Bain Capital and Envestnet: LBO Analysis

(Disclaimer: Excel file attached below the post) 

One of my passions is to keep track of the M&A sector and search for transactions that I find intriguing, and keeping up with my usual methods, I came across Bain Capital's take-private acquisition of Envestnet a few weeks ago. I wanted to analyze the transaction and assess the potential returns, but I was preoccupied with work related responsibilities and couldn't conduct the analysis, but better late than never, right? I had never heard of Envestnet prior to the announcement of this transaction, and so I think a good place to start would be to briefly introduce the company and what it does and then move onto the numbers.

Envestnet (ENV)

Envestnet is a leading provider of integrated technology, intelligent data and wealth solutions. As of the transaction, the company manages over $6 trillion in assets, oversees nearly 20 million accounts, and enables more than 109,000 financial advisors to better meet client financial goals with one of the most comprehensive, integrated platforms delivered at scale in a unified, engaging digital experience. The company has had great success enhancing the advisor and investor experience, and currently supports over 800 asset managers on its Wealth Management Platform. Additionally, Envestnet was recently recognized by the 2024 T3/Inside Information Advisor Software Survey as a leader in Financial Planning, Portfolio Management, TAMP and Billing Solutions.   

Envestnet is organized around two business segments based on clients and products and services that it provides. 

• Envestnet Wealth Solutions
• The company is a leading provider of comprehensive and unified wealth management software, services and solutions to empower financial advisors and institutions to enable them to deliver a holistic advice to their clients.
• Envestnet Data & Analytics
• Envestnet is a leading provider of financial data aggregation, analytics and digital experiences to meet the needs of financial institutions, enterprise FinTech firms and investment research firms worldwide.

As for the company's business and revenue model, it has a model that provides consistently recurring revenues and predictable cash flows. The company earns revenues through three different avenues: "Asset-based Recurring Revenue", "Subscription-based Recurring Revenue", and "Professional Services and Other."

• Asset-based Recurring Revenue
• In the company Wealth Solutions segment, asset-based recurring revenue primarily consists of fees for providing customers continuous access to platform services through the company's uniquely customized platforms. These platform services include investment manager research, portfolio diagnostics, proposal generation, investment model management, and rebalancing and trading along with a packet of other services. Asset-based fees that the company earns are generally based upon variable percentages of assets managed or administered on the company's platforms. 
• Subscription-based Recurring Revenue
• In both the Wealth Solutions and Data & Analytics segments, subscription-based recurring revenue primarily consists of fees that the company generates for providing customers with continuous access to the company's technology platforms for wealth management and financial wellness. The fees vary depending on the scope of technology solutions and services being used, and are priced in a variety of constructs based on the size of the business, number of users or accounts, and in many cases can increase over time based on the growth of these and other relevant factors
• Professional Services and Other 
• In both its Wealth Solutions and Data & Analytics segments, the company generates revenues from professional services for client onboarding, technology development and other project related work as well as revenue generated from Annual Advisor Summits. 

Lets Talk Numbers

Before moving onto the LBO analysis, I think that it is prudent for me briefly talk about the company's historic performance and numbers, and as such, here is a look at company's historical income statement going back four years:

As you can see, more than half the total recurring revenue- comprised of assed-based and subscription-based recurring revenue- is made up by asset-based revenue. Asset-based recurring revenues are not only more than half of the company's recurring revenues, but have also seen somewhat mediocre growth over the last four years. Subscription-based revenues on the other hand have been declining over the course of the last four years, and percentage wise, revenues generated from professional services have stayed pretty consistent over the observed period. 

As for the operating expenses, they have either come pretty close to 100% of total revenues or exceeded the total revenues by a pretty hefty margin. Company reported total operating expenses of 116% of total revenues for the FY '23. Operating expenses consist of direct expense (38% of total revenues for FY '23), employee compensation (36% of total revenues for FY '23), general and administrative (17% of total revenues for FY '23), and depreciation and amortization (11% of total revenues for FY '23). Thought that came to my mind was that the company is either investing a lot in its future growth or is not spending well, and when I look at the top-line growth over the last two years, I fear that it may be the latter and not the former. The company did report positive operating margins for FYs '20 and '21, but then ventured back into the negative territory for FYs '22 and '23. Another thing that stands out is the company's consistently high interest expense with the company reporting $25MM for FY '23 and $17MM for FY '22, which considering that this a growth company, might not be a bad thing, depending on how one views it. Finally, it goes without saying that the company reported negative NI for three of the four years that I looked at it its financials, the company reported $13MM in NI for FY '21 mainly driven by 19% growth in total revenues and about 2% reduction in its overall operating expenses. With a look at its income statement, lets move onto the company's balance sheet:

I do have a few thoughts when looking at Envestnet's historical balance sheet. The company did report a healthy amount of cash reserves for FY '21, but then reported dwindling numbers for the following two years with ending the FY '23 with $91MM. Additionally, company has been reporting higher amount of receivables along with other current assets over the last three years, which of course are cash outflows. PP&E, considering the company's business model, is not a huge part of the balance sheet, but internally developed software and other intangible assets make a good chunk of the company's assets. Over the last few years, Envestnet has been engaged with inorganic growth which explains the inflated goodwill numbers, the lower goodwill number for FY '23 was due to an impairment at the end of the year. Final thought on balance sheet would be the high amount of debt the company has which would explain the high interest expense. 

LBO Analysis

I think that I am in a good place now to talk about the LBO transaction, and I must preface the following analysis with the fact that my resources are limited and so I have had to rely on a few assumptions in terms of the debt to equity structure for the transaction as well as what I think about the future. As I mentioned at the start of the post, Bain Capital's acquisition of Envestnet was finalized and approved by the target's board with an overwhelming support last week. Bain Capital and consortium offered $63.15 for every share of the company, which looking at the company's share price from a month before the transaction announcement ($60.62) is a premium of about 4%. 

When looking at take-private LBO transactions, they are usually structured in one of two ways, they are either in the form of an offer price (which is the case for this analysis) or they are done as a multiple of the target's EBITDA, and to better understand the transaction, I think that it is always a good practice to look at both approaches, and as such, in the image above, we can see that with an offer price of $63.15 and Envestnet's fully diluted shares outstanding of 56,325MM, we get an offer value of $3.5BB, and given the target's net debt of $905MM, we get an enterprise value of $4.5BB, which given the target's EBITDA for FY '23 of $250MM, yields an EBITDA multiple of 17.8x. This is why when analyzing these transactions we must look at both approaches, because at initial glance, the premium of 4% might have looked like a bargain, but the EBITDA multiple of 17.8x tells a different story. Moving onto the assumptions that I mentioned at the start of this section, here is a look at the sources and uses of funds along with the possible transaction and financing fees for the deal. 

For the purposes of this analysis, I am assuming 79% debt, 20% equity and the remainder 1% of the company's existing cash being used. I am assuming 2% of transaction fees ($71MM) and $150MM in financing fees. With these assumptions out of the way, lets talk about the future. 

Future

LBO transactions are structured in a specific manner and there are a few levers that the PE firm can pull in order to boost their returns down the road, and knowing how the industry works, here is what I think about the company's future. 

• Growth in revenues
• Asset-based recurring revenues
• In my base case assumption, I expect asset-based revenues to grow from 1% in FY '23 to 31% by the end of FY '28, in line with 31% growth rate that the company witnessed in FY '21. I believe that this growth in revenues will be driven by the company's future ability to leverage their large base of existing customers, expanding their current relationships through new products and services as well as creating new revenue streams, either through organic or inorganic means. 
• Subscription-based recurring revenues
• The company reported subscription-based revenues growth of -2.7%, and I expect their subscription-based revenues to gradually increase to 7%, which again is in line with what the company reported for FY '21. I expect the company to innovate given its new management and strategy teams and leverage their existing position within the industry, which given Bain Capital's brand name and portfolio of companies, seems like an easy uphill battle. 
• Professional services and other revenues
• Professional services and other revenues consist of fees that the company charges for client onboarding, technology development and other project related work as well as revenues generated from Annual Advisor Summits. Given the historical trends, I expect this particular revenue stream to stay somewhat flat over the next five years. 
• Cost reductions
• The company reported 38% margins for direct expense, 36% margins for employee compensation, and 17% for general and administrative for FY '23. I believe that Bain's expertise and strategic vision for the future should allow the firm to run the company in a more lean manner and not be haphazard with growth and reinvestment. As such, going forward, over the next five years, I expect direct expense to gradually decrease from 38% to 37% of total revenues, employee compensation to decrease from 36% to 32%, and finally, general and administrative to decrease from 17% to 16% of total revenues. 
• Deleveraging
• I do expect the company to generate enough cash flows that would allow the company to meet its future debt obligations in the form of interest expense and mandatory amortization that I have assumed for term loans A and B. 
• EBITDA expansion
• EBITDA is by far considered the most pivotal metric when assessing an LBO transaction and the future exit. Given the increase in revenues that I have assumed, and the cost reductions that I expect Bain to be capable of conducting, I expect the company's EBITDA to grow from 14% in FY '23 to 29% in FY '28.

Future Income Statement

With all of my assumptions in place, here is what I think the company's income statement could like in the future:

As you can see, with my assumptions about the company's segments' growth for the next five years, I expect the cumulative revenue to grow from 0.5% in FY '23 to 22% by the end of FY '28. I also expect operating expenses margins to decrease from 116% in FY '23 to 96% by the end of FY '28. My total revenue growth rate and reduction in operating expenses seem plausible and very much in line with how the PE industry and firms work. Moving on to non-operating expenses, given that I have assumed 79% debt for the transaction, we get interest expense of $268MM for the next five years as well as an interest income of $3MM given the minimum cash balance of $50MM. Lets now move onto the pro-forma balance sheet and see what the company's balance sheet could look like on the day the transaction closes:

I will refrain from delving into the adjustments and why they are made as that is a topic for another day, but I would like to show you how the pro-forma balance sheet could look like for the next five years:

You can see the minimum cash balance that I have assumed for working capital and daily operational needs as well the changes to debt and the new equity for the next five years. Lets now look at probably the most important financial statement in an LBO setting: the cash flow statement.

As you can see, the company does not generate enough or healthy cash flows despite the growth in revenues and the reduction in costs that I have assumed. Cash flows from operations is negative for the two projected years and begin to turn positive from the third year. I expect company's investing activities to be in line with historical numbers where capex and additions to capitalized software and intangible assets margins would remain flat for the entire projection period. This is not the typical convention because as the company grows its revenues and reduces its costs, it also expects its reinvestment to decrease in order to yield higher free cash flows, which in our case, are negative for the entire projection period, but I kept the activities from investing flat because I wanted to see what the cash flows might look like if nothing changed, and it doesn't look good. Finally, because the company does not generate healthy free cash flows, I do not believe that the company will be able to make any discretionary payments beyond the mandatory amortization, and also will need to rely on its revolving credit facility for its day to day operations. With all of this in place, lets now look at what the returns could look like.

Returns

A typical convention for the exit analysis is to assume the same exit EBITDA multiple as the entry multiple, and so my exit analysis is based on the fact that Bain Capital will exit their investment at 17.8x EBITDA, and assuming that multiple, we get an enterprise value of $8.4BB, for comparison, the entry enterprise value was $4.5BB, and given the minimum cash balance of $50MM and debt of $4.6BB, we get an equity value of $3.8BB on fully diluted basis. Again, a reminder, I am assuming Bain Capital puts in about $1BB at the close of the transaction, which gives us the following returns:

As you can, given my assumptions about the exit, Bain Capital would be exiting their investment at a 32% IRR and 4x MOIC. The returns, of course, drastically change if we assume a different EBITDA multiple, for instance, if we assume that Bain Capital is able to expand its multiple and get a 19.8x EBITDA multiple, their IRR would be 38% with a MOIC of 5.0x, and a lower multiple would, naturally, yield lower IRR and MOIC. Another purpose of conducting an analysis of this kind is to see the maximum amount that the sponsors can put in in order to make their minimally desired IRR, and here is what the maximum price could be assuming a different range of Bain Capital's minimum required IRR:

Assuming that Bain Capital's minimum required IRR is 25%, my model, based on my assumptions, predicts that the PE firm can afford to put in $3.8BB instead of the $1BB that I have assumed. 

Conclusion

I conduct these analyses not to criticize the teams or the firms that have worked on the transactions, but to purely quench my own intellectual curiosity. Based on what I have assumed, the transaction seems pretty lucrative from an IRR and MOIC perspective, but not so great from the debt and cash flows angle. As always, I am well aware that everyone thinks and strategizes differently, and so I have linked the Excel file right below the post for you to play with and put in your own assumptions and make your own conclusions.

 

Links:

Bain Capital and Envestnet- LBO Analysis