheimer organization, it's a robust organization largely in the mutual fund industry, but their capabilities extend beyond that. The opportunity outlined here encompasses the institutional channel and non-U.S. operations. When examining this closely, the mutual fund operation has scale benefits that are substantial, particularly in terms of systems conversion and the advantages of operational efficiency that arise from this combination. Comparing this to different combinations observed in the marketplace is crucial; this involves two organizations within the same sector. Our confidence stems from our knowledge of their operational platforms. Oppenheimer was already on a path to implement several changes, which makes this an advantageous synergy opportunity. However, we are not currently in a position to share the detailed level of breakdown that you’re seeking. We need to create those plans collaboratively with Oppenheimer and again, we feel very confident in our ability to do that.

Hi, thanks. Could we first talk about distribution? I understand the scale advantages you've described, but is there significant overlap in distribution where you're strong and Oppenheimer isn't, and vice versa? Can you provide specific distribution details?

The best way to view the complementary nature is shown on page 17, where we list the top ten wealth managers. Notably, you can see where we're particularly strong. This combination creates a much more favorable outcome. Client relevance has emerged with these wealth management platforms. I also want to emphasize that while we're discussing revenue synergies, there are no revenue synergies contemplated in what you're seeing today. This analysis reflects a focused view on the existing business.

That definitely helps, I appreciate that. It leads to another interesting point regarding the 85% of assets that fall into high demand categories, particularly international equities, emerging markets, and global funds. Are you confident that these areas won't just be the next targets for the rise of passive investment options? I want to ensure that you've been strategic about this part of your offering.

It ultimately rests on your core beliefs. We firmly believe that passively managed products and high-conviction active and alternative strategies will remain relevant. Your idea about passive being dominant in various asset categories is valid, but there's still considerable room for active management to generate alpha.

One last quick question on fund mergers. On Slide 18, there appears to be some overlap in high demand strategies. Have you worked through some of those decisions regarding the asset classes?

No, we’re only two hours into this. We'll collaborate with our colleagues at Oppenheimer over the next month to develop a plan and will share updates as needed.

Right, thank you. Robert Lee, KBW. Thanks for taking my question. Regarding the phase of expense synergies, you previously noted synergies in the Van Kampen deal were realized fairly quickly. Can you give us some insight into how you expect these synergies to layer in? Also, regarding the breakage assumptions, considering that Oppenheimer's is primarily mutual funds, how do you assess the $10 billion as a reasonable figure?

Most of the synergies are anticipated to be realized within the first year of closing; we anticipate achieving around 75% to 85% of them, with the remainder expected in 2020. We feel confident in our strategy and have a solid playbook for executing this. In terms of the breakage, we find that the $10 billion estimate aligns closely with our expectations based on historical performance and our knowledge of industry dynamics, even allowing for some wiggle since it’s not a rigid figure.

Great, thank you. If I could just follow up, you guys have made several investments in platforms over the past years. Are you concerned that the size of this transaction could distract focus away from these growth initiatives?

Absolutely not. We wouldn’t pursue this if we didn’t see macro trends that reflect positively on the industry, and we are still able to advance multiple growth efforts, as we've seen through our management team and with high confidence moving forward.

Year-to-date, we've experienced about $13 million of net flows into the areas we've prioritized for growth, including our ETF offerings. We've also seen a robust pipeline for Jemstep, with a large client coming aboard shortly. We're confident about the substantial growth in this space, along with increased wins with major banks and continued success in our strategies in China.

Hi, Ken Worthington from JPMorgan. Your deal comes nine years after Van Kampen, congrats. What are your thoughts on cross-marketing opportunities with MassMutual over time? How much of Oppenheimer's AUM comes from MassMutual, and what new incremental investments might you expect from them?

MassMutual has 8,500 advisors, which provides a clear focus area for us. Additionally, they are implementing unique strategies in Asia that complement our offerings, which we view as an opportunity for collaboration. While I can't disclose specific historical figures, I am confident this partnership will yield excellent outcomes.

Regarding AUM, it's remained reasonably stable around $250 billion, with no significant turmoil recently. We are on a positive trajectory.

Thanks. Could you provide more specifics on recent flow trends within both Invesco and Oppenheimer? Considering you reported outflows and Oppenheimer's recent outflow trajectory, how can you assure positive flows in 2020?

For long-term investors, it's crucial to look beyond quarter-to-quarter fluctuations. We have achieved net inflows for nine consecutive years despite occasional headwinds. As for our capabilities, we believe that, regardless of what the market brings, we will emerge successfully.

There's substantial opportunity in global and international capabilities, which are hard to replicate and have been performing well; this will enhance our ability to drive positive flows in the future. Additionally, we are continuing to make strides in our growth strategies, which are being positively received.

Mike Cyprys from Morgan Stanley. Regarding the challenges around M&A, what do you see as the key takeaways from poor deals executed in the past by others? What must you get right to ensure this is a success for Invesco?

It primarily fails when parties lose sight of the human element involved in these fiduciary organizations. Success relies on understanding and preserving value while ensuring talented individuals are retained and motivated. We focus on this when executing alongside partners, ensuring success based on our proven historical track record.

And can you briefly touch on how you will manage the risk associated with Oppenheimer's large fund franchise? What kind of retention structures are in place to keep key investment professionals, and how much integration of these teams will you perform?

MassMutual has implemented a solid retention program, but more important is ensuring that the team remains passionate about their work and capable of achieving client objectives. We will continue to support their investment philosophy, ensuring they have the tools necessary to create alpha, keeping performance at the forefront.

Michael Carrier, Bank of America Merrill Lynch. Can you comment on the strength of your institutional pipeline despite the elevated outflows? How can you validate that these won't trend similarly to past events?

The significant outflows we experienced were localized events rather than systematic trends. Our institutional pipeline remains robust across a variety of capabilities, and we're confident that, alongside our strategies, we'll return to positive flows.

Thanks for that response. Can you provide insights on how your energy dynamic changes with this acquisition against your objective to realize operating margin improvements?

This combination places us on the path to achieving our operational objectives without undermining any of our existing growth initiatives or risk parameters. The integration intelligently combines established capabilities in ways that yield benefits to both firms.

Hey, it’s Kenneth Lee from RBC Capital Markets. Do you have any updated thoughts on long-term organic growth targets post-acquisition?

We still believe that 3% to 5% growth is achievable across market cycles and that this acquisition will significantly enhance our ability to achieve growth targets. Various initiatives, such as digital advice and international markets like China, are poised for double-digit growth, further solidifying our outlook.

Got it, thank you. And lastly, can you confirm there's an agreement in place for Invesco to provide asset management services for MassMutual's products?

No formal agreement exists. MassMutual is retaining their investment stake entirely, with a clear focus on strengthening their involvement in asset management alongside our efforts.

Hi, Chris Shutler from William Blair. Within retail, how much of Oppenheimer's AUM is within the broker-dealer channel relative to the RIA channel?

They have around $15 billion in the RIA segment, but the bulk is in the wealth management platforms.

Okay, thanks. I believe you stated earlier that approximately 85% of Oppenheimer's AUM is held in mutual funds. Can you provide a breakdown of the remaining 15%?

They have approximately $10 billion to $12 billion in sub-advisory arrangements, in addition to $6 billion in other investments.

Hey, good morning, Alex Blostein with Goldman Sachs. Could you elaborate on the $475 million of projected cost synergies? This figure seems significantly higher than previous transactions. What sets this deal apart?

It should not be viewed as a simple percentage of Oppenheimer's base—it represents the benefits of integration across mutual fund operations where scalability and efficiency can be vastly enhanced. Oppenheimer was already pursuing several operational enhancements, creating a favorable synergy dynamic.

In terms of integration costs, they include expenses associated with the transaction, technology integration, and streamlining our operations. While the costs are substantial, we're confident they'll be efficiently utilized as we integrate these two organizations.

Good morning. This is Greg Warren from Morningstar. Could you clarify why you believe you'll only see $10 billion in breakage out of the gate? Markets have shifted significantly since the Van Kampen acquisition. What reassurances can you provide for sticking to this figure?

The $10 billion was chosen for its conservative, yet achievable nature. It's worth noting that our previous estimate with Van Kampen was significantly overstated, so we are exercising caution here. Still, we believe this figure is a reasonable ballpark.

Overall, there isn’t a significant element that points to a broad pattern of concerns resulting from this combination; in fact, we anticipate collaborative growth, especially in institutional areas.

Once again, I would like to thank everyone for joining us today and your understanding as we have navigated all the changes. We are excited as we continue to make progress on this combination. We will also communicate updates on our core business and its successes in future calls. Have a great rest of your day.