Invesco Ltd (IVZ) — Q2 2019 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 the 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 turns out to be inaccurate.

Thank you very much and thank you everybody for joining us. And if you're so inclined, you can follow along the presentation that's on the website. I'll cover the business results today and talk a little bit about the combination. Loren will get into greater detail of the results and impact of the combination and as practice; we'll open up to Q&A. So, let me get started. I'm on Page 6, if you happen to be following the presentation. And as you saw, we successfully closed the OppenheimerFunds transaction at the end of May with $1.2 trillion in assets under management. We're now the sixth largest retail manager in the United States, 13th largest manager in the world, which puts us in a much better position to meet client needs. We're now just two months past close and we are more confident than ever in our ability to achieve the deal economics and the tremendous potential of the combination. I also want to point out; we're incredibly pleased that the combination has created a much stronger organization with very talented people. Our conversations with clients reaffirm our view that the expanded set of capabilities we now offer combined with best-in-class distribution formats mean we strengthened our relevance in the market and have lately increased organic growth. I also want to point out there are very clear benefits to shareholders from the transaction. I want to confirm once again we will get the $475 million in net synergies, 85% of that will be accomplished by the end of this year. The additional scale, resiliency, and stability resulting from the combination will help us achieve a greater than 41% run-rate operating margin. And finally, pro forma year-end EBITDA on 2020 is expected to exceed $2.6 billion. Turning to the highlights; investment performance remained strong during the quarter. 58% of actively managed assets were in the top half of peers over both the three and five year period, and I’ll get into greater detail in just a minute. Long-term net outflows totaled $3.9 billion, building on the improved trend over the prior quarter, reflecting stronger flows from our ETF and institutional businesses. During the quarter, we began to see the power of the combination recognizing the deal only closed for one month. There was a 16% increase in net revenue quarter-over-quarter. The operating margin expanded by 300 basis points to 35%, or a 27% increase in operating income quarter-over-quarter to $363 million. We're now operating from a position of strength, which has enabled us to invest in the growth of our business while also returning $389 million to shareholders through stock buybacks and dividends during the quarter. All of this means we're better positioned to deliver relevant outcomes for our clients, invest in the future growth of the organization, and provide solid returns for shareholders. Turning to investment performance on Slide 8; as I mentioned, performance remained strong, 58% of our actively managed assets were at 58% of the five-year period, with 33% of that being top quartile performance. The combination has enhanced the depth and breadth of our investment expertise across the business while further expanding the scale of our investment capabilities. Invesco now ranks in the top 10 in assets under management across 10 of the 15 largest asset categories in the US retail channel, which is the largest market in the world. Best examples are that we're second-ranked in bank loans, HY Munis, third in emerging markets, and fourth in global equities. We see three areas where there's alignment from market demand that is strong, long-term track records of our capabilities being global, international, emerging markets equity, fixed income, and alternatives. All three of these asset classes have significant percentage of our assets in the top quartile across all time periods. So, in short, we're very well positioned in the market, and the capabilities we are seeing strong demand for, which will drive organic growth. I'll now pass over to Loren to go through the results.

Thanks very much, Marty. On Slide 9, you'll find an overview of our long-term flows. In aggregate, we experienced net outflows of $3.9 billion in Q2, which is an improvement of $1.5 billion compared to the prior quarter and $4.1 billion compared to the previous year. As you can see on the slide, the areas driving this positive change were in passive Asia-Pacific, EMEA, ex-UK, and institutional. ETF capabilities globally contributed more than $4.5 billion in net flows for the quarter. ETF flows in the Americas were diversified across our smart beta offerings, led by our S&P low volatility suite and BulletShares ETFs. In EMEA ex-UK, we saw positive ETF flows across a number of our equity and fixed income ETF capabilities. Notably, our ETF flow growth has propelled us to number two in terms of net new ETF assets in this region year-to-date. In Asia-Pacific, we generated $3 billion of net inflows. We saw a growth in sales surge across many of our fixed income and balanced capabilities with particularly robust growth provided by our China, Invesco Great Wall business. In China alone, we added nearly $2 billion of net flows into several of our active balanced and equity capabilities, reflecting the excellent investment performance and market positioning we have in this region. Our institutional business continued to show signs of strength, delivering $2.1 billion in positive flows in Q2. Of note, the last time we posted positive net flows in our institutional business was in the first quarter of 2018. Much of this change is due to the improvement we're seeing in redemptions. On the same slide, you can see the areas driving outflows in the quarter, which included active, the Americas, UK, and retail. The majority of active outflows were in the asset class of equities, although these were offset to some extent by fixed income net inflows. In the Americas, outflows in our US retail equity products were elevated against the prior quarter due to the partial-period inclusion of the legacy Oppenheimer products, which experienced approximately $2.5 billion in post-close outflows during the quarter. The Americas were also negatively impacted by outflows across our bank loan capabilities with about $1.2 billion out, as investors redeemed from this asset class on an industry-wide basis. Industry dynamics also continue to challenge our retail flows in the UK as risk assets remained broadly out of favor with investors in these markets, fueled by the uncertainty from Brexit. Looking forward to the last half of 2019 for Invesco, we expect the factors that are currently impacting our flows both positively and negatively to largely persist. With that said, while we certainly are seeing an elevated level of outflows in the legacy Oppenheimer fund products in the short term, we believe that we'll be able to improve our level of sales growth in the Americas, given the world-class distribution team and platform that we've created through this combination. It's still early days and the opportunity to drive flows through improved sales and marketing efforts have not yet been realized. So, before I leave this slide, I wanted to quickly provide an update on our expectations around AUM breakage as it is related to the combination. Our original deal expectations included an estimate as you'll remember of $10 billion in outflows in the first year after the close. As we look to client breakage, the only item that we've specifically identified at this point related to the announced transaction is the transition of the state of New Mexico 529 plan. This transition will result in a $2 billion outflow in the fourth quarter. So, with this known outflow and considering expectations around potential impacts from the announced investment team changes, we believe that our AUM breakage from the transaction will in fact be meaningfully less than the original estimate of $10 billion. Next, let's turn to Slide 10 which outlines our AUM. Our assets under management increased by $243 billion or 25.5%, which primarily reflects the impact of the OFI combination and positive market returns, partially offset by total net outflows. As a reminder, the RFI combination added $224 billion to our AUM in May. We saw a quarter-over-quarter growth in AUM across both active and passive and across all channels and client domiciles other than for the UK. The Oppenheimer AUM increased the percentage of the firm's AUM and that is active retail in the Americas based while our institutional and passive AUM grew due to long-term net inflows and market appreciation during the quarter. As Marty mentioned, our general net revenue yield excluding performance fees increased 1.4 basis points to 38.5 basis points versus 37.1 basis points in the prior quarter. In addition of OFI AUM for slightly more than one month added approximately 1.3 basis points to our net revenue yield and we also saw one additional day in the quarter, which added 0.3 basis points. These factors were modestly offset by a change in AUM mix. Slide 11 provides US GAAP operating results for the quarter. My comments today are going to focus on the variances related to our non-GAAP adjusted measures which will be found on Slide 12. Moving to this slide, you'll see that net revenues increased by $145 million or they were 16% up quarter-over-quarter to $1.03 billion. This increase reflects primarily the impact of the Oppenheimer combination and the increased day count in the quarter. Adjusted operating expenses at $668 million increased by $65 million or 11% relative to the first quarter; this increase largely reflects once again the impact of the Oppenheimer combination on expenses for the period. Next, moving to Slide 13, I'd like to comment on the progress that we've made on the integration and synergy capture recorded to-date. As noted in the first quarter, we spent a significant amount of time between the announcement date and closing date defining the leadership and the organizational structure for the combined team. This has allowed us to quickly execute on a number of very important post-close activities required to increase our sales growth for the combined business. These activities include moving to a single brand, strengthening our newly combined sales organization through training and definition of go-forward client coverage, and creating a client demand framework and go-to-market strategy for the combined firm. As I mentioned earlier when I was discussing the Q2 flows, we have not yet fully realized the benefit of this work and the impact on our sales in the US retail business. In addition to activating the newly integrated US retail sales platform, the pre-close integration work has also enabled us to make meaningful progress on cost synergy recognition. We remain on track to capture $475 million of net synergies through the first quarter of 2021. As a reminder, this $475 million amount of bottom-line cost savings is net of investments we are making, which will allow us to drive future growth and avoid future costs. This combination is allowing us to accelerate investments in areas that strengthen our distribution investment capabilities and processes as well as allowing us to deploy new technologies and automation to significantly increase our operational efficiency while still delivering the $475 million in savings. In terms of timing, to achieve the net synergies, we originally expected to have 52% of total expense synergies captured at the end of the third quarter of this year. Given the significant amount of progress we've made prior to the deal close to establish, communicate and execute on our end-state organization systems and work placement by location, we were able to achieve this level of synergy capture by the end of the second quarter. With the quicker synergy capture, we remain well on track to recognize 85% of synergies by the end of 2019. Next, let's move to Slide 14 which looks at our adjusted operating and net income. Operating income increased by $79 million to $363 million, largely reflecting the increased operating earnings from the Oppenheimer transaction. Our operating margin improved to 35.2% versus 32% in the prior quarter, reflecting the positive margin benefits from the combination as well as the quicker synergy capture, I discussed on the previous slide. The firm's effective tax rate came in at 21.8%, which was consistent with our prior guidance. We continue to expect our tax rate to come in somewhere between 22% and 23% starting in the third quarter. Lastly, our net income improved by nearly 25% to $280 million, reflecting continued strong non-operating gains from our investments and adjusted EPS improved to $0.65 versus $0.56 in the first quarter. Next, move to Slide 15. This presents a snapshot of Invesco's balance sheet and capital management. So, as I had mentioned, we continue to execute in a very disciplined way to achieve the target level of deal synergies and the improved financial position that the deal provides. In doing so, we expect to continue to return significant levels of capital to our shareholders. You saw this in the current quarter when we returned nearly $390 million to our shareholders through a combination of dividends and share repurchases. This represented a PAT of about 107% of our operating income for the period. You'll recall that we announced a $1.2 billion share repurchase program in the fourth quarter of 2018, and we successfully executed $600 million against that plan through the end of the quarter as we see a significant opportunity to repurchase our shares given Invesco's stock's depressed valuation and trading discount to peers and given our confidence in the strength of the combined organization. In addition, we executed a further $200 million forward repurchase agreement in July. That will bring us to $800 million in stock buybacks. Once this is completed, we expect to have repurchased some 39 million shares since the fourth quarter, which represents more than 8% of our share count outstanding as of the transaction close. Although there was no preferred payment in the second quarter due to the timing of dividend declaration, we will pay the preferred dividend starting in the third quarter. Note that the third quarter payment will be elevated at $64.4 million as it will reflect the additional 80-day post-close period from May. Starting in the fourth quarter, the amount will level out at $59 million per quarter. Turning to the balance sheet; so, you will see that we have a $7 billion increase in assets during the quarter, largely reflecting the indefinite-lived intangible and goodwill assets recognized as part of this transaction. Our equity balance increased by $4 billion, reflecting the preferred issuance to MassMutual close and our cash and cash equivalents balance increased by nearly $200 million. With the increased earning power and cash flow of the combined firm, we expect to reach our targeted $1 billion of cash, in excess of regulatory capital requirements by the second half of 2020. We repaid approximately $400 million of debt in the quarter, largely paying down our credit facility and leaving a near-zero balance, which obviously has a positive impact on our leverage ratios. We expect to be able to maintain our current level of debt going forward. As Marty noted earlier, we anticipate that the combined organization will have pro-forma annual EBITDA post-synergies of more than $2.6 billion by the end of 2020, which represents a significant increase when compared to the pre-combination Invesco. With this increased level of EBITDA, our leverage ratio would be approximately 0.8 times gross debt to EBITDA based on the US GAAP classification of the newly issued $4 billion of non-cumulative perpetual preferred as equity. Conversely, if the preferred were instead treated as 100% debt, the leverage ratio would be at 2.3 times gross debt to EBITDA. This is a level that we certainly view as manageable and one that will certainly come down over time as our earnings grow. So I'll conclude by saying that we're very confident in our ability to capture the $475 million in net cost synergies and deliver the deal economics and other benefits we outlined, which include not only the targeted $1.2 billion in stock buybacks, but also a strong balance sheet with little or no added debt and some $1 billion of excess cash, as we get to the second half of 2020. And with that, I'll turn it back to Marty to wrap up.

Thank you, Loren. Let me make a couple of comments before we get to Q&A. And as we've discussed on previous calls, we continue to be very focused on improving our leadership position in core markets, which of course this combination has allowed us to do, while at the same time investing in those parts of the business where we see rapid growth. This approach has helped us to deliver a best-in-class set of capabilities, which will drive sustainable broad-based growth as we look to the future. The combination with OppenheimerFunds has significantly accelerated the strategy. Obviously, we're expanding our leadership position in the United States while also strengthening our business in areas where we're growing quite rapidly as Loren mentioned, China ETFs, and digital platform solutions to name a few. So again, we're just two months past close, and we have all the confidence that the combination is meeting and exceeding our expectations. And with that, let me open up to questions please.

Hi, good morning and thank you for taking my questions. I think first prior to the deal; I believe Oppenheimer was sort of running neutral to positive net sales. Since the deal was announced, Oppenheimer has seen a pickup in the outflows. I think you said it was $2 billion or maybe $2.5 billion since the deal was closed. I think originally you were modeling 1% to 2% organic growth for Oppenheimer. What are your thoughts for the go-forward there? And then how quickly do you think you get the benefits from a sales perspective? I think you've suggested that the integration of the Oppenheimer and Invesco sales forces was particularly disruptive. We have three months of Oppenheimer in Q3 rather than Q1. So how quickly and maybe what does the cadence look like for an improvement in sales as the sales force is now integrated and hopefully more stable to offset some of these dis-synergies?

Yes. Let me hit some of the high points and I'll let Loren answer the rest. So, this is the most talented sales force I have ever seen. And it is literally made up of half Invesco, half Oppenheimer. That was just the outcome of the exercise that the leadership went through. It is in place; it was in place, and all of that work was done before. That said, it's a new range of capabilities in the focus area. So, I would quite say, through the end of the year, until things settle down is when I think everybody will have their sea legs. But that said, each and every day is a better day and I have reached a degree of confidence there. The other thing that we've discussed is just not the US wealth management platform, but Oppenheimer has a number of capabilities that will be well received in the institutional market and also in the retail market outside the United States. So literally, some of the retail capabilities will be available in October, and we're already working to get them to market with a number of the institutional teams around the world. So again, the big difference is we're up and running and executing where most transactions I have seen, this thing starts to happen after close. And from every transaction I've been involved in, I can say this is the best that we've ever done. So, I think we're in a very good spot. Loren?

And Ken, we had an estimate of 1% to 2% organic growth scheduled to begin in 2020. So, at this point, we're still hopeful that we can achieve those types of levels of growth. Again, there is an opportunity to take these capabilities into our institutional channel and into our offshore business. There is a lot of activity going on as we speak to actually make that happen, a lot of interest in those channels for these products. We have some headwinds on certain key products in the Oppenheimer capabilities, but there are other really high-performing capabilities as well that we think we're going to be able to leverage. I'd say in terms of our distribution efforts, that is really being spring-loaded in terms of being able to execute really in a position as we get to the second half of this year. I mean, again, there are probably some headwinds in the near-term still that we're going to see, as I mentioned; we don’t think anything can change, but ultimately, we're going to start seeing the benefit of this really world-class organization coming together and being able to execute.

Thank you. And then on the institutional side of the business, you highlighted a move to inflows. But you also highlighted that the drive to net sales was driven by redemptions slowing. It does look like gross sales have slowed too. You've talked about in the past that the institutional pipeline was sort of hitting record levels. Should we see gross sales improve from here? If so, what asset classes and geographies? In terms of the decline in gross redemptions, is that sustainable or might that have just been a one-off this quarter?

Great question. So, I think the reduction in sales was really just the market environment that we've been in, things slowed down in terms of funding. So, there is some pause that happens. So, the one but not funded pipeline is still as large as it's been. In fact, it is up 10% versus the prior quarter and up 31% versus prior year. So, the pipeline of one not funded is robust and very strong growing. So, we feel confident those assets are going to come through. It's really just a matter of timing on the solar redemption side. Again, it's hard to say what is permanent and what is not. In terms of what we know, in terms of expected outflows, nothing has increased relative to prior levels. So, we think that looks reasonably stable. But there is always going to be potential for idiosyncratic outflows that come from certain key clients. So again, what we can manage is the sales probably more than the redemption side, and we are feeling very positive about that outlook into the next couple of quarters.

And let me add. Because you raised a very good point. I have absolute confidence that the operating results are going to be as you would predict, as we've talked about through '19 through '20. That said, two fundamental strengths of our organization are seeing headwinds. Brexit is a headwind and for us it is incredibly risk-off in the UK in particular. And the trade wars actually do impact our position in Asia-Pac. That said, we're still going to get the results that we're talking about. So, if you see any benefit in that, we would expect a real strong increase in inflows.

And I didn't answer your last question; sorry, Ken. So, it's about more than 60% of the pipeline is in alternatives, about 23% is in equities and some 10% in fixed income; just to give you a sense of where it is coming from.

Great, thank you very much.

Thanks, good morning. I guess my first question is on just the synergies, the $475 million. Obviously, you've expressed a lot of confidence and have some good kind of runway to start here. So, Loren you mentioned also just kind of reinvestment back into the business. And so just curious, as we think a bit out if there is upside to the $475 million or if you're going to continue to kind of reinvest in growth in other areas as you achieve these synergies if there are additional things that are found?

So, Dan, we certainly have seen this transaction as an opportunity to upgrade significantly. As we've talked about, putting the firm together and becoming a stronger firm has been part of the objective. This has not just been about cost savings. It's actually about creating a stronger organization. And so, we actually view this as a fundamental part of the transaction, the $475 million should be viewed as a net number, net of investments in terms of what we're going to deliver. We're absolutely confident we're going to be able to deliver that. I think the good news is that we've been able, and we expect to be able to continue to invest alongside delivering the savings into critical areas that will strengthen our distribution, our investment capabilities, and invest in new technologies, automation to augment our operational efficiency, really bringing our firm to sort of a state of the art and basically avoiding sort of the need to invest in the future, so really allowing us to accelerate all this activity right now. Today, we've been able to invest a small amount, let's say roughly $30 million. There is an opportunity I think to be able to invest more as we go through, but in terms of kind of the modeling and your thinking, I would bank on the net $475 million is what to expect.

I have a follow-up regarding your comment about Brexit. You mentioned it poses risks, but performance in that area hasn't been strong for your team and some of your former employees are facing challenges. I'd like to discuss the overall franchise there, the strategies you have in place, how performance is faring in this environment, and whether you are considering proactive measures to address these issues or if you are waiting for the macro conditions to improve.

Yes, it's a good point, Dan. I would say it's more broad. I mean, as you know, what has been a fundamental strength of the organization is that we had nine years of net inflow up until throughout '17. Much of that was on the back of value-biased equity capabilities and we're in an extreme period where it's out of favor, almost the most extreme period that we've seen, it's a record. That said the investors are still very, very talented, and I have great faith in them and they are going to do quite fine. So, the business issue that you're talking about is the flows and as I keep pointing out, we're posting these results with these extreme headwinds. But now we're not just waiting for things to change. I would pay attention to the Intelliflo announcement that came out in June, and it is a digital platform that starts with our model portfolio, starting in the fourth quarter of this year; it uses a broad array of our capabilities, both active and passive, and we look at it as a game changer in the UK.

I'd also point out because it's moved quickly, there’s a lot of currency going on here as well, but pre-Brexit, our UK as a percentage of AUM was about 12% of the total. And as we show, it is about 6%. So again, in terms of kind of the total exposure to Invesco just by the nature of the currency and some of the market and flow dynamics, it is not as large an exposure to the firm as you might have otherwise seen just a short period ago.

Great, thank you.

Thanks. Good morning, Marty and Loren. I just wanted to start with the $10 billion of merger dis-synergies. Obviously, you've expressed a lot of confidence and have some good kind of runway to start from here. So, Loren you mentioned also just kind of reinvestment back into the business. So just curious, as we think a bit out if there is upside to the $475 million or if you're going to continue to kind of reinvest in growth in other areas as you achieve these synergies if there are additional things that are found?