Victory Capital Holdings, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Victory Capital Holdings, Inc. is a diversified global asset management firm with a business model that is focused on providing a range of investment solutions to institutions, intermediaries, and individual investors.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Victory Capital Holdings (VCTR) is a diversified asset management firm that offers a range of investment strategies and solutions to a diverse client base, including institutions, intermediaries, and individual investors. Their offerings include separately managed accounts (SMA’s), mutual funds, ETFs, model portfolios, insurance products, sub-advisory services, and fund administration services, primarily focused on U.S. and global equities, fixed income, and alternative investments. The Company operates through a variety of channels, including institutional clients, intermediary partners, and direct channels. VCTR also offers a solutions platform, which is a curated investment program that has many components, including model portfolios and separately managed accounts, that can also be white-labelled for third-party distribution.

In 2021 VCTR had a total of $184 billion in assets under management (AUM). By Dec 31 2023, they now have $169.7B AUM, which indicates a decrease in AUM.
Revenue Distribution:

VCTR’s revenue is primarily derived from investment management fees, which are typically calculated as a percentage of assets under management (AUM). These fees are recognized as revenue over the period the investment management service is provided to the client, be it on a monthly or quarterly basis or as a portion of the performance or total return of the underlying fund. In addition, the company generates revenue through fund administration and distribution fees related to its proprietary funds and vehicles.

Industry Trends: The asset management industry is intensely competitive, with firms constantly seeking ways to increase AUM and market share. Several trends affect the industry:

Passive investing: Investors are increasingly shifting to low-cost, passively managed funds (ETFs, index funds), which puts pressure on fees for active managers.
Alternative investing: There is growing interest in alternative investment strategies for both diversification and higher returns that can be achieved outside of traditional equities and bonds; this includes real assets (real estate, commodities, and infrastructure) and private equity.
Technological advancements: Technology is creating opportunities and competition for asset managers by allowing them to improve investment processes, deliver better client experience, and lower costs.
Regulatory changes: The regulatory landscape continues to evolve in the financial markets and affect firms across the industry, including increasing requirements for transparency.
Globalization: As economies become more interconnected, there is also a greater degree of globalization in the financial markets. There is an increasing need for investment strategies with global mandates, and investors are seeking ways to gain access to international capital markets and diversify away from their local or domestic markets.

In 2022, the market saw declines in both equity and bond markets, so it is important for asset management companies to diversify their offerings in order to have greater sustainability, that also means they can increase and preserve more capital in diverse environments.

Competitive Landscape: The asset management industry is crowded and highly competitive. The main differentiators are size, scale, reputation, investment performance, distribution reach and strategies. VCTR has a complex portfolio structure with a large variety of asset classes and products.

Financials

Analyzing VCTR’s financials involves a look at its revenue trends, profitability, and overall financial health. This is particularly relevant as a major part of VCTR revenues are linked to the stock and bond markets, so it will be vital to monitor their AUM trends.

Revenue Trends:

For the first 9 months of 2023, Victory Capital generated total revenues of $615.2M. In 2022, this figure was $654.9M.
For the year ended December 31, 2022, the company reported total revenue of $854.8M and total revenue of $890.2M for the year ended December 31 2021.
Revenue is derived from investment management fees (which are primarily based on AUM), fund administration and distribution fees, as well as other fees. The decline of AUM throughout the past year is primarily responsible for a lower revenue.

Profitability:

Net income for the first 9 months of 2023 was $157.7 million, which was a decline from $223.2 million in 2022. For the year ending December 31, 2022 they reported a net income of $278.4 and $373.3 for the year before.
The adjusted operating profit margin (adjusted EBITDA over adjusted revenue) has been high, at nearly 40% for multiple quarters in 2023. The company has generally demonstrated great management capabilities when it comes to operational efficiency and expenses management. However, even as the company continues to generate a very good profit margin, their revenue will have to increase in the future to further elevate the earnings and profitability.

Balance Sheet Health:

While I will talk about cash and other short-term assets in the liquidity section, I will provide an analysis into the net assets. *As of September 30, 2023, the company had a total assets of $2.5 billion with the total liabilities of $1.5 billion. The difference between total assets and liabilities was $957.1 million in net assets.

As of December 31, 2022, the company’s total assets were $2.54 billion. Total liabilities were $1.47 billion, meaning net assets were around $1.07 billion.

Liquidity, Capital, and Cash: *As of September 30, 2023, the company had cash and cash equivalents totaling $189.3 million and short term investments of $132 million. In contrast, the company also has a revolving credit facility of $100 million and term loans of $1,001 million.

As of the end of December 2022, VCTR had cash and cash equivalents of around $123 million, while their short-term debt and long-term debt was $1,048 million and $96 million, respectively. The company’s debt is quite high relative to their cash position, so this might cause concerns down the line.

The company relies on short-term funding and credit facilities to finance their obligations and capital structure which carries certain amounts of risk. They will have to make sure that the returns from their portfolio and the investment strategies is more than the cost of that capital.

Recent Concerns and Challenges:

The primary concern for VCTR is related to the fact that it’s AUM has decreased over the past few quarters in 2023 and even though the company has reported consistent net profit and earnings, the revenue is still quite low compared to prior years. The company is also facing increasing operating expenses and the management has stated they are working to reduce them, but the net operating profit has fallen down despite their efforts. Given that many other larger players and competitors in the industry have more flexibility and are more established, VCTR has to be careful about its spending so that they don’t fall out of favor.

Market Volatility: VCTR’s financial performance is significantly influenced by changes in stock and bond markets because its AUM changes depending on the values of assets under management. That will be a key factor in the company’s performance in any period. As such, it is very important for investors to monitor the AUM trends of the company.
Debt and Credit Risk: The company has a high debt balance. Rising interest rates can make borrowing and repaying debt difficult and will put pressure on their profitability. If revenues were to fall even further, they will have a harder time paying their financial obligations.
Regulatory Compliance: The financial services industry is heavily regulated, and VCTR must navigate an evolving and complex regulatory landscape.

Moat Rating: 2 / 5

VCTR’s competitive advantage (moat) is relatively weak, compared to more established players in the financial services and asset management industries, so I am giving them a rating of 2 out of 5. Reasons for Rating:

Limited Differentiation: VCTR operates in a highly competitive industry with many players offering similar products and services. While VCTR has carved out a position as a multi-manager and multi-strategy approach investment management company, it does not have a substantial moat that differentiates them from peers and ensures defensibility.
Lack of Pricing Power: Their primary source of revenue is investment management fees, which are typically very competitive. There is little pricing power due to the large number of players. The client can easily move their funds to a different company or product, putting a pressure on their margins and ability to generate revenue. * Not Necessarily Sticky Customers: Due to the ease with which clients can shift their accounts and their investments to different firms, the switching costs are very low. This gives VCTR very little security as a moat or as a competitive advantage. * Dependence on Talent: VCTR’s success depends in part on attracting and retaining talented investment professionals who can produce competitive returns over a sustained period. Other firms also rely on the same talent, so that also poses another threat to the company and it’s revenues.
Limited Barriers to Entry: The asset management industry has comparatively low barriers to entry, making it easier for new competitors to emerge, and compete with VCTR on various levels. * Industry Consolidation: The recent acquisitions of other firms in the industry are a concern. If larger, more established players with significant financial backing start to acquire similar sized firms, it might put an upward pressure on smaller players like Victory Capital. It makes competing very difficult, especially if there is not a strong value proposition.

Risks to the Moat and Business Resilience

Although VCTR is striving to become a more prominent player in the investment management industry, they still have a long ways to go. If the underlying financial and capital markets start to struggle, the company might not be able to compete with other established firms.

Market Volatility: Volatile market conditions can lead to lower AUM, decreased earnings, and revenue, which will impact the ability to generate profits. VCTR’s business is closely tied to the fluctuations of the market and its volatility.
Regulatory Changes: Changes in regulations can increase compliance costs and potentially limit their investment strategies.
Competition: The industry’s competitive nature might put pressure on fees and profit margins.
Loss of Key Personnel: The loss of a key management personnel or portfolio manager can hurt the performance of the company and might erode confidence with clients and investors.
Acquisition Risks: Because acquisitions are often a core driver of growth for asset management companies, VCTR has to avoid overpaying for them or failing to effectively integrate acquisitions. These issues can all lead to value-destruction for the company.
Reputational Risks: Due to the nature of this business, the company’s reputation can be seriously affected if they have compliance and fraud related concerns. Any issues in the accounting of its financials or any fraud related issue can potentially cause a huge erosion in company’s value.

Despite these risks, VCTR does exhibit some business resilience. They have a diversified portfolio and are trying to tap into high growth areas. They have a proven record of acquiring firms and using their expertise to turn them around. This should aid in the continued resilience and sustainability of the firm. The strong and stable management team, with deep knowledge of the business and market will play a vital part in the success and resilience of this company.

Understandability: 3 / 5

VCTR’s business model is somewhat complex with numerous different revenue drivers. They offer a variety of products and services and have different investment strategies with a wide variety of clients. I am giving a 3 out of 5 because the company has a lot of moving pieces, requiring thorough understanding of the products, client and services to properly analyze.

The value driver of the business (AUM, investment performance) and the cost-side (operations) is easy to understand.
However, their large variety of products and client base and the different channels can be overwhelming for new investors to understand. The details in all these can add to the overall complexity of the company.

Balance Sheet Health: 4 / 5

Based on my understanding of VCTR’s balance sheet, I am giving a score of 4 out of 5. Even with the significant amount of debt, they still have a reasonable cash position and their AUM is their primary asset. They are a profitable and well-functioning company, making them resilient in the face of adversity. * Good amount of assets compared to liabilities. * The company is generating positive free cash flows, allowing them to pay back debt and reinvest into the business to create more value. * However, their debt level is quite high and should be lowered in the future. This debt can become extremely risky if interest rates rise even more. * The company has a robust credit profile, and their profitability enables them to manage any existing debt obligations.