Last October, a month after an activist investor took a large stake in LPL Financial Holdings Inc. and claimed that its shares were undervalued, the company announced a plan to boost its stock price. It was going to borrow $700 million and spend $500 million of it buying back its stock.
While company stock buybacks are common and often have the intended effect of raising share prices, this one didn't. In fact, the exact opposite happened. When Marcato Capital Management, the activist investor, revealed last September that it had bought its 6.3% stake in the company, the stock was at $43 a share. Today, more than halfway into the stock buyback program, shares are trading closer to around $25, a 42% drop. LPL's stock is now worth less than its initial public offering price six years ago of $30 a share.
To make matters worse, the stock buyback program has sparked a class shareholder lawsuit. In its complaint, the plaintiff claims that LPL not only failed to raise the price of the stock, it actually cost shareholders $115 million. The plaintiff, a police and firefighters pension plan in Clinton, Mich., called the buyback program “a wasteful and inefficient use of company capital,” according to the lawsuit.
LPL would not comment on the shareholder lawsuit directly because it is a legal matter.
Mark Casady, LPL's chairman and CEO, blamed LPL's stock decline on market volatility. “The stock price is the stock price,” he said in an interview with InvestmentNews last month. “Our job is to build a business that does well through all different seasons.”
Christian Bou, a research analyst with Credit Suisse, said he thought the market's reaction to LPL's fourth-quarter earnings was “overdone.” In a research report on the day of the market rout he wrote: “Management's decision to lever up for stock repurchases in hindsight was an unforced error. Leverage issues aside, we believe business inflection towards advisory and positive implications for operating leverage and valuation are underappreciated.”
A slumping stock price and the shareholder lawsuit are not the only problems LPL is facing. In its latest earnings report, the company, which operates the nation's largest independent broker-dealer, reported dismal results. Growth in the numbers of advisers joining its broker-dealer has stalled, turnover in the executive ranks is high, and it remains to be seen if the company has truly put its compliance problems behind it as it has claimed.
Meanwhile, overhanging the entire brokerage sector is the coming fiduciary rule from the Department of Labor, which could halt the sale of high commission products such as nontraded real estate investment trusts in retirement accounts. Because of its size and mix of products, LPL is a leading seller of nontraded REITs as well as variable annuities, another high-commission product whose sales are expected to suffer because of the DOL's fiduciary rule.
In perhaps a preview of what is to come regarding nontraded REITs, Mr. Casady said in the fourth-quarter earnings call on Feb. 11 that commissions from the sales of nontraded REITs and other alternative investments were down about 75% from the year-earlier quarter. The company reported that total adviser commissions were $464 million, down 12% from the year-ago quarter. Overall, LPL reported adjusted earnings per share of 37 cents, missing Wall Street's consensus forecast of 51 cents per share.
Investors reacted bitterly the next day. LPL's shares, which had already been trending downward since December, were throttled. The stock closed at $16.50, a one-day rout of 35% on a day when the S&P 500 was up. In the shareholder lawsuit, plaintiffs noted that analysts described the earnings results as “ugly” and observed a “lack of confidence in management.” Credit Suisse immediately lowered its price target on LPL's shares, and Wells Fargo downgraded the stock to market perform from outperform.
In the InvestmentNews interview, which took place in early March in LPL's Boston offices, Mr. Casady said that he has the confidence of the company's board of directors.
ADVISER GROWTH FLAT
One of the key metrics that analysts and the industry judge broker-dealers on is growth in the number of advisers, as it is advisers who generate the firm's revenue. In the past LPL had annual goals of adding 300 to 400 advisers on a net basis. Last year, it had a paltry gain of only 18 advisers.
UBS analyst Alex Kramm noted the slowdown in a research report he issued after LPL released its earnings on Feb. 11. “Underlying growth metrics were unimpressive, as adviser growth and client assets missed expectations and net new adviser growth slowed,” he wrote. “We continue to believe that LPLA could be a winner long term, but we do not think there is any reason to own the stock now.”
Although net new adviser growth stalled last year, Mr. Casady said it was the firm's third-best recruiting year on record based on adding advisers that produce greater revenue.
And the number of the firm's most profitable advisers — or those producing more than $500,000 each year in revenue — has increased. In 2009, 6% of LPL advisers produced $500,000 or more; in 2014, that number had grown to 14% of the firm's advisers, according to Credit Suisse.
Meanwhile, the disruption in the independent broker market, including the bankruptcy of RCS Capital Corp., parent to 9,000 Cetera Financial Group advisers, creates opportunity for LPL to have a strong recruiting class in 2016, Mr. Casady said.
And LPL has a clear competitive advantage when going head to head with its competitors in recruiting, particularly for advisers known as “hybrids.” Such advisers generate substantial advisory fee business with some brokerage commissions. For some hybrid advisers, LPL offers up to 100% payout of fees on advisory assets, while its broker-dealer competitors typically collect five to 10 basis points on those fees, according to executives and advisers.
LPL's direct competitors are quick to contend the firm has slipped, particularly in the area most essential to advisers' businesses: service.
“If you've been tracking the service ratings of broker-dealers in various surveys, LPL's ratings have moved from the top years ago to the middle and now to the bottom,” said Eric Schwartz, the founder and CEO of Cambridge Investment Research Inc.
In critiquing the shortcomings of LPL's service, formerly a hallmark under the firm's founder Todd Robinson, Mr. Schwartz pointed to last year's survey of 2,000 advisers by WealthManagement.com.
Asked to rank five service metrics including “helpful home-office support staff” on a scale of one to 10, with one being the lowest, LPL ranked at the bottom of 19 identified firms with an “overall rating” of 8.1 compared with a 9.4 average for all firms surveyed.
Such surveys often don't give a complete picture of a firm because they are based on a limited number of a firm's advisers. But Mr. Casady acknowledged in the interview that there had been service issues affecting advisers, such as waiting too long on the phone for answers to questions or problems.
The company addressed such issues last year when it hired Thomas Gooley as managing director of service, trading and operations, as well as Tim Hodge, executive vice president of service, he said. “There is absolutely measurable improvement, and that's Tom's and Tim's work.”
To be sure, some advisers praise LPL's service, recognizing the growing pains of a firm that has quadrupled in size in the past 15 years. And many advisers praise the company's proprietary research group, headed by Burt White, LPL's chief investment officer.
“LPL gives you the freedom to run your business the way the adviser wants to run it. That number of choices for advisers will inherently create more challenges,” said Doug Flynn, a veteran LPL adviser. “I'm willing to give them more than one quarter of underperformance, although that's not the way everybody sees it these days.”
Persistent change among the firm's top executives, including former president Robert Moore in 2015, Derek Bruton, a managing director, in 2014, and William Dwyer, former president of national sales, in 2013, raises questions about LPL's ability to follow through effectively on the number of new initiatives it currently is undertaking.
Take, for example, the long-awaited rollout of a new wealth management platform, called ClientWorks, to its advisers. Currently, 3,000 LPL advisers have full access to ClientWorks, while other functions are being introduced over time to the rest of the company's 14,000 advisers. LPL, however, is behind schedule. When it announced ClientWorks to its advisers at its annual meeting in August 2014, the company said the full product would be released by the spring of 2015.
“The turnover in upper management was incredible. I had never seen that at any firm,” said Scott Bordelon, an adviser who left LPL last year to join Securities America Inc., which is part of the Ladenburg Thalmann network.
“They don't have a consistent game plan because management is constantly changing,” said an LPL adviser, who asked not to be identified.
He pointed to LPL's hiring last year of Mr. Gooley. “Tom Gooley was with Morgan Stanley, and they say he fixed Morgan Stanley. Now he's coming to fix LPL,” the adviser noted. “What happens if they get rid of him in two years?”
“The management changes have not had an impact on any of the initiatives we are working on,” said LPL spokesman Brett Weinberg. “In fact, in some cases the impact has been positive.”
LPL has been plagued by compliance problems over the past few years and paid $70 million in fines and restitution in 2014 and 2015 alone. As late as last September, LPL had agreed to pay $1.8 million to settle charges that it had improperly sold and marketed risky exchange-traded funds to retail investors in Massachusetts.
The same month, the firm agreed to remediate investor losses and pay $1.4 million in civil penalties for failing to implement an adequate supervisory system over the sale of nontraded REITs. Mr. Casady apologized to shareholders in 2014 for taking so long to clean up LPL's regulatory issues, but the company has indicated it believes the worst is behind it.
“As a regulated entity, we should always expect a certain level of regulatory activity,” said Mr. Weinberg. “However, we have now resolved the most significant historical matters we were working on.”
When asked about its myriad problems, Mr. Casady defends LPL's record.
“At the end of the day, what matters is, are you able to win business, are you able to grow profits, are you able to run a business that is successful,” he said. “What people have a hard time understanding are circumstances like changing regulation and putting that in the context of what the business is actually doing.”
He is quick to focus on the positive. Gross profits in 2015 were $1.4 billion, an increase from the prior year of 7.7% during a period when the broad market was essentially flat.
LPL is also following through on its promise to decrease the rate of increase of core general and administrative costs, something LPL announced when it revealed the stock buyback program, Mr. Casady noted. The company also has strengthened its balance sheet after refinancing its debt last year, and its current leverage ratio of 3.8 times, based on net debt divided by credit agreement earnings before interest, taxes, depreciation and amortization or EBITDA, is well below its covenant limit of five times.
MARKET DOESN'T UNDERSTAND
Wall Street does not fully comprehend the business of LPL, which offers service and technology to a wide variety of advisers and brokers, Mr. Casady said. And LPL does not make products or have investment banking offerings, making it the only firm without conflicts among the country's leading securities firms, he adds.
“What the market is saying today ... broadly speaking, LPL's brokerage assets have zero economic value to LPL,” he said. “That seems a little hard to believe. And that interest rates will never go up again. Ever.”
While the DOL fiduciary rule is clearly a hurdle for all brokerage firms at the moment, Mr. Casady is confident of LPL's future.
“I would argue we have transformed the business from a brokerage business to an advisory business,” he said, noting that advisory assets account for 55% of LPL's gross profits. “That's a very dramatic change from five years ago. We just need to do more of it.”