Business Context and Reporting Period
Affiliated Managers Group, Inc. (AMG) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2016. AMG invests in and partners with boutique investment management firms, which operate through Institutional, Mutual Fund, and High Net Worth distribution channels. Assets under management were $647.6 billion at June 30, 2016, up 1% from $642.7 billion a year earlier. Management reported approximately $700 billion of pro forma assets under management including pending and subsequently completed investments.
Financial Performance and Liquidity
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Revenue | $554.1 million, down 14% | $1,099.5 million, down 14% |
| Operating income | $181.8 million | $360.5 million |
| Operating margin | 32.8%, compared with 30.2% | 32.8%, compared with 33.3% |
| Net income | $182.7 million, down 4% | $356.7 million, down 13% |
| Net income attributable to controlling interest | $107.4 million, down 17% | $212.0 million, down 17% |
| Diluted EPS | $1.97, down 15% | $3.89, down 15% |
| Income from equity method investments | $65.2 million, up 8% | $133.2 million, up 18% |
| EBITDA attributable to controlling interest | $220.3 million, down 8% | $436.1 million, down 5% |
| Economic net income attributable to controlling interest | $166.5 million, down 3% | $326.4 million, down 2% |
Revenue pressure reflected lower average assets under management at existing Affiliates, lower average fee rates, unfavorable market and foreign-exchange effects, and net client outflows. Mutual Fund revenue declined 18% in the quarter and 20% year to date; Institutional revenue declined 14% and 12%, respectively. High Net Worth revenue increased 1% in the quarter and 4% year to date.
Operating cash flow was $341.1 million for the first six months, compared with $470.5 million in the prior-year period. Investing cash flow was negative $540.0 million, primarily due to $551.4 million of investments in Affiliates, including minority investments in Systematica Investments and Baring Private Equity Asia. Financing cash flow was negative $14.1 million. Cash decreased to $360.4 million from $563.8 million at December 31, 2015.
At June 30, 2016, senior bank debt was $898.4 million, senior notes were $938.2 million, and convertible securities were $300.3 million. AMG amended its credit facilities, increasing revolver commitments to $1.45 billion and term-loan commitments to $385.0 million, with maturities on September 30, 2020. Approximately $900 million of revolver capacity remained available, and the company was in compliance with its covenants. AMG was rated A3 by Moody’s and BBB+ by S&P Global Ratings.
Material Changes Versus the Prior Comparable Period
- Revenue declined 14% in both the quarter and first half, while controlling-interest net income and diluted EPS declined 17% and 15%, respectively.
- Consolidated average assets under management declined 10% in both comparable periods, primarily due to lower assets at existing Affiliates and unfavorable client flows, market movements, and foreign exchange.
- Income from equity method investments increased because of 2015 and 2016 Affiliate investments and higher average assets at equity method Affiliates; this benefit was partly offset by substantially higher equity-method intangible amortization.
- Operating expenses declined 18% in the quarter and 14% year to date, led by lower compensation and related expenses and lower Mutual Fund sub-advisory and distribution costs.
- Results benefited less from contingent-payment revaluations than in 2015. The prior-year periods included gains of $15.0 million in the quarter and $44.7 million year to date, compared with a $0.8 million expense in the 2016 quarter and a $1.1 million gain year to date.
- Other comprehensive income changed from positive $95.7 million in the 2015 quarter to negative $67.6 million in 2016, primarily due to foreign-currency translation losses and investment losses.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
Management did not provide specific numerical earnings or revenue guidance in the filing. Management expects continued demand for alternative strategies and believes the transaction environment remains favorable, with opportunities to invest in additional boutique managers. Previously announced minority investments in Winton Capital Group and Partner Fund Management were expected to close by year-end 2016. On July 1, 2016, AMG completed approximately $310 million of additional minority investments in Capula Investment Management, Mount Lucas Management, and CapeView Capital.
- AMG entered into a forward equity agreement covering approximately 2.9 million shares at $167.25 per share. No shares had been settled by June 30; management expected full or significant settlement by December 31, 2016, with approximately $480 million of net proceeds assuming full physical settlement.
- The company also established equity distribution and forward-equity arrangements permitting up to $500 million of aggregate sales; no sales had occurred at quarter-end.
- Unfunded co-investment commitments totaled $87.5 million. A prior owner may reimburse AMG for $15.3 million if certain commitments are called.
- Potential contingent payments through 2019 totaled up to $84.9 million for consolidated Affiliates and $316.5 million for equity method Affiliates. Expected payments were $10.3 million for consolidated Affiliates and none for equity method Affiliates in 2016.
- Redeemable non-controlling interests increased to $745.0 million. AMG expected to repurchase approximately $100 million of Affiliate equity during 2016.
- Third Avenue Management and AMG face legal actions related to the liquidation of the Third Avenue Focused Credit Fund. Management believes the claims are without merit; no significant accrual was recorded.
- Declines in the fair value of indefinite-lived intangible assets at two global-equity Affiliates could result in future impairment charges.
- Key operating risks include market declines, foreign-exchange movements, client outflows, changes in asset mix and fee rates, investment performance, performance-fee variability, acquisition execution, and the ability to fund Affiliate equity purchases and other commitments.
- Management stated that disclosure controls and procedures were effective and that there were no material changes in internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Reconcile the 14% revenue decline with changes in average assets under management, fee rates, client flows, market performance, and foreign exchange.
- Assess the sustainability and valuation impact of the $551.4 million of 2016 Affiliate investments and the subsequent $310 million of investments completed July 1.
- Review debt covenant capacity, the planned use of forward-equity proceeds, interest costs, and refinancing requirements through the September 2020 credit-facility maturity.
- Evaluate exposure to $87.5 million of unfunded commitments, contingent payment obligations, Affiliate equity repurchases, and potential put rights.
- Monitor intangible asset impairment risk and the increase in equity-method amortization, which affected reported earnings but was excluded from certain non-GAAP measures.
- Review the definitions and reconciliations of EBITDA, Economic net income, and Economic EPS because these non-GAAP measures differ materially from GAAP results.
- Assess the outcomes of the Third Avenue litigation and any tax examinations or uncertain tax positions; the filing does not provide a clear expected ultimate exposure for these matters.