How Envestnet may use its IPO to speed growth

Brooke’s Note: The chairman and founder of a company two weeks off its IPO is busy and purposeful. I caught up with Envestnet’s Jud Bergman by cell phone Thursday in a New York cab as he arrived at the airport for a flight back to Chicago, where his company is based. I journeyed with him electronically as he paid the driver and negotiated checking in with his airline. I asked a few questions to gauge his company’s appetite for aggressive action and what shape it might take. Bergman mostly stuck to broad themes with his answers but — with the aid of some paragraphs deep in the S-1 SEC filing that I hadn’t paid much attention to before and help from Chip Roame — I was able to get a good sense of where his company is headed as a cash-rich, small public entity. My takeaway: Envestnet plans to be the giant technological plug-in for breakaway brokers and fiduciary advisors seeking investments, asset management, performance reporting and due diligence on an outsourced basis. Gaining the economies of scale it needs to be the technology provider for tens of thousands of advisors ahead of competitors is likely to require ready cash.

Two weeks after Envestnet completed an IPO to raise more than $30 million, chairman and founder Jud Bergman remains cagey about exactly what the company plans to do with its new access to capital. Bergman said the company is going to grow ‘organically,’ which is another
way of saying that its current business plan does not call for spending the new cash that it raised.

Companies that grow inorganically often employ a rollup strategy of companies that fit with their business model. Envestnet’s S-1 SEC filing suggests the company is — at some point — considering this course of action. See: 10 reasons why the Envestnet IPO filing is for real

“We intend to continue to selectively pursue strategic acquisitions, investments and other relationships that we believe can significantly enhance the attractiveness of our technology platform or expand our client base,” it says.

But Bergman seems to be downplaying the possibility that Envestnet will shift into high deal-making gear. [Bergman owns 6,804,652 shares or 5.11% of Envestnet, according to his company’s S-1 filing.]

Accelerate investments

“I don’t see that an IPO changes our strategy,” he says. “It’s a capital access event for us to accelerate investments in certain areas but I can’t
say when that might be.” The company offered 3.85 million shares to the public at about $9 a share to raise more than $30 million.

The company’s S-1 filing offers this additional insight into how Envestnet intends to spend capital:

“To continue to attract and retain enterprise clients and financial advisors, and to deepen our relationships with them, we intend to continue to invest in our technology platform to provide financial advisors with access to investment solutions and services that address the widest range of the financial advisors’ front-, middle- and back-office needs. In the years ended Dec. 31, 2007, Dec. 31, 2008 and Dec. 31, 2009, we had technology development expenditures totaling $4.2 million, $4.5 million and $4.5 million, respectively.”

Chicago-based Envestnet has a unique position in the market. On one hand, it has bundled products under its PMC brand, and it trails competitors like SEI, Genworth Wealth Management of Pleasant Hill, Calif. and Russell Investments of Seattle in this high-margin TAMP market. On the other hand, it has a technology platform that has given it the dominant position as the clearinghouse of choice for broker-dealer reps seeking access to separate account managers. Yet, that business — though it opened up big leads on previous leaders like Pershing-owned Lockwood — is a low-margin one.

“Envestnet’s been a low-margin, no-margin type business,” says Gurinder S. Ahluwalia, president and CEO of Genworth Financial Wealth Management.

Tidy profit center

PMC has about $11 billion of assets under management. This gives Envestnet a tidy profit center, analysts say. Of that $11 billion, about $8.5 billion is invested in its own proprietary [PMC-managed] funds, Bergman says.

It has an additional $44 billion of assets under advisement through its managed account program [some of which it charges asset-based fees to]. There’s an additional $45 billion of assets under advisement supported by the platform for other organizations.

Indeed, asset-based fees accounted for approximately 88%, 78% and 73% of total revenues for the years ended Dec. 31, 2007, 2008 and 2009, respectively. As of Dec. 31, 2009, about $38 billion [of about $100 billion of total assets under either management or administration] of investment assets for which Envestnet received asset-based fees were managed or administered utilizing its technology platform by approximately 8,400 financial advisors in approximately 175,000 investor accounts.

Some of Envestnet’s strategic moves in 2010 were aimed at rapid growth.

In February 2010, Envestnet signed a seven-year deal with FundQuest of Boston to replace its technology platform. FundQuest will continue to provide investment products to its clients. Upon completion of the conversion of FundQuest’s clients to our technology platform, Envestnet expects assets under administration on its technology platform to increase by approximately $13 billion, the number of advisors served to increase by approximately 6,200 and the number of accounts on its platform to increase by approximately 90,000, according to its S-1 filing.

This kind of deal requires cash. Envestnet will make an up-front payment to FundQuest upon completion of the conversion of FundQuest’s clients’ assets to its technology platform, five annual payments and a payment after the fifth year of the agreement calculated based on the revenues it receives from FundQuest during the first five years of the contract term.

Non-cash currency

And — in an indication of how the IPO may be used as a non-cash currency — Envestnet also issued FundQuest a warrant to purchase shares of its common stock, with an exercise price to be calculated as 120% of our initial public offering price.

In June Envestnet also acquired B-Ready Outsourcing Solutions Inc., a Landis, N.C.-based company that provides Schwab PortfolioCenter on an outsourced basis. See: Envestnet buys a company to gain an edge with Schwab RIAs

Though much of its assets are administered at lower profit margins, Envestnet sees ways to leverage it position in the marketplace.

“We think the opportunity right now is huge,” Bergman says. “We’ve built a platform that supports fiduciaries. The world is more and more coming that way and there will be opportunities that we want to take advantage of to accelerate that growth.”

This one-two punch of proprietary and open architecture offerings is a good strategy for Envestnet, according to Charles “Chip” Roame,
managing principal of Tiburon [Calif.] Strategic Advisors.

Financial plumbing

“Their model is both strategically and economically logical to me,” he says. “They seek to own the platform — or the plumbing or the cable TV connection, whatever you want to call it — and then they seek to push through some but certainly not all or even a majority of their own investments, their own water.”

Still, to succeed the company needs to grow its high-margin TAMP business, too. Doing so successfully – perhaps by coupling it with more technology and more investment options – means taking on competitors SEI and Genworth. Executives at these companies say that their companies are experiencing good success. SEI experienced its first positive inflows in several quarters for the three months ended June 30. Genworth continues to bring in about $500 million of net new assets each quarter. [For more in-depth information on these companies, look for an article coming in the next couple of days.]

Neither Ahluwalia or Kevin Crowe of SEI considers PMC to be a big competitor to their TAMPs, though Crowe allows that he is seeing more of PMC in competitive situations than he used to.

PMC represents about one in five dollars that Envestnet either manages or administers, Bergman says.

“It’s for advisors that want help in all aspects,” he adds. “That’s where PMC comes in.”

PMC also conducts research and due diligence on a number of the separate asset managers to which it provides access.

Giant killing

Envestnet doesn’t need to make PMC a giant killer for it to succeed for Envestnet, Roame says.

“PMC need not become a competitor to Russell or SEI,” he says. “PMC can continue along as a mid-size AUM player and still hugely benefit
Envestnet’s profits.”

Whatever Envestnet does now – and many eyes are on it – it must do with the greater scrutiny and costs of being a public company.

“I was a little surprised that it was a firm that wasn’t making money but it was selling itself to the public,” says Ahluwalia. “Being a public company is
a lot of work.”

Bergman says his company is profitable. Though the company recorded a net loss of $0.9 million on revenues of $77.9 million in 2009, it had income from operations of $4.3 million, adjusted EBITDA of $10.6 million, adjusted operating income of $6.1 million and adjusted net income of $2.4 million, according to the company’s S-1 filing.

Profit margins aside, Bergman is pleased with the position that Envestnet holds in the marketplace.

Superior infrastructure

“We believe we have a superior management infrastructure. That’s what makes us different; we believe advisors like the fact we are truly open
architecture. You don’t have to use our investment expertise.”

Though the assets under advisement don’t alone drive big profits, they may be a key for Envestnet’s long-term business success.

“Slow and steady may win this overall race, and the overall race is the combination of assets under administration and asset under management, in my mind,” he says.