Blucora (BCOR) – Asset Sale/Large Capital Return – Upside TBD

Current Price: $24.05

Target Price: TBD

Upside: TBD

Expiration Date: H1 2023

This idea was shared by Jordan.

 

Event Summary

On November 1st, Blucora announced an agreement to sell their tax software segment, “Tax Act,” to Cinven for $720m or $620m in after-tax proceeds. Blucora mentioned that they would use the proceeds of the transaction to pay down debt and return excess capital to shareholders. The transaction is expected to close by the end of the year, pending regulatory approval (HSR).  

Blucora has highlighted that they anticipate the return of excess capital to shareholders will be $400 – $450m. They have also said that they will be targeting 2.0x – 3.0x Net Debt to EBITDA pro forma:

And so the expectation, Alex, would be to basically refinance at the point of close, whether that takes the form of paying down the entire debt completely and then just basically refinancing back up to 2x to 3x, that enables us to return the number I mentioned earlier, between $400 and $450 million back to shareholders, which is our expectation to return a significant majority, if not all, of the excess capital back to shareholders.

The return of excess capital is based on their target leverage range using trailing EBITDA. However, EBITDA in 2023 is positioned to more than double (pro forma). Therefore, the ultimate return of capital could be $485m – $635m, or around 40%-50% of the $1.2bn market cap today. We believe this will be done through share buybacks, and, potentially, a tender offer. 

 

RemainCo Overview: 

After the transaction closes, BCOR will rebrand to Avantax, named after their tax-focused wealth management business. Blucora’s wealth management business contains both an independent broker-dealer and an RIA business. There are roughly three key drivers to the revenue model: interest rates (particularly the Fed Funds Rate), AUM, and financial professionals. Although a little tedious, we want to walk through each of these drivers to explain why pro-forma EBITDA could more than double in 2023 and the assumptions embedded therein. 

The Wealth Management segment or RemainCo consists of 4 revenue streams: 

  • Advisory fee revenue. At the close of Q3, BCOR had ~$72.6bn of total client assets split into $37.2bn of brokerage assets and $35.4bn of advisory assets. Advisory revenue is generated only from the advisory assets and the fee amounts to slightly over 1% of AUM. Advisory fee revenue is the largest part of BCOR’s total revenue and it is highly correlated with returns in the S&P. We are modeling this business to be up low single digits next year, essentially modeling that the S&P 500 is flat from where it is trading today. This is a big assumption. If the S&P goes up, BCOR will benefit, and vice versa. The rule of thumb here is that every 100pt move in the S&P 500 impacts EBITDA by $2-3M – our work indicates that the impact is at the lower end of the range. We have included a chart below that shows the equation for how the quarterly returns of the S&P 500 impact advisory assets. It is important to note that BCOR’s financial professionals are successfully attracting assets to the platform organically with $1.26bn newly recruited assets added in the first nine months this year; however, these additions pale in comparison to the impact market returns have on assets. Overall, we are modeling $423M of advisory revenue for 2023.

  • Commission revenue. Commissions make up the second largest component of BCOR’s revenue. Commissions are closely related to the average number of financial professionals at Avantax. Although financial professionals have churned historically, the agents leaving are the least productive agents. Due to a change in recruiting practices, I think financial professional attrition will begin to stabilize, and commission revenue will be down low single digits next year. We are modeling $167M of commission revenue for 2023.
  • Asset-based revenue (mostly cash sweep – see details below on how this revenue is generated). Although historically, asset-based revenue has been the smallest part of revenue, it is arguably the most important because it carries 100% margins. BCOR’s asset-based revenue was $22m last year, and, in Q3 of this year alone, it was $21m. Management has outlined that every 25bps improvement in the federal funds rate results in a $6m – $7m increase in annual adjusted EBITDA; this is a 100% margin revenue stream, so what is true of EBITDA should be true of revenue as well. Asset-based revenue in 2021 was $22m when the federal funds rate was at 0%. Asset-based revenue in ’22 will likely be ~$65m. If the Federal Funds Rate increases 50bps at the December meeting and remains at that level all next year (4.25%, a discount to current expectations), asset-based revenues will total ~$138m for 2023.
  • Transaction and fee revenue. Lastly, transaction and fee revenue makes up the smallest portion of revenues. Similar to commissions, this is driven by the average number of financial professionals and will most likely be flat year over year. We model it at $28m for 2023.

To recap, we are modeling $423m of advisory revenue, $167m of commission revenue, $138m of asset-based revenue, and $28m of transaction and fee revenue.

Gross profit dollars excluding asset-based revenue are currently hovering around 27% gross margins. Wealth Management operating expenses as a percentage of ex-asset-based revenue are at 21%. Unallocated corporate-level G&A will be ~$30m this year and will likely decrease next year as management rightsizes the corporate structure with “meaningful run-rate savings” by the end of 2023. 

More directly, this implies $305m of gross profit, $130m of wealth management operating expenses, and $25m of unallocated corporate-level G&A.  

With these assumptions, we compute our estimate of adjusted EBITDA of ~$150m. The Pre-Transaction enterprise value is ~$1.6bn. Pro Forma for the $620m of after-tax proceeds, BCOR will have a $.98bn EV and be trading at ~6.6x EV/ 2023 EBITDA.  

Because the model is so sensitive to changes in the federal funds rate and the S&P 500, we have included a sensitivity table to show the impact changes in the federal funds rate and the S&P 500 would have on EBITDA. The table assumes the levels are consistent for the whole year. 


What’s Cash Sweep?

Asset-based revenue is mostly generated by BCOR’s cash sweep programs on the idle customers’ cash balance on BCOR brokerage accounts. Best explained by the company itself:

Your available cash — including deposits, dividends, interest and proceeds from sales in your brokerage account — will be automatically deposited into interest-bearing deposit accounts at multiple banks, providing Federal Deposit Insurance Corporation (“FDIC”) insurance.

In exchange for agreeing to a cash sweep, BCOR clients receive a very small interest (0.25%-1.05%) on their cash balance, while the BCOR in turn receives fees/interest from their partners based primarily on prevailing interest rates in the current interest rate environment. In other words, at current FED rates, the customer gets 0.25% while BCOR pockets 3.75% by investing the customer’s cash balance.

 

Valuation

Finding pure-play wealth management businesses that benefit from a cash sweep is difficult. The best comp for BCOR is LPL Financial Holdings (LPLA). LPLA has historically traded at 10.0x current year EBITDA. It is currently trading at 12.0x ’22 EBITDA and 7.5x ’23 EBITDA. LPLA has a scale advantage over BCOR; however, LPLA also has a significant portion of its cash that is in deposit cash accounts that increase with the federal fund’s target rate subject to a cap. Meaning, LPLA doesn’t benefit from federal funds rate increases to the extent BCOR does. We have included a sensitivity table for the impact changes in EBITDA multiples and returns for the S&P 500 have on BCOR’s enterprise value and price target assuming an average of 4.25% federal funds rate for all of 2023. In addition, this sensitivity table does not consider any buybacks. 

Bottom line, to get to 2.0 – 3.0x levered on $150M of EBITDA, BCOR would need to return $485m – $635m to shareholders relative to BCOR’s current market cap of $1.2bn.

 

Transaction Details and Return of Capital

The only remaining regulatory hurdle to closing the transaction is Hart-Scott-Rodino approval. Our talks with BCOR management suggest they have 3% of the tax-pro market share. Their acquirer has a mid-teens share. Management does not believe that this merger harms competition as there are other large players with significant scale: Intuit (Turbo Tax) and H&R Block are perhaps the most notable followed by Wolters Kluwer.  

Because BCOR’s 30 day Average Volume is ~320k shares/day and buybacks are limited to 25% of the average daily traded volume, it would take well over a year to return this magnitude of capital to shareholders via open market purchases. Because of this, we think it is possible that BCOR could tender for shares to accelerate the process.  

 

Key Risks  

  1. The transaction could fail the HSR review – we think this is unlikely for the reasons expressed above.  
  2. The Federal Reserve could pivot and cut rates significantly – this is the opposite of what the Federal Reserve has promised to do.  
  3. The model would be negatively impacted by negative performance in the S&P 500. Ironically, other than a black swan event and geopolitical risk, more hawkishness out of the Federal Reserve is what could most likely cause negative performance in the S&P 500. In this sense, this risk is somewhat hedged.  
  4. BCOR management team fails to return capital to shareholders. This is the opposite of what management has promised to do and the opposite of what management has done so far this year.  

 

Share price behavior for other tenders (added on Dec 21)

 

Disclaimer (by the write-up’s author) – Our firm currently holds a long position in this security which can currently be considered a long-term holding. Our research is completely independent and based on public information, our proprietary research, and our analysis of that information. While the author has tried to present facts it believes are accurate, the author makes no representation as to the accuracy or completeness of any information contained in this note. The reader agrees not to invest based on this note, and to perform his or her own due diligence and research before taking a position in BCOR. Reader agrees to hold harmless and hereby waives any causes of action against the author related to the note above. As with all investments, caveat emptor.

14 Comments

14 thoughts on “Blucora (BCOR) – Asset Sale/Large Capital Return – Upside TBD”

  1. Jordan, thank you for sharing the write-up.

    I agree the situation is interesting and could work out well given the clear upcoming catalyst. First of all, what I like about this setup:
    – The looming large capital return following a major asset sale. Historically, we’ve had good success with such setups, e.g. LAUR, BSIG, DII-B.TO, In all of these cases, the share price failed to efficiently adjust for the upcoming capital return right until the actual capital return announcement. Maybe the same pattern will play out here. BCOR shares are up only 10% since the segment sale PR a month ago.
    – Management really seems eager to promptly return the cash. They’ve mentioned it multiple times in the press release as well as the Q3 call. YTD BCOR has also repurchased about $35m shares at an avg. price around $18.4/share. One insider acquired $118k worth of stock in November at around $23.73/share.
    – The timeline is relatively short. TaxAct sale close is expected by the end of 2022. An update on the capital return should follow promptly after that.
    – BCOR’s asset-based revenue is really on the brink of inflection due to the rising interest rates. Although details and visibility on the cash sweep revenue are very limited, management appears to guide similar profitability performance as outlined in the write-up above. References to ‘segment income’ mean Wealth Management business or basically the whole of RemainCo before overheads. During Q3 call the stated guidance was: “we estimate that an improved outlook for rates of 4% by year-end would now have us delivering roughly $135 million of segment income at an S&P level of 3,000 which is another 16% decline from the S&P close as of September 30th, and upwards of $170 million at market levels above 4,250″. Deducting overheads, Jordan’s model basically lands at the top range of management’s guidance”. Management’s note that each 25bps interest rate hike results in an incremental $6-$7m annual adj. EBITDA is also confirmed by the guidance change from Q2 to Q3. In Q2 result announcement, with rates 3.25% rates at the time, they were guiding $120m-$150m segment income at the same 3000-4250 S&P range. This guidance was upped to $135m-$170m when rates increased to 4% at the time of Q3 call. Hence, $5m-$7m segment income change per each 25bps rate change.

    However, I struggle with the valuation of the RemainCo:

    – The whole attractiveness of the RemainCo, basically boils down to the drastically increased profitability driven by the high-margin Cash Sweep revenues. Using figures in the write-up, it’s $37m of EBITDA (or $618m revenues at 6% margin) for everything outside of Cash Sweep business, then $138m EBITDA (up from $22m last year) from the cash-sweep business, and offset by $25m corporate overheads. While this might be an accurate projection for 2023, I have no idea how sustainable this elevated revenue stream is and what it will look like even in 2024 or 2025. At the moment BCOR is able to pocket most of the generated returns from investing customers’ cash balances, i.e. almost the whole 4% per annum. As the rates have risen in a steep fashion over the last half a year, the interest BCOR pays its customers on their idle cash balances has lagged behind the interest that BCOR receives from investing the same idle cash. However, the rates the company offers to its customers started increasing from 0.1% to 0.25% for the smallest balances and from 0.3% to 1.05% for the largest balances between October and December. Even if FED rates remain at the current levels for foreseeable future, I am skeptical if BCOR can continue pocketing the majority of revenue from investing customers’ idle cash – the eventual split between the company and its customers might be more evenly distributed. All of this to say that the normalized profitability of the RemainCo might be well below the expected 2023 EBITDA of $150m.
    – If this spike in revenues/profitability proves to be a temporary effect only, one could argue that even 6.6x multiple on peak EBITDA is too high.
    – The closest peer LPLA at trades 7.5x forward EBITDA. Given that historically LPLA used to trade at 10x multiple it might be that the market is simply normalizing the earnings and assuming that tailwinds from high-interest rates and lagging customer compensation will not last forever.

    Jordan, my key question here is – how sustainable are the earnings from the Cash Sweep business and why shouldn’t the customers’ share of the pie increase going forward?

    Maybe I am just misunderstanding the business dynamics here and maybe BCOR will be able to maintain the same split/revenues for as long as FED rates stay elevated. If the cash balances when taken individually by each customer are tiny and customers simply do not care if they earn nothing on this idle cash, then BCOR might continue to pocket the full 4% in interest. The projected EBITDA seems to suggest that $3.5bn of assets ($138m revenues at 4% rates) would on average be kept in the Cash Sweep program. That amounts to 5% of BCOR client assets or 10% of the client assets in brokerage accounts. Could BCOR customers on average keep the 5-10% cash buffers without caring that it earns close to zero? Definitely an imaginable scenario (especially for retail accounts and smaller institutionals), but I have no clue how close this is to actual reality.

    10
    Reply
  2. DT,
    Thanks for the comment. I think you captured the set up well. I think this is a very good trade into the actual size of the buyback announcement. I think that size will be consistent with what they have stated publicly, but I think there is an opportunity over the longer term for this company to either be bought or for a larger capital return to shareholders.

    We talked with the CFO today, and I asked a few of your questions.

    Regarding your October / December comment: Avantax has a committee that determines the rate that gets shared with the customer. BCOR is not a leader here. They are a follower for what LPL, Advisor Group, and other players do. They also look at what banks are doing in terms of CDs, etc.

    Regarding the 5% of BCOR assets question: Generally speaking their experience is that the 4-6% of assets in cash stays consistent over time. That being said, FFR hasn’t been near 4% in a very long time. Generally speaking, these assets represent cash for liquidity purposes and not cash that clients are demanding a higher return on. The Cash Sweep return is better than what they could earn in a checking or savings account.

    Regarding the sustainability of earnings from Cash Sweeps: The CFO mentioned that they could hedge the cash sweep. They haven’t commented publicly about duration. They want to hedge, because the Federal Reserve has set the precedent multiple times on going to 0%. This is why LPLA has a cap on their ability to benefit from increases in the FFR. They have some duration hedges.

    5
    Reply
  3. Hi Jordan:
    Thank you for the idea. What do you think is the downside in terms of percentage decline and probability?

    Reply
    • Hi,
      I would point you towards the three sensitivity tables because it’s hard to ascribe probabilities to S&P returns and the federal funds rate. If I could, I think I would be very wealthy ;). In the short term, I think this is a great trade that is hard to have a lot of downside: It’s a real business, that is fairly cheap with real cash flows that is about to return a lot of cash to shareholders. I think they announce a tender and a large buyback, I think those catalysts could help this be a very successful trade. Sorry I couldn’t give a better answer.

      Reply
  4. Thank you, Jordan. It makes sense. Curious about the base business and management.

    If this catalyst doesn’t work out for some reason, meaning you are left holding an RIA business and Taxact. What is your view about the RIA business? How do they compete with top banks (BAC, JPM, MS etc) with great tech? What is it worth? Can the multiple compress or anyother negative?

    I am not sure if management is trustworthy to keep their word. Isn’t this the same management that was defending keeping the asset within the company just sometime back? I am not sure what led them to change their mind and capital allocation?

    Reply
    • Thank you for the questions.

      On management trustworthiness, I don’t have all of the information that you might, but with the information I do have, I would argue the opposite. I would couch a lot of the management problems BCOR has had over the years on the prior management team, but again I don’t have all the information. Chris Walters stepped in as CEO in January of 2020 right in front of the pandemic. For BCOR’s wealth management business, that could not have been a worse time to step in: stocks got hammered and rates went to 0%.
      Regarding the TaxAct divestiture, I would question a lot of the activists. They put their own sum of the parts analysis in their letters to shareholders and the board. Candidly, I think activists were way too aggressive with how they were underwriting TaxAct. Ancora’s presentation (https://www.sec.gov/Archives/edgar/data/1068875/000092189521000880/ex991dfan14a06470029_032921.pdf) shows 13x at the midpoint for TaxAct. Company just sold for 8.0x. In my opinion, it’s really hard to give TaxAct a big multiple when their largest competitors are TurboTax and H&R block. Moreover, the business is a pretty slow grower (albeit a profitable one). That’s also the key reason why I think HSR isn’t a big issue. This doesn’t impact the competitive landscape imo. –> Happy to take any additional comments on this subject as we have only known management for a short time. Their “return capital to shareholders” comments have been very public, so I would be surprised if they don’t follow through (obviously). Moreover, they have bought back ~$35M of stock this year already with only $45M of FCF generated YTD. That has been a good capital allocation decision this year.

      For the valuation of the wealth management business, I would point you back towards the sensitivity tables. Please let me know if I can answer any other questions on that or be more direct.

      Candidly, I don’t think this business is very differentiated from the industry. They attract assets (have positive net inflows), so that’s good, but I think wealth management is very competitive and somewhat commoditized. It’s hard to get current data, but you might be surprised to find out that the second largest Wealth Management Firm by AUM is Edward Jones (>$1.8T). My wife’s parents and family members have been customers for several decades. Their technology is not unique, nor is their financial planning strategy. I also worked in the Wealth Management industry in College as an intern at Wells Fargo. Their technology was not proprietary, and their manage client assets using the efficient frontier with their technology called “Envision.” Essentially they run a Monte Carlo simulation. Wells Fargo’s software capabilities are available from other players. This was a long winded way of saying that technology does not differentiate the largest players from the smaller players. That being said, I think it’s encapsulated by the multiple these businesses receive.

      Reply
  5. BCOR Completes TaxAct sale and announces $250M modified Dutch Auction tender offer and share buyback authorization of up to $200M. The Dutch Auction will take place in Q1’23.

    2
    Reply
  6. An interesting update from Blucora.

    Activist Engine Capital has nominated a candidate to BCOR’s board at the 2023 AGM (date TBD). Blucora’s management noted disappointment by this disruptive action given the good performance of the company lately. Management also said that capital return to shareholders is on track.

    https://www.bamsec.com/filing/106887523000035?cik=1068875

    1
    Reply
  7. Tender $27-31, for $250million or 17-19% of total stock, deadline Feb 24. Stock jumps from 27.28 to 30 at open, now 29.40.
    Tender size previously announced on Dec 19, prompting price to jump from 22.50 to 25.
    Buy, hold, tender, or sell?

    Reply
  8. Jordan, thanks for sharing this opportunity. This setup worked out exactly as you suggested:
    – Initially, the BCOR price ran up leading to and after the sale of TaxAct;
    – And then shares jumped further when the tender was announced above the prevailing trading prices.

    A nice 21% gain in a couple of months.

    With shares trading in the middle of the tender range and limited support from the valuation perspective, I do not think it is worth holding this longer. However, worth noting that the tender is for 16%-19% of shares and insiders indicated they will not participate (albeit they own only 2.7%).

    4
    Reply

Leave a Comment