Current Price: $24.05
Target Price: TBD
Expiration Date: H1 2023
This idea was shared by Jordan.
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.
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.
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.
- The transaction could fail the HSR review – we think this is unlikely for the reasons expressed above.
- The Federal Reserve could pivot and cut rates significantly – this is the opposite of what the Federal Reserve has promised to do.
- 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.
- 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.