AFFILIATED MANAGERS GROUP, INC. quarterly report, Q1 FY2011

Business Context and Reporting Period

Affiliated Managers Group, Inc. (AMG) filed an unaudited Form 10-Q for the three months ended March 31, 2011. AMG is a global asset management company that invests in boutique investment management firms and operates through Mutual Fund, Institutional, and High Net Worth distribution channels. Assets under management were approximately $339.8 billion at quarter-end, managed through more than 350 investment products.

Financial Performance and Position

MetricQ1 2010Q1 2011Change
Revenue$251.0 million$426.3 million70%
Operating income$68.5 million$124.9 million82%
Operating margin27.3%29.3%+2.0 percentage points
Net income$52.8 million$89.4 million69%
Net income attributable to controlling interest$17.5 million$39.1 million123%
Diluted EPS$0.38$0.7495%
Economic Net Income$50.8 million$85.1 million68%
EBITDA$68.2 million$118.2 million73%
Operating cash flow$68.0 million$130.2 million92%

Revenue growth reflected a 53% increase in average assets under management to $330.9 billion, new Affiliate investments, favorable investment performance, and positive net client cash flows. Ending assets under management increased 46% year over year to $339.8 billion. Net client cash flows were $6.5 billion for the quarter.

Operating expenses increased 65% to $301.4 million. Compensation and related expenses rose 51% to $179.5 million, selling, general and administrative expenses rose 93% to $87.5 million, and intangible amortization rose 148% to $22.1 million, primarily due to new Affiliate investments. Performance fees were approximately 1% of consolidated revenue and were not a significant revenue driver.

Cash and cash equivalents declined from $313.3 million at December 31, 2010 to $252.8 million at March 31, 2011. Cash flow from investing activities was negative $12.1 million, including $13.3 million of investments in Affiliates. Financing cash flow was negative $180.8 million, primarily reflecting $120.0 million of senior debt repayments and $69.5 million of distributions to non-controlling interests.

At March 31, 2011, senior bank debt was $340.0 million, senior convertible securities had a carrying value of $425.5 million, and junior convertible trust preferred securities had a carrying value of $510.5 million. The amended unsecured revolving credit facility provides capacity of $750.0 million and matures in January 2015. AMG reported $410.0 million of remaining capacity, a bank leverage ratio of 1.7, and an interest coverage ratio of 8.0, and was in compliance with its covenants.

Material Changes Versus the Prior Comparable Period

  • Revenue increased 70%, driven by higher assets under management, Affiliate acquisitions, investment performance, and net client inflows.
  • Mutual Fund revenue increased 88% to $184.2 million, Institutional revenue increased 70% to $207.0 million, and High Net Worth revenue increased 12% to $35.1 million.
  • Controlling-interest net income increased 123%, despite higher interest expense, imputed interest expense, income taxes, and amortization.
  • Interest expense increased 21% to $19.4 million, while imputed interest expense increased 118% to $8.3 million, principally due to higher accretion on contingent payment arrangements and convertible securities.
  • Income from equity method investments increased 12% to $10.2 million. Investment and other income increased to $8.7 million from $2.8 million, partly due to earnings from new Affiliates.
  • Investment cash outflows decreased substantially from $131.9 million to $12.1 million because Affiliate investment spending was $114.4 million lower than in Q1 2010.
  • Senior bank debt declined by $120.0 million from year-end 2010, while redeemable non-controlling interests increased from $406.3 million to $531.2 million, principally due to changes in redemption value and issuance of interests.

Guidance, Outlook, Risks, and Unusual Items

  • Management expects operating cash flow, available credit facility borrowings, and proceeds from any forward equity sales to support foreseeable cash needs.
  • AMG expects to repurchase approximately $100.0 million of Affiliate equity during the next twelve months and make an approximately $63.8 million deferred purchase price payment related to the Pantheon Ventures acquisition in the second quarter of 2011.
  • Past acquisition agreements create contingent payment obligations of up to $496.5 million through 2015; expected 2011 payments were approximately $1.4 million. The filing also reports $98.6 million of unfunded co-investment commitments, substantially subject to reimbursement of $69.6 million by a former owner of Pantheon Ventures.
  • The company’s results are sensitive to global and equity market conditions because declining markets can reduce assets under management, advisory fees, performance fees, and cash distributions from Affiliates.
  • Additional risks include the ability to identify and complete favorable Affiliate investments, access capital on acceptable terms, manage leverage and interest-rate exposure, and retain key Affiliate management teams.
  • AMG settled $100.0 million of treasury rate locks in February 2011 for a $4.0 million pre-tax gain. Interest-rate swaps had a $3.0 million unrealized gain at March 31, 2011.
  • The company had $24.6 million of liabilities for uncertain tax positions, including interest and related charges. Unrecognized tax benefits could increase by $1.0 million to $3.0 million over the following twelve months as a result of state and foreign tax audits.
  • The filing states that interim results are not necessarily indicative of full-year results. Management concluded that disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.

Important Facts for Investors to Verify

  • Confirm the sustainability of the 46% year-over-year growth in assets under management and the contribution from market performance versus acquisitions and net client flows.
  • Assess the recurring nature of revenue and the limited contribution of performance fees.
  • Review cash generation after distributions, debt repayments, Affiliate equity repurchases, deferred acquisition payments, and contingent obligations.
  • Evaluate the effect of the $1.6 billion principal amount of convertible securities and the potential August 2013 put rights on the senior convertible notes.
  • Monitor compliance with credit facility leverage and interest coverage covenants and exposure to variable interest rates.
  • Review the valuation and timing of redeemable non-controlling interests, contingent acquisition payments, and Affiliate equity purchases.
  • Reconcile non-GAAP Economic Net Income and EBITDA to GAAP results and consider the substantial intangible amortization, deferred taxes, and imputed interest added back in those measures.