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Is Nicholas Schorsch's RCS Capital the new LPL?

Apr 27, 2014 @ 12:01 am

By Bruce Kelly

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"We're not trying to be a better version of LPL. We're trying to be a different business," says Nicholas Schorsch, executive chairman of RCS Capital's board.

Nicholas Schorsch relishes mentioning his hard-charging and fast-changing broker-dealer, RCS Capital Corp., in the same breath with industry powerhouse LPL Financial.

At an investor presentation in January for RCS Capital, commonly referred to by its ticker symbol, RCAP, executives said it and related firm RCAP Holdings would be second only to LPL in potential revenue and number of reps and advisers once RCAP had completed its pending broker-dealer acquisitions. In a February conference call with investors about the broker-dealer's earnings, Mr. Schorsch, executive chairman of the board, touted RCAP's size and dimension, and repeated that comparison.

Initially during the conference call, Mr. Schorsch downplayed a direct parallel between RCAP and LPL, stressing that RCAP had a variety of business lines, particularly the wholesaling of nontraded real estate investment trusts.

Like almost all other independent broker-dealers, LPL has no wholesaling business.

“We're not trying to be a better version of LPL. We're trying to be a different business,” Mr. Schorsch said in response to questions about comparing Cetera (a recent purchase by RCAP) to LPL. “They're a terrific company and do their job very well. But when you look at what our shareholders see, we have a three-legged business, not just a single-focused business.”

Clearly, however, Mr. Schorsch thinks the new RCAP will compete with LPL for the attention of advisers in the marketplace. RCAP also could be a destination for reps and advisers as they slowly but steadily continue to leave Wall Street and regional firms, and move to independent broker-dealers and registered investment advisers.

“There are multiple faces of [financial] advice,” he said on the conference call. “I think LPL has real value there, and I think we have real value there. It gives the advisers another place.”

The association is apt, particularly as Mr. Schorsch has spent the better part of the past year making five deals for nine separate broker-dealers that house 8,900 reps and advisers. Those firms generated $1.7 billion in revenue last year and had $202 billion in assets under administration.

In comparison, LPL Financial, with 13,600 reps and advisers, generated $4.05 billion in revenue in 2013, and had combined advisory and brokerage assets of $438.4 billion.

HIGH STAKES

Through RCAP, Mr. Schorsch has been the most active buyer of broker-dealers since LPL went on its own buying binge after it was sold in 2005 to two private- equity managers.

Though the majority of RCAP's deals to acquire broker-dealers are still pending, the financial stakes are high for Mr. Schorsch and his team to integrate those disparate firms. A trailblazer with nontraded real estate investment trusts, Mr. Schorsch made his mark by shaking up the formerly clubby and relatively small industry of nontraded-REITs. His most impressive accomplishment is speeding up liquidity events, meaning he has shaved years from the time it takes for investors to get a return of capital through a listing or merger after collecting the dividends from the REITs.

Can Mr. Schorsch put a similar stamp on the independent-broker-dealer market and successfully marry the two arms of RCAP, a wholesaling business that distributes nontraded REITs to other broker-dealers and one of the largest adviser networks in the country?

To challenge LPL beyond a war of words, he and his team would have to unite a diverse group of broker-dealers, according to analysts and executives.

Mr. Schorsch “is building a bit of an empire of fiefdoms,” said Brandon Odell, director of business consulting at The Ensemble Practice. “He has Cetera, First Allied and the rest. Tying those all together will be the proof in the pudding.”

Like any remade company, RCAP will face financial challenges. Several of the broker-dealer holding companies it has bought or intends to buy — J.P. Turner & Co., First Allied Holdings Inc. and Investors Capital Holdings Ltd. — lost money in 2013.

The new, combined RCAP also had a net loss in 2013 of between $17.6 million and $21.7 million, following the close of pending acquisitions and depending on financing terms, according to a March filing with the Securities and Exchange Commission. And so far, RCAP has issued $725 million in debt and $270 million in convertible preferred stock, used to pay for the firm's biggest and most important purchase, Cetera Financial Group Inc. and its four broker-dealers.

Yet RCAP has a solid cash flow. On a pro-forma basis and taking into account its host of pending acquisitions, the new RCAP posted earnings before interest, taxes, depreciation and amortization of $201.7 million.

The total cost of RCAP's buying binge is $1.3 billion, which translates into 73.5 cents for each dollar of broker-dealer gross revenue. That's on the high end of the historic range of prices for IBDs, which have been valued at 25% to 75% of annual gross revenue.

In its balkanized state and with broker-dealer purchases due to close this quarter, RCAP is difficult to compare to LPL, Mr. Odell said. LPL is a “giant unified sales force and platform. It's hard to know how [Mr. Schorsch] is planning to manage the broker-dealers he's purchasing. At the moment, they each are more independent, which is how a private-equity investor would do it, rather than a series of strategic acquisitions that you've seen from LPL.”

In a phone interview last week, Mr. Schorsch provided background and reiterated his comments from the February conference call; other information in this story came from RCAP's registration of securities statement filed with the SEC, known as an S-1.

Who can blame Mr. Schorsch for attempting to match LPL? With 13,600 affiliated reps and advisers, LPL is one of the success stories in the IBD industry. Closely held by founder Todd Robinson until two private-equity firms bought a majority stake in 2005, LPL went public in 2010 and has ridden the bull market. Its initial public offering was priced at $30 a share. Shares seesawed between $25 and $38 for two years, and took off in 2013. Over the winter, shares of LPL flirted with $56 before recently settling to $48.

WHOLESALING BUSINESS

RCAP has been primarily a wholesaling broker-dealer for nontraded REITs and other nontraded investment vehicles sponsored by American Realty Capital (ARC), Mr. Schorsch's real estate syndicator. According to SEC filings, it had a 35.1% market share of all direct-investment programs sold via IBDs last year. From RCAP's launch in 2007 through last December, its “wholesale distribution platform has distributed 24 offerings with total equity capital raised of approximately $14.8 billion,” according to the S-1. That won't end anytime soon. RCAP is distributing eight offerings seeking to raise a total of $22.7 billion in equity.

The firm's wholesalers hustle. “Throughout a product's sales cycle, Realty Capital Securities' wholesalers conduct approximately 1,400 meetings each week ... with financial advisers affiliated with selling-group members to introduce the concept of nontraded offerings ... and to inform and educate ... about Realty Capital Securities products, specifically,” RCAP's S-1 states.

LPL has not fully embraced ARC. Along with Ameriprise Financial Services, LPL is one of the biggest sellers of nontraded REITs in the IBD industry. While LPL has sold a limited number of ARC-related REITs, Ameriprise has not sold any.

Robert Moore, LPL's president, noted that LPL sold both Healthcare Trust of America Inc. and Cole Real Estate Investments Inc., which was acquired earlier this year by one of Mr. Schorsch's traded REITs, American Realty Capital Properties Inc.

“We have a very good relationship” with ARC, Mr. Moore said, adding that LPL consistently evaluates ARC products.

Wholesaling accounted for $104.8 million (more than half) in adjusted earnings before interest, taxes, depreciation and amortization of the integrated RCAP, according to the S-1. The financials revealed in that filing tell a story of a company that could undergo major changes.

Though industry chatter has it that RCAP would use the acquired broker-dealers to pump up sales of nontraded REITs, financial advisers often bristle at the mention of pushing products. And they already sell plenty of ARC investments. “Nine percent of the revenues of the acquired businesses on a pro-forma basis were derived from direct-investment programs distributed by Realty Capital Securities,” the S-1 states.

Mr. Schorsch may take a more traditional route to build the profitability of RCAP's new arm, observers said. The company expects to achieve $57 million to $65 million of “synergies” in its first year by combining certain operations, according to the S-1.

CLEARING THE DECK

RCAP may want to consider becoming self-clearing, a step LPL took in 2000, said Dennis Gallant, an industry consultant.

“LPL has built a successful firm with the focus and development of a proprietary advisory program and then self-clearing,” which allows businesses to hang on to more of the costs of a transaction, Mr. Gallant said.

The question, he added, is whether RCAP will focus on self-clearing or building a “top-tier advisory model.”

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