AMG

Business Context and Reporting Period

Company: Affiliated Managers Group, Inc. (AMG)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2005
Business Overview: AMG is an asset management company with equity investments in a diverse group of mid-sized investment management firms ("Affiliates"). Operations are conducted through three principal distribution channels: Mutual Fund, Institutional, and High Net Worth. As of March 31, 2005, Affiliates managed approximately $132.1 billion in assets (excluding pro forma for pending acquisitions).

Key Financial Metrics

Note: Debt figures exclude Mandatory Convertible Securities ($300 million) which management does not consider debt for leverage ratio purposes.

Material Changes vs. Prior Period

• Revenue Growth: Revenue increased 33% ($50.0 million) year-over-year, driven primarily by a 41% increase in average assets under management (AUM). This growth was fueled by new investments in Genesis, TimesSquare, and AQR, as well as the acquisition of $3.0 billion in AUM from Fremont Investment Advisors (FIA) in January 2005.
• Segment Performance:
  • Mutual Fund: Revenue up 34% ($20.7 million) due to a 33% increase in average AUM.
  • Institutional: Revenue up 59% ($32.8 million) driven by a 75% increase in average AUM from new investments.
  • High Net Worth: Revenue declined 10% ($3.5 million) due to a 17% decrease in average AUM, primarily from net client cash outflows at Rorer Asset Management.
• Operating Expenses: Total operating expenses rose 41% to $127.1 million. Compensation expenses increased 42% due to revenue-sharing arrangements with Affiliates and the inclusion of expenses from new 2004 investments (Genesis and TimesSquare).
• Cash Flow: Operating cash flow turned negative ($8.4 million outflow) compared to a positive $11.8 million in Q1 2004. This was primarily due to increased distributions to Affiliate managers (recorded as minority interest) and a significant increase in investment advisory fees receivable.

Outlook, Risks, and Unusual Items

• Acquisitions:
  • Completed: Acquired $3.0 billion in AUM from Fremont Investment Advisors (FIA) in January 2005.
  • Pending: Entered a definitive agreement on April 19, 2005, to acquire First Asset Management Inc. for approximately $250 million (90% cash, 10% stock). This acquisition includes six Canadian asset management firms managing approximately $23 billion. Closing is expected in Q3 2005.
• Capital Structure: The company maintains a senior revolving credit facility of up to $405 million (with an option to increase to $450 million). Outstanding senior debt is $126.8 million. Convertible debt obligations total $424.1 million.
• Contingent Liabilities: Affiliate operating agreements provide managers the right to require the company to purchase their retained equity interests. If all such interests were purchased as of March 31, 2005, the aggregate cost would be approximately $734.5 million. Additionally, the company may be required to make additional payments of approximately $178 million if specified financial targets are achieved at certain Affiliates.
• Risks: Performance is directly affected by financial market conditions. A decline in equity markets could decrease advisory fees and cash flow. The company also faces risks related to the success of new investments and the ability to raise capital on acceptable terms.
• Accounting Changes: The company is required to adopt FAS 123(R) in Q1 2006, which requires fair-value measurement for employee share-based payments. Management does not expect a material impact on the Statement of Income.

Investor Verification Checklist

• Asset Under Management (AUM) Trends: Verify the sustainability of AUM growth in the Institutional and Mutual Fund segments versus the outflows in the High Net Worth segment.
• Cash Flow vs. Net Income: Investigate the divergence between strong Net Income ($25.6 million) and negative Operating Cash Flow ($8.4 million), specifically regarding the timing of fee collections and distributions to Affiliate managers.
• Acquisition Integration: Monitor the closing and integration of the First Asset Management Inc. acquisition and the impact on leverage ratios.
• Debt Covenants: Confirm compliance with financial covenants (leverage, interest coverage) on the senior revolving credit facility, especially given the pending $250 million acquisition.
• Minority Interest Fluctuations: Review the impact of revenue-sharing arrangements on minority interest expenses, which increased 16% year-over-year.