AFFILIATED MANAGERS GROUP, INC. annual report, FY2017

Affiliated Managers Group, Inc. — FY2017 Form 10-K Summary

Business context and reporting period

AMG is a global asset management company that invests in boutique investment management firms and provides centralized strategic, distribution, marketing, product development and operational support. Its Affiliates retain substantial management ownership and operational autonomy. The filing covers the fiscal year ended December 31, 2017; fourth-quarter information is included in unaudited quarterly data.

Assets under management were $836.3 billion across more than 550 products at year-end, up 21% from $688.7 billion.
Average assets under management increased 19% to $779.2 billion.
Growth was concentrated in alternatives and global equities; 2017 net client cash flows were $4.7 billion, while market changes contributed $100.2 billion and foreign exchange contributed $13.0 billion.

Financial performance and key metrics

Metric	2017	2016	Change
Revenue	$2,305.0 million	$2,194.6 million	+5%
Operating income	$1,107.9 million	$1,034.1 million	+7%
Net income	$1,008.7 million	$739.0 million	+36%
Net income attributable to controlling interest	$689.5 million	$472.8 million	+46%
Diluted EPS	$12.03	$8.57	+40%
Adjusted EBITDA attributable to controlling interest	$1,116.2 million	$945.5 million	+18%
Economic net income attributable to controlling interest	$824.4 million	$703.6 million	+17%
Economic EPS	$14.60	$12.84	+14%
Operating cash flow	$1,170.4 million	$1,050.3 million	+11%

Revenue growth reflected a 6% increase in asset-based fees, partly offset by a 1% decline in performance fees and a 3% decline in the consolidated asset-based fee ratio. Income from equity method investments declined 8% to $302.2 million because a $93.1 million impairment more than offset higher underlying equity method earnings.

Total operating expenses increased 1% to $1,499.3 million. Compensation increased 5% to $979.0 million, while selling, general and administrative expenses declined 6% to $373.1 million. The 2017 operating margin, calculated from reported revenue and operating income, was approximately 48.1%, compared with approximately 47.1% in 2016.

Balance sheet, debt and liquidity

Cash and cash equivalents were $439.5 million at December 31, 2017, compared with $430.8 million at year-end 2016.
Total assets were $8.7 billion; equity method investments were $3.3 billion, goodwill was $2.7 billion and acquired client relationships were $1.4 billion.
Carrying value of senior bank debt was $810.0 million, senior notes were $745.7 million and convertible securities were $309.9 million. The filing separately describes total outstanding senior debt and convertible securities of approximately $2.0 billion.
AMG redeemed its $200.0 million of 6.375% senior notes due 2042 during 2017. Remaining senior notes mature in 2024 and 2025.
The company had a $1.45 billion revolving facility and a $385.0 million term loan, both maturing in September 2020. Approximately $1 billion of revolver capacity remained available, subject to conditions.
Bank leverage was 1.3x versus a 3.25x maximum covenant, and interest coverage was 14.5x versus a 3.00x minimum. AMG stated that it was in compliance with its debt covenants.
Financing cash flow was negative $1,189.7 million, driven primarily by $260.0 million of net senior debt repayments, $393.2 million of common stock repurchases, distributions to non-controlling interests and Affiliate equity repurchases.

Material changes versus the prior comparable period

Assets under management increased 21%, but reported revenue increased only 5% because of the mix of consolidated versus equity method Affiliates and a lower consolidated fee ratio.
Aggregate fees earned across all Affiliates increased 29% to $5.5 billion, including an 18% increase in asset-based fees and an 11% increase in performance fees.
Equity method Affiliate average assets under management rose 32% and equity method revenue increased 54%, but AMG’s equity method earnings increased 29% because it owns less of the economics of certain newer Affiliates.
Net income benefited from a provisional, one-time $194.1 million net tax benefit related to the 2017 U.S. tax law changes. Excluding this item and other adjustments, economic net income increased 17%.
AMG recorded a $93.1 million impairment of an equity method Affiliate following cumulative asset declines and the loss of a significant client.
Redeemable non-controlling interests increased to $811.9 million from $673.5 million, increasing potential future cash requirements for Affiliate equity repurchases.
AMG repurchased 2.4 million common shares during 2017 for an average price of $173.19 and paid $0.80 per share in dividends. The board subsequently increased the quarterly dividend to $0.30 per share and authorized an additional 3.4 million share repurchases in January 2018.

Guidance, outlook, risks and unusual items

Management did not provide specific quantitative earnings guidance in the filing. AMG expects operating cash flow, available revolver capacity and potential equity issuance proceeds to support normal working capital and anticipated investments, but future acquisitions and Affiliate equity obligations may require additional capital.

Management expects continued opportunities in alternatives, global equities and multi-asset strategies, while noting ongoing industry pressure from passive products and outflows in U.S. equity strategies.
Conditional Affiliate equity repurchases are difficult to predict; AMG expected approximately $125 million of such repurchases in 2018.
Unfunded co-investment commitments were $98.8 million. Expected contingent acquisition payments were $10.2 million, including $8.2 million expected in 2018; maximum contingent payments could be substantially higher.
A minority owner of an equity method Affiliate obtained a right to sell a portion of its interest to AMG annually beginning in the fourth quarter of 2018.
Key risks include market declines reducing assets and fee revenue, investment underperformance, client withdrawals, loss of key personnel, competition from passive and other asset managers, acquisition execution risk, regulatory and tax changes, foreign exchange exposure, cyber and operational failures, litigation and impairment of substantial intangible assets.
The 2017 tax benefit was provisional under SAB 118 and could be revised as additional guidance and analysis become available. The transition tax liability was $22.8 million and is payable over eight years.
Third Avenue Management settled legal actions relating to the liquidation of the Third Avenue Focused Credit Fund; the Affiliate and its insurers paid settlement amounts. Management reported no current legal proceeding expected to have a material adverse effect, while noting that future outcomes cannot be assured.
Internal control over financial reporting and disclosure controls were assessed as effective, and PwC issued unqualified audit opinions.

Most important facts for investors to verify

Whether AUM growth and positive market effects continue to translate into revenue and controlling-interest earnings given the mix of Affiliates and fee-rate pressure.
The sustainability of performance fees and the extent to which 2017 earnings benefited from unusually strong market performance.
The final accounting impact of the 2017 U.S. tax legislation and the resulting recurring effective tax rate.
The operating performance and valuation of the Affiliate impaired by $93.1 million, together with the risk of further intangible or equity method investment impairments.
The timing and cash cost of Affiliate equity puts, repurchases, co-investment commitments, contingent payments and the 2018 minority-owner purchase right.
Debt maturities, variable-rate exposure and compliance with leverage and interest-coverage covenants.
Client flows, investment performance, key-person retention and regulatory developments affecting active management and international distribution.