Victory Capital Holdings, Inc. (VCTR) Earnings Call Transcript & Summary

Good morning, everyone. This is Terry Sullivan speaking. I run our Global Financial Institutions Group in Investment Banking at UBS, and I want to be the first to welcome everyone to our UBS Annual FIG Conference in virtual format. We've got a great couple of days planned for everyone, a fantastic roster of companies participating as well as a diverse broad set of investors. And hopefully, everybody finds the access mutually beneficial and look forward to hopefully seeing everyone in person next year. I'd like to now turn the floor in a few minutes here over to Victory Capital, who we have as our first company presenting. It's my pleasure to introduce today, Chairman and CEO, David Brown; and Director of Investor Relations and Chief of Staff, Matt Dennis. Victory Capital is a leading integrated investment management firm with an integrated model and specialized investment franchises. As of June 30 of this year, AUM was $129 billion spread across 9 franchises and a solutions platform. And I'd just like to make one more final remark. This presentation may include forward-looking statements. Please reference Victory's SEC filings for a full disclosure of risk factors. With that, I'll hand it over to David Brown.

Thank you, Terry, and welcome, everybody. We're honored and pleased to participate in the conference and hope that you find this helpful. So turning on the presentation to Page 2, just to go over our agenda. I'd like to give you an overview, for the people that are not familiar with our business, of how we're structured and how we go about our business; and then talk about our strategy for profitable growth; and then talk a little bit about our recent acquisition of the USAA Asset Management Company, which we closed a little over a year ago. Turning to Page 4. I'd like to focus on a couple important pieces of our business using this slide. So if you look at the top of the slide under the Who We Are bucket, as Terry had mentioned, we're a $129 billion under management as of June 30. We have 9, we call them franchises, investment franchises and a solutions platform. Each one of our franchises has its own brand and its own distinct, unique investment process. I want to make a note here that even though they have their own brand and even though they have their own unique investment process, they are not separate companies. They're all part of one company, Victory Capital. Those 9 investment franchises as a solutions platform, we have close to 160 investment professionals supporting them. We have 13 offices around the world, 10 are within the U.S. and 3 are outside. And then really since our management buyout in 2013, we've done 5 acquisitions and made a minority investment in the company as well. Our latest acquisition, which we'll go into more detail later on in the presentation, was of USAA's Asset Management business, and we closed that in July of last year. And that was an acquisition that really changed and transformed our company from a size and scale perspective, from a capability perspective and then also creating what we would call a unique distribution channel. I'll talk more about that later. We have sales professionals in the retail, U.S. retail channel, U.S. retail retirement channel and then also in the institutional channel. And then our third channel is really our direct channel, which, today, is made up primarily of USAA members. And again, I'll talk more about that. We have 118 investment strategies, and we utilize a platform. And it's really a centralized platform that includes our operations, technology administration and then importantly, our sales and marketing, which supports all of these investment franchises. So we have 163 sales and marketing professionals, and I'll get more about -- I'll talk more about our model a little bit later. The last point I'd like to make on this page is we are one company with a number of different brands. We have close to 400 employees, and those 400 employees have meaningful ownership in our company. It's part of our culture. We have an ownership mindset. And not only do we have ownership in our company, we also have ownership in our products, and I think it's really important to call this out. At the end of 2019, our employees had about $180 million of our own money invested in our own products, all by choice. So we always talk about when our clients win, we win; and when we win, our clients win. It's really creating alignment. Turning to Page 5. I'll spend a few minutes here talking about our integrated model. We feel it's very unique. It is not a multi-boutique model. And it is probably closer to a fully integrated model, but has a lot of the benefits of the multi boutique but not a lot of the challenges. So let me go through a couple of the pieces of it. I mentioned branding earlier. Our investment franchises all have their own brand. We have 9 different brands. And the reason they have their own brand is really to represent the uniqueness of their investment process. So all of those 9 investment franchises develop their own portfolios, they do their own research and they do their own portfolio construction. And what comes out are really unique portfolios that are interconnected with each other, even if they're in the same asset classes. The independent branding represents the uniqueness of the portfolios. In autonomous investment process, and what we mean here is that each one of the franchises really are doing their own work. We don't have a centralized research group. We don't have a centralized opinion on how to manage money or an opinion on interest rates or oil prices. Each one of the investment franchises has their own unique take on what's happening in the market. And they do not share information unless they choose to, but it isn't required. One of the key parts of our model, which I think really gives us an edge, is the centralized distribution and marketing. So those 163 sales and marketing professionals, none of them specifically work for our franchise. So what we do here is we get the benefits of having a sized and scaled platform that these franchises can plug into to gain access to some of the largest platforms on the retail retirement and on the institutional side. It allows us to partner with the larger platforms and to go deep from a product set, from a franchise set onto these platforms and support them in a big way and support them in a world-class way. We feel that this is quite an advantage when we think about our ability to distribute. And then along the same lines, we do have -- as part of this platform, we have a centralized, and we always talk about not standardized, and I think that's a really important distinction, centralized operations and back office. And that includes administration, technology, data and all of the other administrative functions. And what we do here is we get the benefits of size and scale to build a world-class platform. But then we allow our investment franchises to really dictate what they need, when they need it, the speed they need it. And we think that allows them to be customized and to pull from a much larger platform that has more resources. So not losing the uniqueness of a small boutique mindset of an investment team where they're going to do things their own way so they can still do that, but really pull from a very large and I would say, world-class platform. So we think that that's quite unique. And again, trying to thread the needle between all of the benefits of the multi-boutique and all of the benefits of a fully integrated firm, but not having some of the challenges that each one of those models have. This structure and this model and the way we're set up really puts us in a nice place to execute on acquisitions. So what we're able to do is preserve the investment culture of the businesses that we're purchasing or we're partnering with, preserve that investment culture, which is so important. And I think when you think about acquisitions in this industry and where some have had challenges, it's around the investment culture being damaged through the acquisition. We're able to preserve that. And because we have one platform, we're able to produce quickly synergies and synergies on the cost side because we're able to eliminate duplication, get the benefit of size and scale; and then also on the revenue side, synergies where we're able to take these products and push them through our relationships through this centralized distribution and marketing. So we think this is quite unique. And quite honestly, we don't know anybody that's doing it the way we are, and we think it's quite effective. So turning to Page 6. Turning to Page 6, you can see a visual of really what this integrated model looks like. And I won't spend too much time on this page, but I'd like to point out a couple of things. If you look at the circle on the left side, you'll see the different franchise brands, including our solutions platform, which has our Victory shares ETF business underneath it. So that -- those are the individual investment franchises. Again, not different companies, different brands. Again, they're holders of the investment professionals or holders of VCTR stock. So these are all part of our company. And -- but they're independent, autonomous from an investment perspective. And that middle is really that platform, that centralized but not standardized platform. And you can see as you -- on the right side, you can see a lot of the centralized functions that are truly pulling from that middle. And then we have some joint functions where we feel that there's an intersection point. We do product development and some client service together. And then obviously, on the franchise level side, what they're doing really independently is around security selection, portfolio construction and research. Well, so turning to Page 7. The model sounds great, but what is it producing? And we're proud of this page. We have about almost 2/3 of our mutual funds and ETFs are ranked 4 and 5 star by Morningstar. We have close to 40 4 and 5 star mutual funds and ETFs. And if you look at the critical time periods around the 3- and the 5-year period, we have almost 70% of our assets under management outperforming our benchmarks. And over -- during those time frames, over half of our strategy is outperforming benchmarks. So we're proud of the investment results. And really, as we think about the edge that our investment franchises have, we think about putting them on a platform where they spend all of their time managing money, where they spent all of their mind share not worrying about can I get data or technology to have to run a business? All about managing money, which is really what they're paid to do. So we create an environment where they can be successful and spend all their time being successful. Of course, it's up to them to be successful. But we put them in the best position for them to win. And we think that over a long term that is, for our company, the best way to position our investment franchises for success. So turning to Page 9. I'd like to talk about our strategy going forward when we think about growing. And if you look at the left side, we call this our profitable growth circle. So if you look at the left side, we will do acquisitions should the environment continue the way it is. We are -- really, we've been saying this for years, but we are really just beginning the consolidation phase of this industry. I believe that there will be a lot more acquisitions going forward. And I believe that if you're able to successfully navigate the landscape, a lot of these acquisitions, at least for us, will be extremely value added from a product perspective, from a distribution perspective and then ultimately, be very financially rewarding for our shareholders. So we will do acquisitions. We will also, at the same time because the way our business is set up, have the ability to really delever. Today, most of our free cash flow is used to pay down our debt. So we will take our cash flow and delever. And while at the same time, we do have, I would call, an ancillary dividend and share buyback program. And we'll continue to do all 3 of those things. And you can see on the right, really, that's a visual not to scale of how we're using our free cash flow. But a couple of key points here is every time we do an acquisition, we are thinking about improving our business, making our business better. So it isn't about financial engineering, it's about how do we make our business better. Do we have more products? Do we gain size and scale? Do we open up new distribution channels? And I'll kind of fit that in as we think about the USAA Asset Management business. But if you think about what we've done through acquisitions is we've increased our size and scale. We've increased the number of investment capabilities we have. We've increased our margins. We've increased our free cash flow. We've really opened up new distribution channels in the U.S. and outside the U.S. So when we think of these acquisitions, we think of them very much as how do we make our business better. So on the other side, I want to just talk a little bit about the free cash flow and give you a couple of statistics. We are able to -- and we'll go through the page in here on our tax asset, but we're able to convert about 70% to 75% of EBITDA through free cash flow, and that will turn into the ability for us to delever. So going to Page 10. If you look at this page, this really gets into some of the different products that we're interested in and how we can grow our asset classes and where we can win and where we have won. So if you look at the top part, our current lineup, really, when you look at our 9 franchises, we have primarily capacity constraint. We manage money capacity-constrained asset classes in international and emerging markets. Our ETF and solutions platform is rules-based. And when we look at those asset classes, the way we're approaching them, we think we can win there and we think active management can win there. I'd also add fixed income into that bucket. And we have been able to compile a group of franchises and asset classes to really put us in a position where we think we can achieve organic growth. And part of growing that will be buying or partnering with companies in asset classes where, again, we think that there's an ability with good performance in our distribution to grow. So where are they? In -- starting from probably on the active side, in the public markets, high conviction alpha strategies. So either in capacity-constrained or non-capacity-constrained asset classes where you're really very active, we think that there's an opportunity there. Solutions, our outcome-driven portfolios, we think is another area that we're in today and that we can enhance going forward. Customized portfolios through multi-asset classes, again, is another area. And of course, I think where many have gone and are going in the private and illiquid market, we think there's an opportunity there. All of those areas are within scope of what we're looking at for future acquisitions. And we think with our background, our platform, our size and scale and our distribution proposition to these potential sellers really makes us an acquirer of choice. If you put our current book of business and then our opportunity around the acquisition side that we have, we think over the longer term, and actually, as we've proven out over the longer term, we'll be able to grow our business. So quickly, turning to Page 11. I want to go over just very quickly and I'm not going to go over too much detail. We did this on our call but really, this is a visual of our tax asset. And very simply put, because we're an acquirer, we've been able to build out -- build up a tax asset. You can see the math here and you can see the visual. Again, I'm not going to go through it kind of line by line. But we think there's a sizable tax asset that is worth with some assumptions around $3 per share. And you can see the bolded part is $441 million in future cash tax savings. Assuming the current tax rate that we have around 25%, if we bring that forward discounted very conservatively at 10%, you can see that that's $3 per share. And again, this is a result of the acquisitions we've done in the past. So I do want to leave some time for questions, but I am going to go over just quickly the USAA acquisition and talk about that. That is our latest acquisition that happened about 13 months ago. You can see on the arrow, this has been for us a build. And the build has really started off on the left side that we had a business that we integrated into our business, had put a synergy target of $100 million out there, exceeded that target and realized $120 million of synergies. Very quickly, a majority of those synergies were out the day we closed and 100% of them are out today. So we integrated this business into our platform, if you will. We also created or recreated a call center and a call center that services over 700,000 direct clients, which are USAA members. So we have a call center here in San Antonio, where I'm located, that's answering the phone and servicing very much like you would a direct to client or consumer business around mutual funds and our 529 plan, our USAA 529 plan. So we've reproduced that with world-class service levels. And those service levels are really important because all of those clients are, as we call them, members were used to a certain level of service that they got at USAA, and we've reproduced that. So from there, what we've done is we've been able to really increase our technology and enhance our technology around the call center, which really is the foundation for future marketing, for efficiency and for client experience. And as we've -- and that takes us out really to this August 2020 line. And as we look forward, we are now just looking at the opportunity to grow and through some of our growth initiatives, which I'll flip through the next page, but really, we're entering into this phase. So 14, Page 14, just quickly. And I'm not going to go through every single line here. But over the last 13 months, we've been successful in opening almost 80,000 new accounts in this channel. And also, when we think about opening these new accounts, we've done very little marketing to support this. So a lot of these accounts have come through our agreement with USAA, have come through members finding us and interacting with us. And I would remind you, a lot of these new accounts are not only funding to buy mutual funds in our 529 plan, but they're setting up these automatic investment plans, which are very important because those are plans where every 2 weeks or every month, they're going to come in and they're going to pull from their paychecks or they pull from their bank account and they're buying the product. So this is a great way to be connected with your clients. Really, when we think about the second half of this year, we're ramping up our marketing and media campaigns to grow this channel. This is an exciting channel for us because we think there's a tremendous growth opportunity here. The U.S.A. membership is over 13 million members, and we have a small percentage of those members as our clients today. So we think that there's a great opportunity there. And as we grow this channel, we're going to be expanding our product choices for these members through new ETF launches, through new member share classes, and we have other products in development. So we think we're -- we think that this is going to be a great opportunity to offer more investment choice for these current and new clients. I'm going to skip over 15. I think this is a pretty good visual of how the referral process is working. Very simply put, the U.S.A. member that interacts with USAA will go through some questions, either digitally or over the phone. And if they ask to be involved in our U.S.A. mutual funds or 529 plans, they are pushed over to us. It's a great opportunity to grow our business. And really, USAA has been a great partner for us. So lastly, if you go to Page 16, we are fairly a new public company. We went public in February of 2018. And we really went through 5 key points during our IPO. We said we're going to make accretive acquisitions. And the USAA acquisition was unbelievably accretive and was over 100% accretive, believe it or not. So we have kept that commitment. We said we were going to talk about growing and increasing our scale. Our assets under management are up 112%, which has allowed us to really be more efficient in what we do. We said we needed and would diversify our asset classes. We acquired a best-of-class sized and scaled fixed income team, which we did not have before, which really diversified our business and solutions capability, and it really balanced out our business. And that was really important to us when we think about our opportunity. Broad distribution. We have invested and expanded our existing distribution around retail, retirement and institutional. And we've done that over the last 2-plus years. But really, the big move was opening up what we would say is a third distribution channel, which is quite unique, which is this direct-to-consumer channel, which I just spoke of. So that's really broadened out our distribution. And then lastly, as I went through our business model, I really believe our model and what we have to offer is extremely appealing to many thinking about partnering with firms in this industry. So becoming the industry's consolidator of choice. I think we have a very appealing offering when you think about our platform preserving the investment culture and the distribution side. And then there's some statistics on here. I talked about growing. I think we're all really proud of these statistics. We've grown assets under management from '19 to '20, and it's 133%. Revenue were up 116%. Adjusted EBITDA, $150 million. We've expanded our margins. And I would also note for the second quarter of 2020, our adjusted EBITDA margin was 47.5%. And we've grown our ANI and then we've grown our ANI with tax benefit. So quite proud of these numbers, and I think that they matter quite a bit. And then what's not on this page is we also increased our dividend this quarter from $0.05 to $0.06. So I'll stop there and open up to the operator, at least to Terry, for questions.

Great. Thanks, Dave. We've got our first question in here on the topic of ESG. So how do you think about your ESG positioning? Does it fit better?

You went in and out, Terry. Can you repeat the question, please? Terry, can you repeat the question, please?

I think we may have lost Terry.

Sorry. I'm back. Should I repeat that?

Yes. Can you repeat it?

I must have broke up. First topic is ESG. How do you think about your ESG positioning? Does it fit better as a centralized build function in your model? Or is it better to buy a dedicated ESG strategy team?

So on ESG, we've done a couple of things. Let me level set first. We've done a couple of things. We hired a Director of Responsible Investing, David Alt, who is leading that. And we think of ESG on a couple of different levels. Obviously, on the corporate level, we're doing a lot of different things to ensure that we are an ESG-friendly organization. From an investment perspective, each one of our franchises is incorporating ESG that fits their investment process. So as I mentioned, all 9 of the investment franchises manage money differently. They all are incorporating ESG through the data that we're giving them, through the technology we're giving them, through the resources we're giving them. They're incorporating ESG as it -- as they see fit for their investment process. We also are launching or in the process of launching a multi-franchise ESG product that we'll be launching later on this year, which will be a collection of a number of our franchises in really an ESG format. I think that there is an opportunity, of course, to maybe go out and acquire a firm that is just ESG focused. Absolutely. There are opportunities to do that and that would be great. But I don't think that's the only way to do it. And I don't think that that's the only way for our franchises to have an ESG perspective. So I think it can be successful in our model. And then there's an opportunity to go out and, of course, buy an ESG-focused franchise as well.

Great. Thanks, Dave. Next couple of questions actually are on flows. So I'll put them together. [Technical Difficulty]

Terry, we can't hear you.

All right. Let me try again. Can you hear me now?

I can hear you. Yes.

Okay. Let me try to squeeze this in. The next topic is flows. They seem to suggest the path to positive flows this year on the first quarter earnings conference call. Is this a correct interpretation? And specific to USAA, when do you expect U.S.A. direct-to-consumer flows to inflect positive?

So I think as we guided on the call, the -- we see flows improving as we go through the year and into next year, into 2021. There was a lot of noise in the second quarter. There was a lot of onetime activity in the second quarter. And we see a lot of positive developments happening with our 1-but-not-yet-funded business, our pipeline. And I can't predict when clients will fund. So I want to stay away from predicting in time periods when things will turn to positive or when they won't be positive. What I do know and I stand behind is, is that we see some really good things happening. We think the direct channel is an unbelievable opportunity. We see a lot of great things, indications through the number of accounts we've been able to sign up, through some of the feedback we're getting and some of the things that we're doing now that will pay benefit -- will pay us dividends in the future and be a benefit in the future. And I go back to when we originally announced the USAA acquisition, we said that the opportunity set of having a membership with over 13 million members and having a very, very small percentage of that membership own a product and then having the brand on our mutual fund and on our 529 plan, we felt that is really powerful. And we knew it was going to be a build and would be very methodical. And I think we've come through on all of the things we've committed through the synergies, through the integration, through the client servicing. And I believe that as we look forward, again, not being able to predict the exact time, this is going to be a very beneficial channel for our organic growth.

Okay. We probably have time for one more question. So maybe, Dave, just on the digital platform that you talked about that you're developing. Given what were all experienced with COVID and the acceleration of technology in various aspects of our lives, can you maybe talk a little bit about behaviors, changes in behaviors of clients that you feel the platform will align with well in the future?

Yes. So I think, generally speaking, we've seen a couple of different things happen. One is we have seen buyers, platforms, individual buyers, institutional buyers embrace the ability to be serviced and the ability to buy from a -- through technology, through video, through non -- in the old way, non-traditional means. And so we've seen some very fast adopters. And we've also seen, on the other side, some groups that have been very slow to adopt some of these means, but we see them coming around. I think what will happen going forward is there will be changes that will be permanent. Many will buy through platforms. Many will buy through -- if you have the right digital platform that you're rolling out, many will buy through that platform. And you will be able to be more efficient and more effective. And ultimately, that will be the only place that those buyers will buy. And I think that will be a growing part of the buying universe. But there are other characteristics that will -- and other things that will turn back to what is more traditional, which would be face to face, more of some of the things that we historically have done from selling and servicing where the digital platform will just be a support system and not be the primary use. So we think it's important to have both. And part of what I think the sorting out is, is to know what parts of the industry will do what. And I think we've had a lot of learnings over the last, call it, 6 months, and we're starting to see trends develop. And I think, ultimately, what it means is asset managers are going to have an opportunity potentially to be more efficient in selling and servicing. And some of those dollars that are saved will fall to the bottom line and maybe make up some of the -- if there's fee compression or there's other areas that are going to be more costly, some of that will fall to the bottom line and will make up for that. What we will do is we will take -- because of our -- I'd say, our edge on the business model and how efficient we are, we will reinvest in areas around technology and data, in our digital platform, in our investment side, and I still think be better off for it. But I think really, what we've seen over the last 6 months is this trend where people will continue on what they're doing, and there will be pieces where they'll want to go back to being serviced and buying kind of the more traditional way.

Great. Well, I think we're just about up on time here. So thanks, Dave and Matt, and thank you all for participating.

Thank you, Terry.