Wednesday, June 1, 2011

LPL Success?

LPL’s successful IPO has set the standard that most private wealth advisory firms in the roll up space such as United Capital, Focus Financial and HighTower, are hoping to achieve. As these private firms consider their strategic options, a big question remains: “Is LPL’s huge success replicable?”

LPL Successes

LPL has grown its advisor base from 3,500 advisors in 2000 to over 12,000. That growth is the result of acquisitions and from a forced exodus of lower-producing wirehouse stockbrokers. A $200,000 - $300,000-a-year producer is not profitable in the high cost Wall Street business model. However, they are very profitable for LPL. The company doesn’t have expensive investment bankers, research analysts and multimillion-dollar proprietary traders. LPL makes money two ways: 1) From a revenue share with its independent contractor brokers; 2) From transaction fees, asset-based fees and net interest margin that it earns through its broker-dealer. This combined revenue stream allows LPL to profitably support a $300,000-a-year broker that has a business mix of 70% commissions and 30% fees. It also allows LPL to offer the broker a much higher payout than Wall Street.

Here is how LPL describes its business in the S-1 filing for its November 2010 IPO: “Our singular focus is to support our advisors with the front, middle and back-office support they need to serve the large and growing market for independent investment advice, particularly in the mass affluent market, which we define as investors with $100,000 — $1,000,000 in investable assets." [Emphasis ours]

Red Flag

It all sounds very good, but consider this: Near the end of the 180-day IPO lock-up, Ron Carson, LPL’s top producing broker and largest broker shareholder, announced that after a 22 year relationship with LPL he was going to set up his own independent RIA.

Isn’t he already independent with LPL? In fact, not independent enough, in Mr. Carson’s opinion. As his business has grown to the impressive level of $3 billion in AUA, he realized that the LPL service offering – built to serve mass affluent clients – was not sufficient to address the needs of his clients with greater than $1,000,000 in investable assets. While Carson will continue to use LPL for his mass affluent clients, the asset management solutions for his larger clients will be sourced by his new firm and held at Schwab or TD Ameritrade.

While one advisor’s departure will not have a material impact on LPL’s current business, I’m sure it has caught the attention of senior management, LPL’s private equity investors and other top producing LPL brokers.

The Rainmaker’s Dilemma

Rainmakers typically leave large organizations to start their own firms so they can increase their compensation and assert greater control over the strategic direction of their business. LPL’s independent contractor model has successfully addressed the higher compensation needs for the $300,000 producer. This group of producers constitutes the largest in number of brokers, but the top producers (rainmakers) still remain on Wall Street or in trust banks, and LPL has not been able to attract them. That’s not to mention the reality that most top producers – because of their egos – don’t want to be associated with a firm that focuses on mass affluent clients. LPL might not want the rainmaker broker, but after three years of Wall Street’s salesforce rationalization the forced breakaway trend appears to have run its course. That could force LPL to join the ranks of HighTower, Dynasty and Sanctuary in trying to attract rainmaker advisors in order to meet the growth expectation of their new public shareholders.

Position of Strength

LPL has several assets that could make it a formidable competitor if it chooses to pursue the rainmaker advisors. With a cash position of over $500 million and a market capitalization of over $3.8 billion, LPL has ample cash and a potent balance sheet it can use to buy market share. And LPL’s biggest asset could be its private equity partners, Hellman & Friedman and TPG. These organizations understand the high-end client and the high-end wealth management business very well.

The $3.8 billion question for LPL management? Do they believe that the economics of addressing the high-end market segment are as attractive as the economics of selling to the mass affluent? And are these two versions of the same business, or do they need separate business units with separate management teams and separate client service philosophies?

Stay tuned.