Waddell & Reed Financial (WDR)

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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,^[4] ahead of competitors such as Eaton Vance, Jefferies Group, and Legg Mason.

[edit] Corporate Overview

WDR Revenue Breakdown^[5]

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.^[6]

In 2Q2008, earnings per share grew by 27% over Q1 and 17% from a year ago.^[2] Moreover, operating revenue grew by 8% while operating expenses increased by only 4%.^[2] The firm's sales in the Wholesale Distribution Channel grew by 169% from over a year ago.^[2] 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.^[2] The strong growth results can be attributed to increases in sales per advisor, net asset inflows, and strong investment positions.^[2]

[edit] Business Segments

WDR Distribution Channel Breakdown Note: $ in millions^[5]

• Investment Management Fees (44% of Revenue) depend on the average value of the firm's assets under management. Such fees are calculated as a percentage of AUM. Within this segment, Waddell offers investment advice and management services to its clients.

• Underwriting and Distribution Fees (44% of Revenue) are based on commissions received on investment transactions and advisory services. WDR earns revenue in this segment by distributing mutual funds (their own and sometimes the funds of other companies) and buying/selling the shares of the funds continuously.

• Shareholder Service Fees (11% of Revenue) refer to portfolio accounting charges, custodian fees for retirement accounts, and other maintenance costs.

[edit] Distribution Channels

• Advisors Channel (53% of AUM; 24% of Channel Sales): WDR provides financial advice to clients, often marketing its own funds in the process.^[7] The Advisors segment gross sales revenue grew by 10% to an all-time high of $3.5 billion and sales per advisor hit a new high of $1.2 million.^[7]

• Wholesale Channel (33% of AUM; 64% of Channel Sales): The company's Wholesale Channel accounts for the distribution of assets through brokers and dealers, investment advisors, and retirement platforms.^[7] Waddell offers families of mutual funds to its clients, including the Ivy Funds and the Advisors Funds. Within this channel, Waddell distributes these families to customers' portfolios including 401ks and retirement accounts. Wholesale assets doubled over 2007 to nearly $22 billion, thanks to weighting investments toward internally managed, profitable funds^[8] and Waddell efforts to expand AUM distributed in this channel.^[9] Moreover, market appreciation of nearly $4 billion and net sales of nearly $7 billion over 2007^[10] both bolstered Wholesale growth.

• Institutional Channel (14% of AUM; 13% of Channel Sales) includes any organizations that would have pension plans or endowments. Within this sector, WDR distributes its funds to such benefit pension plans, other investment firms (as a subadvisor), endowments, and other high net worth customers.^[11]

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^[12] and one of its subsidiaries.^[13] 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.^[13]

WDR Historical Revenue and Net Income^[5]

[edit] Key Trends and Forces

[edit] Waddell's relatively small size inhibits competitive stance

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).^[14] (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.^[15] Finally, of the $16 billion dollar surge in assets under management, $10.0 billion came from market appreciation^[16], reflecting strong investments.

[edit] Waddell's increased emphasis on its Wholesale Channel translates to greater redemption rates

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^[17]--of 9.1% and 9.2% for 2007 and 2006 respoectively.^[3] In other words, redemption rates indicate how long investors decide to stick with a company, and the lower the better.^[18]

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.^[3] 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%.^[3] 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.

[edit] WDR's status as a holding company inhibits debt payments and growth

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.^[19] 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.^[20] Should WDR have to focus on repaying the debt with its own profits, it will bypass opportunities to invest and expand the firm.

[edit] Competition

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.^[4] Eaton Vance and Janus Capital ranked second and third.^[4] Below is a chart of relevant operating metrics for Waddell and Reed and its industry competitors.

Note: Margins and Returns Data for all companies but JNS taken from Reuters on September 30, 2008. JNS taken on October 11, 2008

[edit] References

1. ↑ WDR Earnings Call Transcript 1Q2008
2. ↑ ^{2.0 2.1 2.2 2.3 2.4 2.5} WDR Earnings Call Transcript 2Q2008
3. ↑ ^{3.0 3.1 3.2 3.3} WDR 2007 10-K pg. 14  
4. ↑ ^{4.0 4.1 4.2} WSJ Mutual Fund Family Rankings
5. ↑ ^{5.0 5.1 5.2} WDR 2007 10-K pg. 23  
6. ↑ WDR 2007 Annual Report pg. 2  
7. ↑ ^{7.0 7.1 7.2} WDR 2007 Annual Report pg. 3  
8. ↑ WDR 2007 Annual Report pg. 5  
9. ↑ WDR 2007 10-K pg. 14  
10. ↑ WDR 2007 Annual Report pg. 9  
11. ↑ WDR 2007 Annual Report pg. 7  
12. ↑ Austin, Calvert & Flavin, Inc. Website
13. ↑ ^{13.0 13.1} WDR 2006 Annual Report pg. 30  
14. ↑ Wikinvest Janus Capital Competitors AUM
15. ↑ WDR 2007 Annual Report pg. 2  
16. ↑ WDR 2007 Annual Report pg. 27  
17. ↑ Wikipedia: Redemption Value
18. ↑ Business Week: Redemption Rates
19. ↑ Wikipedia: Holding Company
20. ↑ WDR 2007 10-K pg. 19  
21. ↑ EV 2007 10-K  
22. ↑ JNS 2007 10-K  
23. ↑ TROW 2007 10-K  
24. ↑ LM 2007 10-K