Nomura Sees Too Many Hurdles to a LPL Investment (LPLA) Deal
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Nomura Securities analyst Steven Chubak weighed in on LPL Investment (NASDAQ: LPLA) following reports Tuesday that the company has hired bankers to explore "strategic alternatives", including a potential sale. Chubak sees too many hurdles to a deal, suggesting it is unlikely.
Factors cited by Chubak include:
DOL risk remains sizeable and difficult to quantify or mitigate. The largest of these is the DOL risk associated with operating in the brokerage retirement space, as a number of DOL-related earnings headwinds have not yet been clarified. 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 LPLA’s current AUM in brokerage retirement accounts, is material.
Negative TCE would meaningfully impact capital ratios, rendering deal less attractive to regulated bank buyers. In addition to the consideration paid to LPLA, any potential acquisition by a bank would be complicated by LPLA’s large negative tangible common equity (TCE) balance (-$985mn as of 2Q16), which 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.
Debt covenant limits leverage, which could preclude interest from PE firms. LPLA is subject to a debt covenant, wherein its total net debt is limited to 5x adjusted EBITDA, with the limit expected to rebase to 4.75x in the future. As of 2Q16, its leverage ratio was 3.7x, 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.
Better cash sweep economics not enough to attract bank suitors. On the flip side, we do see value creation potential in LPLA’s $29bn of Cash AUM which is currently swept to third-party banks, and earns a sweep fee of ~55bps; a potential bank acquirer would be able to bring these balances on balance sheet and generate a much higher yield (e.g., 175bp reinvestment yield as quoted by ETFC), supporting upside to NII. However, this may not be enough to offset the variety of risks and hurdles associated with the factors as listed above.
Neutral price target of $27.00
Shares of LPL Investment closed at $33.01 yesterday.
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