Victory Capital squeezes costs out of USAA mutual funds following acquisition, but Schwab may walk off with brokerage, wealth manager in purported $2B deal
With the deal closed, shares of the Brooklyn, Ohio-based holding firm keep skyrocketing as it exploits an asset worth far more than it paid
Brooke's Note: Call it vulture capitalism, or what have you. Victory Capital is picking the USAA investments carcass clean before our very eyes yanking out chunks of fat to fuel what appears to be a lean, mean machine ready to generate profits. Just since the deal was announced in November, Victory's market cap has more than doubled to $1.2 billion, and its share spiked from around $8 to more than $18 -- not bad for a nearly pure act of financial engineering. See: Victory Capital to pay $1 billion -- of mostly other people's money -- for USAA mutual funds and use of its sweet brand-- Victory who? What was USAA's fund division's mortal sin that earned it this carrion's fate? Everything, it seems. Its costs were surely out of control, in part because it never achieved the right scale. But Victory suggests the meager size of USAA's fund family is mostly the product of its meager efforts to serve and educate its 12 million members about wealth management. That is an oversight Victory is now prepared to exploit. It has full access to those 12 million members and it can use the USAA brand to make it all feel normal -- or actually better than normal.
Victory Capital's CEO keeps piling up the victories in his takeout of USAA's investment business, but the larger deal for USAA's wealth management franchise needed a bigger white knight with a very different set of skills.
Charles Schwab & Co. is reportedly big-footing Victory with its own $2 billion deal to buy the two remaining USAA financial services units, according to The Wall Street Journal, citing "people familiar with the matter."
If the deal happens it could be wrapped up as early as this month, the newspaper reported.
The news broke just as Victory Capital was in the middle of a victory dance following the July 3 close on its acquisition of the San Antonio insurer's mutual funds unit.
CEO David Brown let analysts know in a conference call in April that shareholders are getting more cash flow than they even bargained for -- because USAA was even more profligate in its spending than realized.
Earnings-per-share accretion exceeding 100% is anticipated in 2020, and 40% accretion is likely to occur in the final six months of 2019, he said on the call. Victory Capital also increased its cost-synergy estimates from $110 million to $120 million, after an original projection of $100 million.
"As we continue to progress with the integration, we are finding even more opportunities to gain efficiencies as a combined platform," Brown said.
"We expect to generate more than $850 million in annual revenue, and nearly $400 million in adjusted EBITDA, with adjusted EBITDA margins of approximately 46%," he added on the call.
The Brooklyn, Ohio roll-up firm, founded in 2013, borrowed $1.4 billion to buy $69.2 billion in assets under management in 53 investment funds. Excluded from the deal were $11 billion of "managed assets," which appear to be held by USAA's wealth manager.
Harder to measure is just how keen USAA members, among the more loyal financial services customers in the world, react to being shunted over to Victory Capital (VC).
One comment on RIABiz left by "Don," showed that not everyone is impressed by the new regiome.
"Finally got a person on phone with VC," he wrote. "I just wanted to know the address to send my transfer paperwork to move my IRA to another firm. I got a full court press on why I should leave the money with VC. We had a long discussion. I had no idea this transaction was in the works. We moved this money to USAA in March and no one ever mentioned this sale was happening. We feel betrayed. They have lost their way. Not the same company I joined 35 years ago."
Weak sales
How the purported Schwab deal will figure into the mix remains to be seen.
The San Francisco company, which holds $3.5 trillion in client assets, could pick up an estimated $100 billion of "wealth management" assets from USAA, which appears to be refocusing efforts on its core insurance business.
Schwab's retail business is headed by a former USAA executive, Terri Kallsen. See: Schwab promotes relative newcomer Terri Kallsen to head retail, with John Clendening getting the golden parachute and Andy Gill transitioned
Schwab has struggled to grow its wealth management assets. Schwab Private Client still has just $91 billion and 650 advisers, according to its ADV. It's new $30-a-month subscription service grew by just $1 billion during the three months ended June 30. See: Schwab Private Client edges its fee closer to the classic RIA standard
Schwab Private Client had $58 billion in assets-- mostly from high-net-worth clients and 440 employees, according to its ADV in mid 2014.
USAA offers home, life and auto insurance to current and former military personnel and their families, according to its website. Its online banking and investment services were an attempt to leverage its customers into buying other products.
But analysts told the Journal that USAA's effort to up-sell investment advice to insurance customers hasn’t gone well, which may have been the catalyst to off-load those businesses.
Victory ended up with its mutual fund and ETF operations and its 529 college-savings plan. As of April 30, those businesses had $81.3 billion under management.
"USAA's direct-member channel represents a tremendous opportunity," Brown said on the call. He added that selling USAA products to Victory's third-party channel is another big growth potential -- particularly USAA fixed income products.
Integration apace
Meanwhile, the integration of the two firms continues. Victory's staffing of the call center for the direct-member channel is nearly completed, with 50 employees making the transition from USAA.
Additionally, Victory's outsource partners retained an additional 120 USAA employees, both for customer services and back office functions.
The employees of our outsourcing partners will be co-located with us in our San Antonio headquarters, the company said.
Only 1.5 million of the 12 million USAA members own at least one investment product today."There are so many opportunities out there given where the industry is," Brown told the analysts. "I think we're going to have our choice of the top opportunities, when we think about adhering to what we're really looking for."
For its part, USAA is selling at the top of the market, thanks to a robust U.S. economy, strong financial markets and an easing of regulatory oversight.
Actively managed funds, however, are continuing to cede ground to passive funds, according to Morningstar.
Passive U.S. equity fund assets nearly reached parity with active U.S. equity funds in April. Passive U.S. equity funds topped $4.3 trillion in total assets by month end, just $6.0 billion shy of active U.S. equity funds, the fund tracker reported.
"This is a milestone that has been a long time coming as the trend toward low-cost fund investing has gained momentum," said Kevin McDevitt, senior analyst and author of the Morningstar Fund Flows Report, in a statement.
"Active U.S. equity funds have had outflows every year since 2006 with roughly equivalent inflows into passive funds during that time."
USAA mutual funds have experienced an average 10-year organic growth rate of 3.4% compared with 1.1% for their active manager peers, Victory reported announcing the deal last November
Bitter pill
USAA just did not mix well with wealth management.
On the same day (July 3) as Victory took possession of its funds, USAA swallowed another bitter pill Shustak Reynolds & Partners, P.C. (www.shufirm.com) announced it won a $1.8 million arbitration award on behalf of two financial advisors who were terminated from USAA Financial Advisors, Inc. in May 2017.
Of the $1.8 million, $700,000 was for punitive damages based on USAA’s egregious conduct and $250,000 was for attorneys' fees.
“The award represents a complete victory and total vindication for our clients,” said Jonah Toleno, partner at Shustak Reynolds & Partners in a release.
“The inclusion of almost $1 million in punitive damages and legal fees only underscores how outrageous the Panel found USAA’s actions and conduct to be.”
Claimants Christopher Johnson and Lee Przybyla's allegations included defamation, wrongful termination, breach of contract, tortious interference and negligent supervision and retention.
