LPL Financial Holdings Inc. (LPLA) Earnings Call Transcript & Summary

[Audio Gap] important disclosures on the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, feel free to reach out to your Morgan Stanley sales representative. Good afternoon, everyone, and welcome back to Morgan Stanley's Financials Conference. I'm Mike Cyprys, Equity Analyst, covering brokers, asset managers and exchanges for Morgan Stanley Research. And welcome to our fireside chat with LPL Financial. We're excited to have with us today, Matt Audette, the CFO of LPL Financial. As you may know, LPL is a leading provider of investment and business solutions for independent financial advisers with over $1 trillion of client assets on the platform, a milestone that the company had just crossed in April of this year. Matt, thanks so much for joining us today.

All right. Thanks, Mike. Happy to be here.

Great. So why don't we just dive right in, start off with recruiting, important topic here on the minds of investors. You've seen a strong uptick and recruiting over the past year with new advisers joining the platform, and they're on track to hit some new records this year for net new asset growth. Can you talk about what's driving the recent success? And do you expect a pickup as advisers return to the office and in-person meetings resume?

Yes. Sure, Mike. I think when you -- when we look at the success, I mean, I think it's really driven by the strengthening of our firm and our value proposition. And by that, I mean, when you look at our service, our care offering, right, which I don't think has been the hallmark of the independent space where we've really seen that as an area to distinguish ourselves and invest in delivering a service experience or a customer care model that I think resonates really well. Technology, as you well know, is at the center of everyone's value prop, and I think we continue to really focus on that and invest in a way that is really driving value in that offering for advisers. I'd also highlight the culture of the firm is a big one. I think it's maybe tried to say or that everybody says it, but our advisers are the center of our firm, right? And I think you just -- you feel that when you are in meetings, you feel that I'm in the office today, you feel that when you walk around, and I think when you compare that to the places new advisers are coming from, right? When we talk to them about how and why more, they chose LPL. I think the feeling here on both the value prop and the culture is a little bit different into the positive. I think we're also starting to operate as a more data-driven team and really just identifying what's important to advisers to make sure that our value prop is matching that and meeting that. And then I'd say when you look at the new models, right, when you look years ago, we had a pretty focused offering versus today, it's expanded with our -- I'm sure you'll -- we'll get into it, with our SWS offering, our employee offering, our reinvested and reinvigorated RIA offering, the progress we've made in the bank, our financial institution space. I think you pull all that together, and I think it's really, really collectively been driving the recruiting success. And I think to the last part of your question, when you think about the impact from -- of reopening, I think a couple of things. One, I think when you look at the past 1.5 years, there really wasn't a huge negative, right? If you were invested in technology and digital capabilities to be able to really bring people on board. But at the same time, from the overall industry, you've certainly seen the amount of churn or the number of advisers that are choosing to change firms in every given year, really, really come down to probably near all-time lows. So I think as we look ahead and more and more of reopening happens, I think it's fair to say that's an environment that could be conducive to advisers who want to make a change to get a better value prop but really haven't because of the quarantine environment. So I do think it's potentially a tailwind as we get deeper into the reopening.

From new advisers joining your platform, existing advisers increasing the wallet share and winning more from customers and winning new customers, you've been able to take your organic growth from low single digits just a couple of years ago into the mid-single digits and then this past year or so, it's into the high single digits. So the question here is, how comfortable are you that you can sustain or even improve on those growth rates?

Yes. I mean we've had a lot of momentum going into this year, right? And if you just think about the growth rates that could come from that, if you just take the growth from 2020 or from last year and just assume that's consistent, then you start to add in the larger opportunities on the banking side or the financial institution side, like M&T, BMO and you put that math together, you're -- you pretty easily get into the low double-digit growth for this year. So I think we're pretty excited about it, right? When you look at the traditional markets that we're primarily just talking to in the prior question to the bank opportunity, and I'm sure you saw our latest opportunity there with CUNA in the announcement yesterday and being able to partner with them to help their credit unions move forward. And then you add in the new models that I was just talking about from SWS to employee to RIA, you're just collectively -- I think, when you look ahead on kind of dream a little bit about what you -- where you think growth can go from here, I think we feel really good. And that feeling is not only grounded in the value prop. But if you just look at the data, if you look at last year, the vast majority of our recruiting really came from the traditional markets. So when we look ahead to this year and you think about the additional growth from an M&T and BMO, the additional growth from the new models, right? I think it gets you pretty excited that growth can continue to grow. Now we've got to execute, and we've got to deliver on the value prop, but I think that reasonably puts double-digit growth for this year within our grasp if you continue that traditional market. And now with CUNA, you look ahead to 2022, right? It puts double-digit growth in play for the second year in a row. So I think we're, suffice it to say, pretty excited about the momentum, but it's all grounded and back to that culture point. The only way that happens and the only way that works is if the advisers are at the center of everything we do, and I feel confident they are.

Why don't we dig in a little bit to these new models and initiatives that you touched on. Let's start with SWS that's here, Strategic Wealth Services. I think you launched that back last year as a way to capture -- better capture breakaway advisers. So can you talk about how this offering operates? How is it different from where you recruited advisers in the past with wires? And what kind of traction are you seeing with that?

Yes, sure. I mean I think -- so that offering really plays into the long-term shift from wirehouses to independents, right? And when you look at our traditional IBD model, it really didn't provide that high level of support and advice and guidance or whatever those advisers needed to get from the wirehouse to independents, right? We were largely focused on folks that were -- if you looked at our value prop, it was largely focused on folks that were already independent and really walking through that -- doing that business at LPL and how that could be a much better situation. So they're really just -- when you look at prior to this model, there weren't a lot of wins in this particular area because the value prop wasn't there. So I think when we look to design this offering, and how it's different, it really is focused on not only what our traditional model offers but in addition to that, helping the advisers not only get to independents, but also once they are independent, helping them run that small business, which is where our business solutions come into play. So it's really just a model that adds to the value prop in a place where that's really, really important to an adviser who's looking to break away. So I think it's -- I think as far as what traction we're seeing, I think it's going really well. I mean the nature of developing a new model in a space that we're not known for, like there's a natural period of time where you've got to get brand recognition. You start to get a critical mass on the platform where people that have joined your platform, start to provide referrals to other folks. There's certainly a natural ramp-up. And I think that's what we're seeing, right? I think when we look at being a little bit over a year from when we launch this and having about 7 teams and over $2 billion of AUM on the platform, I think that we feel like that's really good momentum. Feels ahead of schedule to us when you think about a natural curve. And I think as we look ahead from here, I think we're excited about what this model can deliver.

The independent employee model is another -- one of your newer initiatives I think you launched out last year. Can you talk about how this affiliation model differs from your more traditional models? And what does the pipeline look like there?

Yes. And we launched it after the SWS model, so it's the newer of those 2. And it's really similar to SWS in the offering, right? It's focused on core office, breakaway advisers from wirehouses that really are focused on the benefits of independence, right, things like owning their own clients, really being product agnostic on what they distribute to their clients, and then, of course, the better economics that come along with being independent. But at the same time, these are folks that really don't want to end up running their own small business. So the employee model really solves for that, right? So you think about all the capabilities of the SWS model, but you're an employee as opposed to a small business owner. And so from a scaling standpoint, I think it's very similar to my comments on the SWS model, and that there's a natural length of time where between announcing the products, building the capabilities, getting brand recognition, especially in an area of the wealth management space where an independent firm like ourselves doesn't come to mind when you're thinking employee model, right? So it takes time to get the brand recognition out there. But I think with all of that as a caveat, we've got 3 teams onboard now. And I think we feel good similar to SWS on how that's going to ramp over time and feel good about the value prop. It's just earlier in that ramping than SWS is.

Maybe moving on to the bank channel, which you had alluded earlier to the CUNA win just from the other day. Can you just share a little bit more color around that announcement yesterday? And beyond the CUNA announcement, can you just update us more broadly on the progress that you're making in the bank channel?

Yes, definitely. So it seems like a long time ago, it's just yesterday. But yesterday, we announced that CUNA will be joining our platform early next year. And I think the way to think about CUNA is a large enterprise that serves and coordinates with around 300 credit unions that have around 550 advisers and over $30 billion of assets. Now those assets are primarily brokerage, call it, over 95% of those assets are brokerage-related assets. But by joining our platform, CUNA and the credit unions that are with them really get the access to and the benefits of our capabilities and technology and specifically the advisory capabilities that we've invested in for quite some time. So that's the overall concept. I think maybe a couple of things I'd highlight on there, maybe on the economics first. And when you think of the typical range of gross profit ROA in the financial institution space, it's usually on the lower end of that 15 to 20 basis point range that we highlight for brokerage-related assets, right? So call it in the 15 basis point range. Now given CUNA is kind of like a large enterprise above the 300 credit unions, not all of that economics would come to us. So think of our participation here more in the, call it, 10 to 15 basis point range. But at the same time, the costs associated with supporting such a large group, there are benefits in that when you think about the cost and basis points of AUM. And then typical to all of our underwriting, the transition assistance associated with this deal factors all of those economics in. So you kind of come down to the bottom line or the EBITDA margin, it's an accretive deal, even though the starting point on the revenue side is a little bit lower than you would typically see. I'd also highlight these financial institution contracts usually include some incentives in the first year or 2. So you've got a kind of structural ramp-up to a run rate EBITDA margin that's accretive to where we are today. So economically, it's exciting. I think when you think about this, if I take a step back from a strategic lens on the financial institution space, right? You just look at the 3 wins of the 3 large firms that we've signed, BMO, M&T and then CUNA collectively. I mean that's nearly $70 billion assets. It takes us in the institutional channel from about a 12% market share to nearly 20%. I think that puts us nearly 3x -- at least what we can see, 3x the size of the #2 player in that space. So I think we like this -- the position it puts us in of having the size and scale to really serve these financial institutions really, really well. And then maybe on the last economic point, you kind of -- you almost compare it to -- on the M&A side, when we look at our most recent transaction with Waddell, and you just look at where we underwrote that. These financial institutions kind of get into the same economic zone of that deal, but there's no purchase price, right? It just -- it gives you a sense of the power of organic growth when you look at it from that lens. So we're super excited about it. We've got a lot of work to do between now and when we're onboard to make sure that we're bringing the best of LPL to them. Now -- so second part of your question, so just more broadly on the bank channel. And I think those 3 institutions, I think, are great examples of how things are going, but maybe just to level set on the overall opportunity, the channel is about $1 trillion in AUM, and we think of that $1 trillion in 3 buckets, roughly 1/3 each. The first being folks that have outsourced today, right? And that's where we've got the dominant market share position. You've got another 1/3 that are the large money center banks that are highly unlikely to outsource this solution given how large they are. And then you've got another 1/3 where, from our perspective, it really makes sense for those firms to move their wealth management offering or their brokerage and advisory offering for -- to outsource to someone like us. So it's a pretty large opportunity. And I think the progress -- if we kind of go to that last 1/3, right, where I think is the longer-term opportunity, the progress looks good. I think when you look within the market overall, if you go prior to the 3 deals that we're talking through and you look at 2019, 2020, we're recruiting, call it, $5 billion to $10 billion in that space, right? And then you add on M&T and BMO this year and you get about $35 billion of assets. And then you add CUNA to the list for early next year, you're getting to $30 billion just from CUNA itself. So I think when you factor all that in and think through the outlook from here, right, the environment that I think is leading to these choices, I think, only increases the focus on outsourcing. And what do I mean about that? So scale, right? Scale -- being able to offer this offering, scale is becoming more and more important. When you look at the client experience, meaning the advisers' clients, right, their expectations of the offering is only getting higher and higher. Advisory capabilities are only becoming more and more important, right? And so if you haven't been able to invest in advisory capabilities, you've got a lot of spending in front of you to catch up. And I think when you stare down those 3 factors and realize that you don't have to do all of this yourself, right? It can be your clients and your advisers, but you could outsource this to someone and get the benefit of their investments. I just think that -- and as time passes by, just think that logic is going to build and build and build at the same time that the risk of being in this space is -- becomes more and more complex. So why not outsource that to someone who spends their primary focus on managing those risks. So I think that is going to trigger more and more folks to think through outsourcing and then you package that around anybody who's giving that some thought quickly looks up and sees that M&T made the choice to go to LPL. BMO made the choice to go to LPL. CUNA, on behalf of its 300 credit unions, made the choice to go to LPL. So I think it puts us, I think, in a pretty good position to be the top of the consideration set for a group of institutions that I think are going to be considering outsourcing more and more.

And speaking of outsourcing, you've had some big success with your business solutions offerings. Are there any plans to sort of offer these to third parties at this point?

Yes. I think our primary focus on business solutions is really with our existing advisers. And the focus is really helping them run a great business. And I think we've talked a bit about it, but just to level set for anyone that's not familiar, the business solutions are really capabilities that are focused on advisers who are independent in running their own small business, giving them the capabilities to assist in that, whether it be a financial service or marketing or administrative services, et cetera. So we think there's a big opportunity there. When you look at the amount of money advisers spend on really running their business, just the advisers with us, it's over $1 billion a year in and -- call it, local level services. So to the extent that we can offer something that's better and cheaper than them doing it themselves, I think -- we think there's a big opportunity there. And while we're still early in developing and rolling these solutions out, I mean we're -- at the end of last quarter, we were at 1,700 subscribers. I think that was double a year ago. So we feel really good about that. Now to your question, Mike, I think when we look at those solutions and think about, okay, the solutions that we're offering, if there's an adviser who's doing the same thing and running the same small business, but not at LPL, right, is there not an opportunity to offer those capabilities to them. And I think our hypothesis is yes. But we need to go experiment with that and figure out what value prop resonates? What do we need to do specific to our offering where it's to an adviser that's outside of LPL versus inside? So I would describe it as an experiment and us thinking long term that there's an opportunity here, but the near term is primarily focus on our existing advisers or advisers with LPL, but at the same time doing some work to make sure we understand what it would look like if we were to do something outside LPL.

Great. Can you talk a little bit about some of the enhancements that you've made to your core adviser workstation, that is ClientWorks? What's there resonating with advisers and helping to drive organic growth?

Yes. I think that the technology investments, as I was talking about earlier, right, they're just so, so important. And I think when you look at where we're investing, it's pretty simple. It's what do advisers do on a day-to-day basis. right? And if you can make that process more efficient value prop to them, then it's going to matter, right? And it's going to help your existing advisers be more efficient and grow and it's going to help you attract advisers to your platform. So simple examples, right? They spend time trying to attract new prospects. When they get a new client, they've got to onboard them. When they get them on board, they've got to bring in and manage their portfolios. They do goals-based planning with them, right? And the list goes on and on. So if you can make that efficient for them in an integrated technology suite, it's going to matter a lot. So I think that's a big example of where our dollars are focused. I think you've seen us -- and we think it's key to the drivers of our organic growth is really meaningfully ramped up that spend in technology over the past several years, right? We were growing for a while that portfolio at about 20% a year. Now the last couple of years, you've seen that kind of flatten out a bit to much, much lower growth rates. As I think we've reached a point where you get to a point of equilibrium where there's only so much technology that you can develop and deliver that people can reasonably absorb and adopt, right? You can build the best technology on the planet, but if there's just too many new things coming out, it's not going to be very efficient. So I think we've started to get to -- we're not at that place, but I think we started to get closer to that place, which is why you've seen our spend kind of flatten out a little bit, although it's still growing. I think from a priority standpoint, looking ahead, it's really in 3 areas. The end investor experience, right, it's becoming more and more relevant, as I talked a little bit about on the large financial institutions. Advisers, clients expectations of the digital capabilities are rising. Second is in the adviser technology itself that I was just talking through, ClientWorks as the example. And then third is the advisory platforms, right? The majority of dollars coming in are going on advisory platforms. So it's key to be investing in there. So those are the 3 areas. And I think we're pretty excited about our technology platform, but at the same time, we're continuing to invest to make it better.

Why don't we shift over to M&A topic that gets a lot of interest from investors now that you've closed the Waddell transaction. Can you talk about how integration is progressing there towards your updated $80 million EBITDA target that you have for the Waddell transaction? And given that you're still integrating Waddell, do you have any financial and operational capacity to do another acquisition if something compelling arises?

Yes. So I think on the first part of the question, I think our -- anyone who has our Q1 earnings deck handy or you can reference it later, I think we've got a good slide in there, I think it's Slide 8 that walks you through that. I think we're proceeding on that path, right? I think the details that are there are really about the path to achieving that run rate of $80 million plus EBITDA is really 3 things. It's, one, getting to a place where we onboard the advisers; and then second is really after that you can start to realize the gross profit synergies, and then you start to do your more classic integration and the expense synergies. And I think we think -- we estimate that will be about a year-long process, right? So kind of closing in this quarter, the second quarter, it kind of puts you into the second quarter of 2022, where we'd get to that run rate EBITDA of $80 million. So I think where we are today, we feel good. Things are progressing. And I think we feel good about not only progressing to getting that done in the year, but also feel good about progressing to that $80 million estimate, and there's even opportunity to do even better than that depending on how the integration goes. I think on the second part of your question on the capacity, I think when we look at M&A, we always look at it from 3 lenses, right? Does it strategically make sense? Does it financially make sense? And of course, to your question, do we have the operational capacity to do so? And I think honing in on the operational capacity, I think the interesting thing is we have -- when you look back at the last several years, one of the areas of focus and investment on the technology side has really been on the capabilities to bring advisers and their clients on board. So I think as -- if you think about our capacity to absorb over time, just anchoring back to 2017 when we did our last kind of large deal, versus today, our capacity to absorb is much, much higher. So I think we feel really good that -- we'll continue to always focus on those 3 lenses, but the operational capacity is much, much higher. And just to give an example of CUNA that we were just talking about, that's -- when you think about the size and scale, that's M&A like from just a size standpoint. And while I just emphasize there's a lot of hard work to be done, I think we felt really good about the capacity to bring that on board. So hopefully, that gives you a sense of how we feel on the capacity side.

Great. Maybe shifting gears over now to interest rates now that we've seen the increase in back-end yields has somewhat stabilized. What's the latest, would you say, on bank's appetite for your deposits and your ability to extend duration? And can you also touch upon your recent ICA guidance change following an early termination of a fixed rate contract.

Yes. I think the market -- and it's not specific to us. I think the market in general is very similar to what we've talked about the last couple of quarters and most recently at our Q1 earnings call. It's really -- it's no different. There's very little demand for sweep deposits in general. I think it's probably well documented or widely discussed why, just the massive amounts of liquidity that's in the system, whether it be from the Fed or just consumers still having the quarantine era funds that they were saving still on their own personal balance sheet. So I think that's the environment we're in today. I think that's the environment that -- to the second part of your question, I think, led to that one particular bank needed to terminate that deposit arrangement early, which they had the option to do so just really connected to the same point, the amounts of liquidity in the system that was driving up their balance sheet size. So I think looking ahead, Mike, I think the environment we're in right now, again, really no change. But I think as we look ahead, we continue to increase our size and scale. We continue to have a large amount of deposits that I think as we move into a period of time where liquidity does become more and more important, I think we're going to be one of the larger liquidity providers in the system, and we'll be ready to really work with banks at the time that they have the need.

And given some of the recent Waddell acquisition and the recent bank mandate wins, you've had quite a number of them, plus you add in the overall higher level of organic growth that you guys have been putting up, is -- just thinking about expenses, is the mid-single-digit core G&A growth sustainable? And under what scenario could we see that drift, say, into the higher single digits, if not teens?

Yes. I think the -- first, I mean, I think when you look at what we're investing in, it really is the capabilities and the variable costs associated with organic growth, like that's the primary focus of those investments. And I think we're very disciplined about it. And I think we feel like they're working, right? When you look at our organic growth, you go back 3 -- a few years ago, right, we were in the 3% zone. You go back 2 years ago, we were 5%. You go back last year, we were 7%. And then I think we talked through a little bit earlier, you've got a reasonable path to both this year and next year being potentially over 10% organic growth with those large financial institutions. So I think we feel like we're making the right investments, and it's driving the growth. I think to your question on like what scenario can drive that higher, it really comes back to organic growth. I think a scenario where our core G&A is growing in the high single digits or low double digits, I think, is a scenario where you're getting the opportunities on whether it's existing growth or new models like SWS and employee being examples where those types of opportunities would be causing us to want to invest more, right? I think that would be the scenario that would occur, meaning I think you probably feel that was money well spent.

Great. And we're just about time. Maybe just last question here on capital management. How are you thinking about capital management these days, more broadly, particularly now that you've had the CUNA win, what does that mean for share repurchases?

Yes. I don't think -- the CUNA win really doesn't change our approach, both our philosophy and our plans. I think when you look at our approach, it continues to be organic growth first, M&A second and returning capital to shareholders third. I think when we look at our focus for this year, I think we spent a lot of time really looking at the first half of this year when we've got some pretty meaningful uses of our cash in the organic growth and M&A space, right, M&T and BMO as well as the rest of our traditional recruiting on the organic growth side. On the M&A side, Waddell & Reed, both the purchase price payment as well as the transition systems kind of landing this quarter. And I think as we get on the other side of those opportunities, I think is where we're really going to reassess what the future looks like and what the rest of the year looks like. And I think if we have ample liquidity and cash that's building up, when we -- when we look at our view on organic growth and M&A, I don't think we would intend to let that cash just build. I think we would naturally move to doing share repurchases. And I think when you think about that approach and kind of factor in the CUNA win, I don't think it changes that approach and I don't think it changes the dynamic of the second half of the year. So we'll keep everybody posted on that as we march forward. But the headline for me is CUNA, just given the amount of cash and capital we generate, doesn't impact our prior dialogue and discussion on share repurchases.

Great. I'm afraid, we'll have to leave it there. Matt, thanks so much for joining us today. Appreciate the insights.

Yes. No problem. Take care.

Take care. Bye-bye.