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October 12, 2016 at 10:48 AM
LPL Financial (LPLA) is reportedly looking at a potential sale or other financial arrangements. But when it comes to finding a buyer, the nation’s largest independent broker-dealer could be in real trouble, analysts say.
A deal with LPL “comes with too much baggage,” said Nomura Securities analyst Steven Chubak in a research note Wednesday.
While LPL’s shares closed up 7% Tuesday as the news broke, the stock was down 4.5% on Wednesday, trading near $31 (it is down about 26% so far this year).
“Early investor feedback suggests E-Trade, Charles Schwab, Raymond James or Stifel Financial could all be potential suitors…,” Chubak said, “but we see too many hurdles,” such as the DOL fiduciary standard, the company’s capital issues and its debt covenants.
Potential buyers, the analyst said, must consider “a number of complex factors,” and such risks “suggest that the deal is unlikely to be completed.”
The analyst sees the “top hurdles”—the need for capital and costs associated with DOL—“as being insurmountable, and more than offsetting any potential earnings accretion benefits (i.e., modest expense synergies, cash-sweep transfer, DOL ‘scalability),” explained Chubak. “While there has been some talk that a regional bank may emerge as the buyer, we see valuation as a significant hurdle here.”
LPL is currently valued at just under $3 billion.
With the new DOL rules, the risk tied to operating a broker-dealer in the retirement space, is greatest, “as a number of DOL-related earnings headwinds have not yet been clarified,” he said.
“Further, any potential acquirer would have to be comfortable taking on the litigation/earnings risk that will arise from the best interest contract exemption (BICE), which, with 30% of LPL’s current AUM in brokerage retirement accounts, is material,” Chubak added.
The firm’s negative tangible common equity, which was -$985 million as of June 30, “would meaningfully impact capital ratios, rendering [a] deal less attractive to regulated bank buyers,” the analyst points out, since this TCE “would result in a meaningful hit to the acquirer’s capital ratios barring a significant (and dilutive) equity raise. In our view, this could be reason enough to rule out an acquisition by any regulated bank subject to capital requirements.”
LPL’s debt covenant limits total net debt to five times adjusted EBITDA and is expected to fall to 4.75 times in the future.
“As of Q2 2016, its leverage ratio was 3.7 times, suggesting limited capacity for additional debt issuance. In our view, any potential private equity suitor would look to utilize leverage to enhance returns; this strategy appears to be dead on arrival in this circumstance,” Chubak said.
On the flip side, he noted, LPL clients keep about $29 billion of cash in their accounts, earning LPL a sweep fee of about 55 basis points. A potential bank buyer could “bring these balances on[to the] balance sheet and generate a much higher yield (e.g., 175 basis-point-reinvestment yield as quoted by E-Trade), supporting upside to net interest income,” the analysts explains. “However, this may not be enough to offset the variety of risks and hurdles associated with the factors as listed above.”
