Virtus Investment Partners, Inc. (VRTS) Earnings Call Transcript & Summary

Good morning. My name is Latonya, and I will be your conference operator today. I would like to welcome everyone to Virtus Investment Partners conference call. The slide presentation for this call is available in the Investor Relations section of the Virtus website, www.virtus.com. The call is being recorded and will be available for replay on the Virtus website. [Operator Instructions] I would now like to turn the conference over to your host, Sean Rourke. You may begin.

Thanks, Latonya, and good morning, everyone. On behalf of Virtus Investment Partners, I'd like to welcome you to the discussion of our announcement of our agreement with Keystone National Group. Our speaker today is George Aylward, President and CEO. Mike Angerthal, our Chief Financial Officer, will also be available for Q&A, which will follow our prepared remarks. Before we begin, please note the disclosures on Page 2 of the slide presentation that accompanies this discussion and is available on our website. Certain matters discussed on this call may contain forward-looking statements, which are subject to risks and uncertainties, including those factors set forth in our SEC filings. These risks and uncertainties may cause actual results to differ materially from those discussed in the statements. Today's call may also reference non-GAAP financial measures. Please see our most recent quarterly earnings material available on our website for discussions of our non-GAAP measures and reconciliations to the applicable GAAP measures. Now I'd like to turn the call over to George. George?

Thank you, Sean. Good morning, everyone, and thank you for joining us today on short notice. I'm very excited to announce that we have signed an agreement to add Keystone National Group as a Virtus Investment Manager to expand our investment capabilities to include private market strategies. Keystone is a distinctive private markets manager specializing in asset-based lending and a pioneer in bringing asset-centric private credit to the wealth channel through RIAs, high net worth investors and family offices. This transaction with Keystone fits well with our stated strategic objective of providing the building blocks of a well-diversified portfolio, which should include differentiated private market strategies. Slide 3 highlights the compelling strategic rationale for the transaction. Partnering with Keystone establishes for us a foundation in private credit and real estate with a capability that is differentiated from other private credit offerings through its focus on asset-based lending, and addresses the growing demand for private market strategies, particularly uncorrelated sources of income. We see significant growth opportunities through further expansion of its established presence in the wealth channel with its flagship tender offer fund and in making their strategies available to an institutional client base both U.S. and non-U.S. With the deep experience of Keystone's management team and their track record of compelling investment results, we also see opportunities to extend into other products for broader client usage. Keystone has an attractive financial profile having generated strong financial performance, with revenue and EBITDA CAGRs north of 35% over 3 years, with positive net flows and strong double-digit organic growth rate. I would note that we anticipate the transaction will be immediately accretive to margins and non-GAAP EPS upon closing in the first quarter of 2026. And importantly, Keystone and Virtus operate with similar philosophies and have a strong alignment of culture and strategic priorities. Both firms share an emphasis on investment excellence, client focus and long-term value creation. Keystone managing partners will maintain significant equity and have entered into long-term employment agreements, ensuring continuity of the team, culture and strategies. Slide 4 provides an overview of Keystone. The firm offers differentiated exposure to private credit and real estate and is known for its asset-based lending strategies anchored by disciplined underwriting and a focus on capital preservation. Since its founding in 2006 as a distinctive manager specializing in diversified asset-centric private credit strategies, Keystone has grown assets under management to $2.5 billion, primarily sourced through the RIA channel where they have meaningful long-term relationships in a large and growing private wealth base. The firm is led by a highly experienced management team that has invested over $6 billion in more than 750 transactions spanning equipment finance, real estate finance, financial assets and asset-based corporate loans, and has delivered an attractive investment performance over nearly 2 decades. Keystone's asset-based lending approach is differentiated from the more common private credit direct lending strategies, including a different risk profile. Keystone's asset-based lending approach differs from direct lending as its financings are generally secured by specific collateral, are self-amortizing with regular payments of both principal and interest, have a shorter duration, and includes strong covenants and triggers that may give more control and protection to the lender. This makes Keystone's strategies attractive for investors that are underexposed to private markets, as well as a good diversifier for investors with existing exposure to traditional private credit as it may provide more downside protection with its collateral-backed focus and covenant-heavy approach. On Slide 5, we provide an overview of their current strategies. Keystone's flagship $2 billion tender offer fund, the Keystone Private Income Fund, or KPIF, which launched in 2020, has gained meaningful traction with leading wealth managers as a result of its attractive and consistent investment performance relative to other private credit interval funds and income-oriented funds more broadly. It can complement mainstream private credit funds by providing a differentiated exposure, as well as deliver an attractive yield in excess of what is generally available in traditional fixed income. Keystone also manages 2 private REITs, investing across private real estate debt and equity, with approximately $500 million in assets under management. I'd emphasize our excitement around welcoming Keystone's talented team of professionals to Virtus. The transaction will enhance Keystone's ability to focus on managing its distinctive strategies while benefiting from our support model. As part of the Virtus family of investment managers, Keystone will maintain autonomy over its investment process, brand and culture, have greater flexibility to focus on client outcomes and on achieving sustainable, predictable investment performance, retain significant equity ownership in the business and receive support for intergenerational transfers of equity interests, benefit from the expertise and expanded resources available as part of a larger company, and be supported by our strong distribution, marketing and client service capabilities to accelerate their growth. Turning to a summary of the transaction on Slide 6. We would acquire a 56% majority ownership stake in Keystone for $200 million at closing, that will be funded with existing balance sheet resources. The transaction also includes up to $170 million of deferred consideration over 2 years, including earn-out payments subject to achievement of future revenue targets. As a reminder, at the end of the third quarter, we had $371 million of cash and equivalents, an undrawn revolver with $250 million of capacity, and our net leverage was 0.1x EBITDA. After closing, we will continue to have significant financial flexibility to continue to balance investments in the business and return of capital to shareholders. And while we were not in the market to repurchase our shares in the third quarter given advanced discussions with Keystone, we do intend on resuming our buyback program. After closing, Keystone's management team will retain an ownership position of 44%. Through put and call options in years 3 through 6, we would increase our ownership to approximately 75%. The balance of the equity will remain as a minority interest and be available for recycling to future generations. Regarding the financial impact, we anticipate the transaction will benefit the operating margin by approximately 200 basis points and contribute about $1.50 to EPS as adjusted in 2026, assuming a March 1 closing. In addition, we expect intangible assets created by the transaction to create annual tax savings of approximately $5 million per year. We will update you on all key modeling assumptions on our next earnings call. Before we open it up to questions, I would like to provide some additional thoughts on why we believe this is an attractive opportunity for us. Keystone is well-positioned in what we believe is a favorable environment for private market strategies in general, but particularly for differentiated, asset-centric private credit targeting attractive areas of that market. Keystone has a track record of strong and diverse sourcing and have demonstrated themselves as a good partner in the asset-based lending market with a high level of repeat business. Their capabilities are already available in an at-scale tender offer fund that is being utilized by an established base of wealth management firms that we believe we can significantly expand. The team at Keystone has strong and deep experience over 2 decades, demonstrated in the compelling performance they provided on a risk-adjusted basis, their low loss rates and in the returns. Their differentiated assets and credit strategies are an attractive way to gain exposure to private markets, which will complement traditional private credit. They provide a significant growth opportunity in both the retail and institutional channels. So with that, we'll now take your questions. Latonya, would you open up the lines, please?

[Operator Instructions] Our first question will be coming from Crispin Love of Piper Sandler.

Congrats on the deal. Just first on private markets, private credit, credit quality. There have been some worries and headaches out there recently. It looks like Keystone's flagship Private Income Fund has some exposure to the First Brands issue out there. So first, can you size that? And then just your confidence in Keystone, the broader credit markets currently and how First Brands might have impacted your diligence on the company and if you think there could be any impact to flows going forward from that.

Sure. No, great question. And a lot of the commentary about "private credit and the concerns" are, generally, there is legitimacy to some of those concerns. But in many of those instances, it's really more along the lines of the more direct lending types of capabilities, right? So private credit, just like public credit, is not all one thing. And I think what we find interesting here is that this is very different approach in the private credit market to what you're seeing. And for example, specifically on the First Brands, a lot of what you've read about in the First Brands and the exposures have really been related to the loans that are outstanding. And that is not the type of exposure that Keystone and their fund have. They actually have the asset-based equipment leasing type of strategies. And currently in their holdings, they're not expecting to have losses on those loans. You never know. But again, it is very different from the direct lending side. So they're not participating on the loan side that you're reading a lot about in that instance. And we did spend a lot of time and we're very happy to hear how they had approached their investing in -- particularly with regard to that name, in the equipment leasing portion, as opposed to what we're seeing in some of the other holders of their actual debt. So we do think that that's one of the reasons that this is interesting, is it is different than the traditional direct lending that you're seeing where people are making loans based upon the credit of the firm. Whereas here, they're basically doing a collateralized, asset-secured, asset-heavy, covenant-heavy approach to lending money.

Okay. That makes sense. So there were no kind of issues with Keystone and First Brands with the assets that were being collateralized or anything like that?

Currently, the expectation is that based upon the underlying holdings that they have and the pools that they're contained within, they have not taken any write-downs on that.

Okay. Perfect. I appreciate that. And then you gave a lot of good financial detail on the call and also Slide 6. But are you able to share what Keystone's current fee rates are, comp ratios and then operating margins? And then just also if you could detail some of the key synergies you might expect from the deal that both you and Keystone will benefit from.

Yes. I mean I'll have Mike follow up on any of the details at this point. And again, we will be providing updates going forward. But our main focus here really is on growth. I mean what makes this interesting to us, as well as to Keystone, is we think they have a very compelling offering. That offering is already available in the wealth and RIA channels. We believe that, working together, we can be very successful in significantly expanding it. So this is really about adding to our capabilities that we offer, and growth. This is not a synergy play. Mike, I don't know if you want to make any comments on other attributes.

Yes, Crispin. I would just reiterate the point on the overall margin expansion that we anticipate of about 200 basis points on our run rate Q3 profile. And as we get closer, I would expect on the next call we'll start to go into each line item, specifically on fee rate and employment and other operating. I think on the fee rate, we alluded to 200 basis point benefit to our blended fee rate. But we'll go into specificity around some of these details on the next call.

Our next question will be coming from Michael Cyprys of Morgan Stanley.

I was hoping maybe you could elaborate on Keystone's approach to sourcing an origination around the types of loans that they are extending, how they go about that in the marketplace. That would be helpful.

Yes. I mean I'll keep it at a high level. So again, they're really asset-centric lending as opposed to really the general direct lending. So again, in all of the types of things that they do, whether it be in equipment finance or real estate, et cetera, it's really focused on a heavy level of collateral, generally for the types of transactions that have shorter terms. So again, comparing it to the traditional private credit. These are usually 2 to 5-year kind of durations with payment streams that commence generally early, with both principal and interest payments, covenant-heavy as opposed to covenant-light, which is something you see on the traditional side. And in terms of their sourcing, is they're focusing on a part of the market that some of the larger players would not focus in on. So their ticket sizes will generally be a little bit smaller. And they're very just focused in on those things, from a capital preservation perspective, that they can get comfortable that they can be the party lending the money through the financing or an equipment lease transaction or an inventory transaction, and less about the direct lending on the corporate side or for such things as factoring receivables, et cetera. So they're kind of in a very interesting space that's not a crowded space and they just really specialize in what they do.

And sorry, how is it exactly that they're sourcing these loans? Do they have like dozens of lenders? Or are they partnering with banks or other types of institutions in terms of flow arrangements? Are they investing in the funds of other managers?

No, they're not investing. So they're doing their own direct sourcing and origination, and they're generally not necessarily piggybacking off some -- will piggyback off of either PE firms or other sourcing. So they have their own network of companies as well as leasing firms and leasing agents who they partner with to identify opportunities. And they have had a number of transactions, as we said. Over the years, they've done over $6 billion of investing in 750 transactions. So they have a very large network of contacts of people that might be seeking either the equipment financing, the real estate financing, et cetera. So they're doing their own direct origination and they're not doing it generally in part and parcel with other -- with the other PE firm or another backer.

Okay. And just a follow-up question, one of the things we are hearing about in the asset-based finance space is issues in some pockets around double dipping on collateral or even some instances of fraud we've seen where collateral maybe wasn't there. So just curious, as part of the diligence that you guys have done, looking at the business, how you got comfortable with their approach to underwriting? As you look at the type of lending they do, any particular color you're able to share around how you guys got comfortable and how you went about diligencing that?

Yes. No, and we spent a lot of time on their underwriting and going through multiple case studies of the things that they've done, and they are very focused on collateral, right? So getting back to like their main approach, which is on capital preservation, a lot of that starts with the strength of collateral, senior position in collateral. Real collateral, not paper collateral, but actual -- if they're financing an actual machine, generally, they'll look for machinery that is critical to the company's future as opposed to ancillary. So they really do focus primarily first on the strength of the underlying collateral. And again, even in a liquidation mode, so as they do the underwriting for collateral, and not just getting fair values, they're getting liquidation values so that they can be very comfortable through different risk scenarios, the collectibility of that. And I think you kind of see that in the loss ratio which they have, which is generally lower than some of the other loss ratios that you've seen in other types of private credit strategies.

Great. And if I could sneak one more in, just as you think about growing the firm and helping them accelerate their growth path, just curious like which 1 or 2 things you think could be most meaningful. Is it extending into other channels beyond the RIA, into the wires, is it international, is it institutional? Which one would you say is most -- could be most meaningful? Talk about some of the stuff you may take there to accelerate that. And how do you think about the scalability of their strategy? I think you mentioned they operate in sort of putting out smaller tickets, smaller, different part of the marketplace. Just curious if you can speak to the scalability of that part of the channel.

Sure, sure. And on the growth, I think all of the areas that you mentioned are very exciting. But one thing that's particularly interesting here is this is -- I hate to say retail ready, but it's retail ready, right? And in certain instances, as traditionals try to partner with private markets managers, the question is, how will they develop a product that can be extended into the retail marketplace? Their primary fund is already in the wealth space. It is widely used in the wealth space. They've been able to partner with many of the leading wealth management types of firms for that. So we already have something that, with our larger distribution footprint, we do believe that we significantly can help grow those existing capabilities. We also see many attractive areas in the institutional space, both in the U.S. as well as outside the U.S. Keystone does not have a large sales force, and they've been very focused on what they should, which is generating good returns for their clients as opposed to a lot of marketing. So I think the fundamental, mutually beneficial aspect of the relationship is we feel very comfortable on both the retail and the institutional side. Everyone is very excited about the opportunity about bringing them to a wider number of clients. And again, the approach that they have can be applied in other ways. So further along the line, there may be other opportunities for us to develop and extend their capabilities. And then going to the last part of your question, they're very focused on maintaining their investment performance and the discipline they have in terms of capital preservation. So they will put money to work at a reasonable pace that they are comfortable that they can do. And because of the general part of the market that they're applying in, it's not as large as some of the larger parts of the market, but they still have a lot of opportunities to put capital to work given the extensive network of sourcing that they already have in place. So we really do feel very, very optimistic that there's a lot of great opportunity here for us to hit the ground running quite quickly, particularly on the retail side where there is already the ability to bring to the retail marketplace an existing product that in some ways was built with the wealth client in mind.

I would now like to turn the conference back to Mr. Aylward for closing remarks.

Great. Thank you. So I want to thank everyone for joining us today. And obviously, if anyone has additional questions, please feel to reach out. Thank you so much.

And that concludes today's call. Thank you for participating. You may now disconnect.