Waddell & Reed Financial (NYSE: WDR) is an asset manager and investment advisor with nearly $65 billion in assets under management. The firm earns the majority of its revenue by providing financial planning advice for clients and earning a percentage of the assets it manages. About 85% of the firm's AUM is invested in equities. Sales from Waddell's Wholesale Channel, which distributes families of mutual funds to clients, grew by 169% from 2006 to 2007 and was a strong driver in the the firm's total 34% increase in AUM over that year. From 2003 to 2007, Wholesale Channel assets, as a fraction of WDR total assets, have increased from 10.4% to 33.2%.
Waddell competes against household financial services firms, whose assets under management often overshadow that of WDR's $65 billion. Moreover, Waddell has $200 million of debt, and with credit conditions in mid-2008, the company will be hard-pressed to refinance the loan. Also, firm management has stated that it plans to grow its Wholesale investment channel and decrease investments in other segments. The Wall Street Journal ranked Waddell as the number one fund-family, ahead of competitors such as Eaton Vance, Jefferies Group, and Legg Mason.
Waddell's revenue, AUM, and net income reached all-time highs in 2007. The widespread success was driven by the 34% increase in AUM to $65 billion.
In 2Q2008, earnings per share grew by 27% over Q1 and 17% from a year ago. Moreover, operating revenue grew by 8% while operating expenses increased by only 4%. The firm's sales in the Wholesale Distribution Channel grew by 169% from over a year ago. Weighted average returns in the funds and managed accounts of Waddell outperformed the S&P index by more than 525 basis points during the second quarter of 2008 and over 700 basis points as of the year-to-date. The strong growth results can be attributed to increases in sales per advisor, net asset inflows, and strong investment positions.
In the longer run, WDR's revenue has grown every year since 2003, hitting an all-time high of over $837 million in 2007. Waddell's net income decreased consecutively in 2005 and 2006. The consecutive slips in net income can be attributed to one-time regulatory and legal settlements. Waddell, as a holding company, is composed of several subsidiaries, through which they offer their services and earn revenue. The 2006 drop in net income occurred as a result of restructuring charges for Austin, Calvert & Flavin, Inc. (ACF), an investment management firm and one of its subsidiaries. The 2005 net income fall was also due to restructuring and severance charges, this time with the Advisors Channel as well as a separation of employment deal with its former CEO.
Waddell & Reed is a relatively small asset management firm. Its assets under management total just $65 billion, which is dwarfed by household names like T. Rowe Price ($350 billion), Fidelity ($1.2 trillion), and Vanguard Group ($800 billion). (Note that the AUM values are of 2006.) Smaller asset managers face a roadblock when it comes to competing and raising capital to manage. Even so, Waddell's AUM and net income hit all-time highs in 2007, thanks to net inflows and market appreciation. The company's ability to compete with the big name asset managers will depend on strong investment performance, especially through this subprime lending credit crisis. Waddell's funds have demonstrated strong performances in the past, including its Advisors Funds top ranking by Barron's in 2007 and Ivy Funds coming in eighth. Finally, of the $16 billion dollar surge in assets under management, $10.0 billion came from market appreciation, reflecting strong investments.
Within Waddell's Advisory Channel, WDR boasted industry-low redemption rates--the frequency of an buyer executing his option to sell a certain security (before maturity) back to the seller at a predetermined price--of 9.1% and 9.2% for 2007 and 2006 respoectively. In other words, redemption rates indicate how long investors decide to stick with a company, and the lower the better.
However, WDR's Wholesale securities tend to be more liquid (transferable) and have a greater rate of redemption--more than double that of the Advisor Channel--at 18.5% and 21.0% for 2007 and 2006 respectively. The Wholesale Channel has also been expanding -- from 2003 to 2007, Wholesale Channel assets, as a fraction of WDR total assets, have increased from 10.4% to 33.2%. With a higher rate of redemption (investors staying with Waddell & Reed for shorter periods of time on average) in the Wholesale department and its growing size, the ability for WDR to obtain and maintain investors and AUM in this increasingly emphasized segment comes into question.
The corporate structure of Waddell is that of a holding company, or a business that owns any amount of the outstanding stock of another company. As such, Waddell runs much of the firm through its subsidiaries, such as Ivy Funds. Waddell does face a few obstacles as a holding company, including the fact that each of their subsidiaries is a separate legal organization, and is not required to help WDR on any payments of debt. Though WDR made $125 million in net income in FY2007, it may run into problems paying back its $200 million in debt. Should WDR have to focus on repaying the debt with its own profits, it will bypass opportunities to invest and expand the firm.
Waddell competes with a variety of companies within the financial services industry. Its closest competitors include Eaton Vance, Janus Capital and Legg Mason, which all invest in mutual funds. The Wall Street Journal published a mutual fund family ranking based on factors such as U.S. equity, world equity and bond performance, which listed WDR first along with its subsidiary, Ivy Funds, in eighth. Eaton Vance and Janus Capital ranked second and third. Below is a chart of relevant operating metrics for Waddell and Reed and its industry competitors.
|Company||AUM ($ in billions)||Operating Expenses ($ in millions)||Operating Margin (TTM)||Net Profit Margin (TTM)||Return on Assets (TTM)||Return on Equity (TTM)|
|Waddell & Reed||$ 64.9||$ 642.9||21.82||13.99||16.96||41.90|
|Eaton Vance||$ 161.7||$ 851.0||34.49||19.89||29.54||69.68|
|Janus Capital||$ 165.0||$ 2,175.8||32.21||18.32||6.05||11.40|
|T. Rowe Price||$ 400.0||$ 857.2||43.77||29.28||22.17||25.68|
|Legg Mason||$ 950.1||$ 3,583.9||22.02||1.02||0.40||0.68|
Note: Margins and Returns Data for all companies but JNS taken from Reuters on September 30, 2008. JNS taken on October 11, 2008