FCP Fund Manager, LLC (FHI) Earnings Call Transcript & Summary

Greetings. Welcome to the Federated Hermes-FCP Acquisition Conference Call and Webcast. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to your host, Ray Hanley, President of Federated Investors Management Company. You may begin.

Good morning. Thank you for joining us today. We're very excited to discuss the agreement for Federated Hermes purchase a controlling interest in FCP Fund Manager. Leading today's call will be Chris Donahue, CEO and President of Federated Hermes; Esko Korhonen, Founder and Managing Partner of FCP Fund Manager; Tom Donahue, Chief Financial Officer of Federated Hermes; and joining us for the Q&A is Saker Nusseibeh, CEO of Federated Hermes Limited. During today's call, we may make forward-looking statements. We note that Federated Hermes' actual results may be materially different than the results implied by such statements. Please review the risk disclosures in our SEC filings. No assurance can be given as to future results, and Federated Hermes assumes no duty to update any of these forward-looking statements. Today's call may also include certain non-GAAP financial measures. Please see the analyst presentation for the transaction, which we will refer to during today's call and which is available on our website and in the 8-K that we filed yesterday for important information about these financial measures. Chris?

Thank you, Ray. Good morning, and indeed, welcome. As announced yesterday, Federated Hermes has entered into a definitive agreement to purchase an 80% controlling interest in FCP Fund Manager, LP, or as we're going to refer to it FCP, a U.S.-based real estate investment manager. Post closing, FCP's management team will retain an ownership position of 20%. We have been seeking the right firm to expand our private markets real estate business into the U.S. as we have said many times on these calls. In FCP, we have found a growth-oriented company with a differentiated approach, and excellent management team and workforce and solid investment performance. Slide 3 of the presentation outlines the strategic rationale for the deal. The FCP fits well with our stated growth ambitions to anchor our private markets investment footprint in the U.S. and to increase our investment offerings for our clients. We have a strong existing vertically integrated real estate platform in the U.K. that made its first investment in 1983, expanding our real estate offerings to include an established U.S. platform, one that is a specialist in the multifamily housing asset class is a natural extension. The acquisition will facilitate Federated Hermes entrance into the U.S. real estate market at a time when the multifamily sector in the U.S. enjoys strong fundamentals and significant growth opportunities. We were attracted by FCP's national platform, their active, disciplined investment philosophy and their extensive experience with investors in this space. FCP's culture and principles align well with Federated Hermes. FCP is focused on U.S. multifamily real estate with approximately $3.8 billion currently invested in strategies throughout the real estate capital structure. The FCP team has a strong local knowledge and capability in high-growth areas of the company -- country. FCP brings more than 75 employees located in various U.S. offices, providing deep local coverage of 19 priority U.S. markets. We believe FCP will be an excellent complement to our U.K.-based real estate business. With more than 40 years experience, the U.K.-based team has more than 55 professionals managing $5.5 billion of AUM as of the end of the third quarter. Our U.K.-based real estate team is responsible for some of the most successful and iconic developments in the United Kingdom across multiple sectors, such as center city office, leading urban regeneration, innovation-focused life science and technology hubs and multifamily residential assets. Importantly, while the U.S. and U.K. real estate teams will operate independently within the broader Federated Hermes private markets offering, we do anticipate benefits for our collective global clients by introducing additional expertise as we seek to develop product solutions for our client base at a time of increasing demand for the private markets asset class. Slide 4 shows the projected pro forma impact of the FCP addition to Federated Hermes private markets alternative platform. With the FCP addition, Federated Hermes, who have a global real estate platform with over 130 professionals managing approximately $9.3 billion. FCP will continue to work to execute their growth strategy, led by its strong, experienced management team who have led the firm's growth through changing market conditions over 25 years. We will develop ways to enhance FCP's resources and capabilities, including opportunities to expand distribution through our client base. We expect to retain all FCP employees. On behalf of Federated Hermes Board of Directors, executive management team and employees, I want to welcome FCP employees. We look forward to working with you to grow to new heights. I will now turn it over to FCP Founding Managing Partner, Esko Korhonen.

Good morning. Thank you, Chris. First of all, on behalf of the partners, managers and employees of FCP, we are very excited by our alliance with Federated Hermes organization and the opportunities for growth that we expect to develop. As noted on Slide 5, FCP is a multifamily real estate investment manager founded in 1999. We are headquartered in Chevy Chase, Maryland with regional offices in New York, Raleigh, Miami, Dallas and Denver, each a growth area for multifamily developments. FCP has raised over $6.3 billion in equity capital and has invested in or financed more than $14.6 billion in gross asset value since its founding. We invest throughout the capital stack and have more than 130,000 multifamily units that we have owned, operated, financed or advised since 1999. We've developed an investor base rooted in long-term relationships with institutional limited partners across pension funds, sovereign wealth funds, endowments, foundations, high net worth, funded funds and others. Looking at Slide 6, our founding partners who will remain leaders of the firm have 30-plus years working together across market cycles. We also positioned the firm for future growth with 5 next-generation partners among more than 14 years -- with more than 14 years of experience with FCP. On a brief note, just to give you a little bit of a bio on Lacy Rice, Alex Marshall and myself, the founding partners, Lacy and I met over 30 years ago while we were at the Carlyle Group and part of their real estate team there. Alex joined us very shortly thereafter, where in his previous experience had been at JPMorgan and Clarion. Moving on, Slide 7 highlights some of FCP's key attributes. Among these are our differentiated investment approach that targets U.S. markets experiencing outsized growth, particularly in the Sun Belt. The U.S. space is a persistent structural housing shortage and market dislocation exacerbated by interest rates, repricing and over-leveraged borrowers. FCP leverages local market expertise to source off-market opportunities characterized by cyclically high yields and discount to replacement costs. Our investment focus is multifamily residential, with a particular emphasis on acquiring Class B & C moderate income housing; acquiring, developing and redeveloping Class A multifamily properties; and opportunistically participating in special situations, including mixed-use and commercial. Slide 8 presents our AUM by investment vehicle, featuring a series of flagship value-add funds and multifamily focused credit, separately managed accounts. We have also launched a housing preservation open-end fund this year. We have a hands-on investing approach, utilizing cutting-edge technologies and proprietary data analytics to lower costs, select markets and drive income. In addition, we provide a suite of resident-focused services that are meant to enhance the living experience in our communities, improve property operations and drive performance while maintaining leadership on environmental sustainability. So why Federated Hermes? As Chris said, we believe that the culture and principles of each firm are aligned. We were attracted to Federated Hermes position as a global leader in active investing across multiple asset classes. We appreciate its well-established private markets platform primarily operated outside of the U.S. Our alliance provides FCP an opportunity to strengthen our institutional platform, enhance our growth trajectory and provide expanded resources for our clients and stakeholders as the anchor for Federated Hermes entry into U.S. real estate private markets. For FCP, the completion of this transaction with Federated Hermes will mean we will remain highly focused on our clients and our core strength, investing across the U.S. multifamily asset class, leveraging our deep local market knowledge and utilizing our proprietary data and analytics and technology. Our team will continue to operate as we do today, maintaining our culture and commitment to excellence. We will explore opportunities, our capital formation capabilities through access to Federated Hermes global distribution channels. Further, we will benefit from the complementary experience and knowledge of Federated Hermes U.K. real estate business, particularly in the living asset class sector as both U.S. and U.K. teams develop and grow. Our founding partners and next-generation leaders will continue to guide FCP, ensuring continuity and stability for our clients and employees. We believe that our alliance will give us the opportunity to enhance growth by raising the profile of FCP's brand both in the U.S. and internationally to capture new investors and recapture previous investors to boost new vintages of FCP equity and debt offerings. We expect to launch new investment offerings based on FCP's broad capabilities in multifamily debt and equity investments, beginning with the next iterations of FCP's equity and debt offerings in the living sector. Additionally, Federated Hermes will leverage its extensive global network of distribution relationships, including U.S. institutional consultant relations teams to deepen FCP's relationships further. We also see the opportunity to develop new product capabilities to service wealth clients and retirement assets. And with that, I will turn it over to Tom.

Thanks, Esko. Looking at the transaction details on Slide 9, we will be acquiring 80% interest in FCP for up to $331 million in aggregate purchase price, subject to potential post-closing purchase price adjustments. The aggregate purchase price includes $215.8 million in cash consideration and $23.2 million in FHI Class B common stock that will be paid and issued at closing as well as opportunities to earn contingent consideration of up to an aggregate of $92 million over multiple years based on achieving certain financial thresholds. The FHI Class B common stock will be issued in a private offering to certain of FCP selling owners, subject to a 2-year lockup period. We expect to fund the cash portion of the aggregate purchase price for the acquisition with cash from our balance sheet. The total purchase price represents a valuation of 13.7x 2025 projected EBITDA of approximately $30 million less the 20% minority interest of about $6 million. The upfront consideration represents approximately 9.9x 2025 projected EBITDA less the 25% minority interest 20 -- plus the 20% minority interest. We expect an IRR of about 13.1% on the transaction. After the close, FCP management will hold 20% of FCP. Through put/call options, there are opportunities to acquire the remaining FCP shares beginning after the 5th anniversary of the closing. Through the deal structure, including the employees' equity stake and other incentive programs, we believe we have an excellent alignment of interest among FCP employees, their clients and Federated Hermes. Performance fees and carried interest from FCP's completed deals will go to existing carried interest holders. Federated Hermes will receive a portion of any of these funds for any of these fees for future funds. We estimate on a preliminary basis that the transaction will result in about $0.04 of EPS accretion in 2026, excluding transaction expenses, assuming a closing at the end of Q1, and $0.13 in 2027. We have recognized about $2 million in transaction costs through September 30, 2025, and expect to incur an additional approximately $5 million in Q4 and approximately $4 million in Q1 of next year. We entered into exclusive negotiations with FCP in August. As a result, we suspended our share repurchase program for the full third quarter with no shares purchased in the open market. In closing, we've spent considerable time working with Esko, Lacy, Alex and the entire management team at FCP, and we have found a great cultural fit, as you've heard Chris and Esko say. And also, we are very excited about our future together. So Holly, we would like to open up the call for questions now.

[Operator Instructions] Your first question for today is from Ken Worthington with JPMorgan.

This is Michael Cho in for Ken this morning. Congrats on the deal. Chris and Esko, you touched on a few different areas of overlap between Federated and FCP. I was hoping you could flesh out some of those comments around where you think Federated can really deliver the most incremental value relative to a stand-alone FCP? And how do you envision the progression or the pace of progression when we think about new products and distribution within U.S. real estate?

Okay. Thank you, Michael. Say hello to Ken. We're one week early for him. So I would sort of question the word overlap. Yes, we both are in the real estate business. We've given you the numbers. But the beauty of this organization that Esko has created is that it is independent, will function as what we have called historically an area of excellence in the U.S. And so the kinds of working together that we see are expertise where we can bring things like our experience in doing Kings Cross or Paradise Circus in Birmingham through various people showing how these things work and what success can look like there. I mean we have created things that have thousands of homes in England, in Kings Cross, and we've managed 1,700 apartments over in London. So that is one area of similarity. The way that we can enhance value is by supporting FCP and what it does in putting out new products. We can also support them by introducing them to our distribution force, which is very, very good. Now we don't sell real estate here in the U.S. So that's not something that's going to happen tomorrow. But over time, as we enhance our private markets distribution efforts, this will go with it and is an essential key to making that happen. And I think Esko has some comments on this as well. And I think he can illuminate it by talking about some of the geographies that they are most enthusiastic about in the U.S. with their investments.

Thanks, Chris. So with regard to your last point, as mentioned, we are active in 19 to 20 markets. They're primarily focused on the high-growth markets in this country. We have owned operated assets in all of those markets. However, I will suggest there may be times where we don't actively own assets in a particular market, but we continue to focus. We have people and resources that are focused on investments because none of our markets move directly in a correlated manner. So we're always looking for those kinds of opportunities. I would also echo what Chris talked about with regard to combining our sort of distribution channels and access to global capital, which I think is increasingly important, and something that I think that together, we will be stronger than apart. And with regard to new products, as mentioned, one, our focus really has been in the living sector. That includes multifamily, but it may include other sectors. By way of example, it could be student housing, it could be seniors housing, both of which we've done in the past, not in a big way, but are sectors that could be attractive that we could open up. And then I think the other piece would be investment vehicles, i.e., whether it's obviously our closed-end funds, we've got separately managed accounts, our open-end funds and other vehicles of that type that would be attractive to different types of capital and different costs of capital as well. As mentioned, we invest up and down the capital stack, meaning equity and debt. And those obviously require capital with different expectations as far as returns. And I think that, again, this enhanced distribution channel will really impact that in a good way.

So one other thing I'd add is that when we talk about adding it to the distribution of FHI, we think it can operate as a gateway or access to the wealth and high net worth channels that have been very, very successful at FHI. And this, of course, is in the U.S. And that's why we keep talking about, "Oh, this will be attractive to our clients and our investors as well."

Mike, this is Tom. One more thing. In our discussions with Esko, Lacy and Alex, we have talked about the capital that Federated Hermes generates. And while we've talked on this call many times that our order of interest is acquisitions and of course, then dividends and the regular capital things, we spent some decent amount of time talking to them about using the capital at Federated Hermes for new products, new ideas there. And so we have excitement there, and I think they have even more excitement about that.

That's great. I appreciate all the color there. If I could just quickly follow up just on fundraising. It looks like FCP's flagship product, is out in the market maybe every 2 to 3 years. I recognize that the 2023 vintage is investing now. But any thoughts around fundraising around the flagship product expectations maybe going into '26? And any way to kind of size or frame the relative size or growth and as we think about fundraising ahead.

Esko, they want to talk to you.

Okay. Well, we just had the final close on our last flagship fund in December of last year, we're actively investing that. Per our agreement with our limited partners, we can start marketing and talking about the next fund once we are 70% invested or committed. Our expectation is that, that will happen sometime during the end of next year, the beginning of '27, and so that would be when we would start looking to raise our next flagship value-add fund. That fund -- the last fund was about $1.1 billion. And frankly, it has the opportunity to even grow with co-invest, which is another element that we're using here. So over time, that would be something that we think could even be larger. I think that when we look out at the market and sort of what we're seeing both generally in fundraising as well as just the interest in the living sector our expectation is that we'll be able to hopefully grow the next fund, Fund VII in a meaningful way. Does that answer your question?

Yes. No, that makes sense.

Your next question is from Patrick Davitt with Autonomous Research.

I guess first, I think the performance data you gave is since 2008, but you've been operating since '99. Any color you could give on how the portfolio performed through the GFC would be helpful.

Esko?

It's interesting. So we had what we call our legacy portfolio, and that was really started in '99 and went until about 2006, 2007. And those were one-off transactions. And the reason for that was that we realized we needed to have our own track record under the FCP banner as well as we wanted to take that time to build our operating platform because we knew that would be important to both those factors being important to institutional investors. So we started contemplating raising a discretionary closed-end fund in '06, '07. Well, we all know sort of what happened as we went into the GFC. So we had closed that fund in February of 2008. And in many ways, you look back at that, it was a tough time, but it was a great time to have dry powder. And we were buying into distress at that period of time because of the impact of the GFC. Interestingly, we had raised the fund in February 2008, and I remember standing in front of our first ever Annual General Partner meeting with our investors and had to say, the bad news is we haven't actually committed any of your capital. The good news is we haven't committed any of your capital. We were patient as there was still a falling knife in that environment. We incubated a number of deals, and then we sort of struck as we went into '09 and '10. And that fund performed exceptionally well as a result.

Got it. Okay. My follow-up is on the fund structures, the traditional kind of close-end 10-year life fee structure? Anything unusual about the structure of the funds?

No, it's exactly as you say, it's a closed-end fund. We have a 3 years in which to commit the capital, i.e., invest it, then we have 7 years in which to operate and harvest. Typically, we have two 1-year extensions at the end that we could exercise if needed. And other than that, it's structured like most other closed-end funds.

Your next question for today is from Kenneth Lee with RBC Capital Markets.

Congrats again on the deal. Wondering if you could talk a little bit more about the earn-out provisions, specific targets or goals? And whether the payout is in cash or equity?

Tom?

Yes, Ken, the payout is in cash. And there's two different structures. One is based on revenue growth. And the other one -- and it's a 3-year type payments. And then the other one is based on how much money gets raised in Fund VII and payments based on pro rata type payments. Importantly, we want to pay it.

Yes. Yes. Every time that there is a payment, we are happier and we would be thrilled. Esko and team would be thrilled, and we will be thrilled and our shareholders will be thrilled if we pay the whole thing, i.e., we're all on.

Great. That's great. And then one brief follow-up here. And then in terms of the key employee 5-year agreements, any particular details around that, any sort of lockup details and that sort of thing?

Well, that's really easy because Esko, Lacy and Alex are the main players on that. And they still own a good share of the 20% and also we'll share in carry. So it's all aligned properly. And then the second wave of next generation of managers are all tied in with carry, and we also have a restricted stock plan that will come about over a 3- to 5-year period to keep everybody interested and aligned.

Your next question is from Bill Katz with TD Cowen.

Okay. Apologize for my horse voice, and congrats on the deal. Maybe the first question is, you mentioned some baseline accretion for '26 and '27. Can you unpack some of the assumptions underneath that in terms of what kind of growth you're anticipating and/or how you're thinking about capital return? And is there any impact on your existing buyback? That's my first question.

Yes. So on our buybacks, we expect to still continue on doing share buyback. I said -- I mentioned -- I wanted to mention in there that we took a pause on that because we were -- had material inside information. So we didn't think it was appropriate to buy shares, but we would expect to restart that up. And in terms of the accretion, we do -- we did our models, and we took Esko and team's forecast, and we analyzed that and we had an adviser scrutinize all their assumptions and then we put together what we think was our base case, and that's what we've used to develop those models. We think we're going to hit them, Bill.

Okay. Just as a follow-up, maybe a 2-part is somewhat unrelated. As part of your press release, you announced that your 9/30 alternative AUM or $19 billion that does down somewhat meaningfully from the June update. Can you maybe unpack me what's happening there? And then as part of this transaction, was this a -- just a bilateral negotiation? Or is this more of an open bid opportunity?