Financial technology is a favored space of mine currently. Many companies here have seen stock prices remain restrained due to lingering association with beleaguered financials, continued stringent regulation, and other more nuanced sector headwinds (active to passive investing shift, etc.).
Unfortunately, many of these companies do not get the coverage they deserve, as it can be tough to understand both the products themselves and how they are being received by customers. SEI Investments (SEIC) fits that mold perfectly, given it has a great product suite that most outside the industry are not aware of. Is the value there for investors to build a stake in this company?
SEI provides investment processing, management, and operations solutions to larger clients like institutional investors, financial advisors, and ultra-high net worth individuals. Broadly, investors can view the company’s solutions as falling into three buckets: investment processing, investment management programs, and investment operations. Most core is investment processing solutions, which is made up of business process outsourcing (“BPO”) services, as well as application and professional services directed towards commercial customers.
Primary method of delivery is through the company’s two proprietary application suites: TRUST 3000 and the SEI Wealth Platform. The TRUST 3000 platform is a comprehensive trust and investment accounting system that provides securities processing and accounting for trust accounts. The SEI Wealth Program is a scaleable platform designed to support wealth advisory and asset management functions, revolving around encouraging a strong client-centric relationship.
Throughout this year, SEI has been converting two large bank clients (Wells Fargo (NYSE:WFC), Regions (NYSE:RF)) to newer versions. These installations are key, as other potential core customers will be watching to make sure that the company’s products can handle these types of large customers. Regions Financial is scheduled to be done within the next six months, while Wells Fargo won’t be fully converted until the end of 2018. Once those projects roll off, expenses will moderate, which should provide a nice little tailwind to margins. See management’s commentary from the most recent conference call:
We believe that from the develop standpoint, that’s generally peaked and it’s now plateauing and our goal would be as things like — as clients like Regions settle in, that some of that would start to come down post the installation of Regions and then certainly, an even bigger step down post the installation of Wells Fargo.
Within investment management, SEI offers a multitude of fixed income, equity, and money market products, primarily more niche ETFs like SEI Multi-Asset Accumulation (SIMT) or state-specific municipal bond funds, like SEI Pennsylvania Municipal Bonds (STET). At the end of the last reported quarter, SEI had $297.1B in assets under management (“AUM”) and another $478.1B in assets under administration (“AUA”).
AUM relate to assets that SEI directly manages investment direction in through its equity and fixed income investment programs, while AUA assets are those that the firm provides administrative services for. Unlike most other asset management firms, trends in AUM and AUA have been positive for several years, which is indicative of the healthy underlying strength in the firm’s investment strategies.
Historical Results, Valuation
Recent historical results have been extremely positive. Revenue growth has averaged 5% annually over the past two years, driven by growth in both AUM and AUA. Sales to investment advisors and managers have seen the strongest growth in near-term results, while sales to private banks continue to lose their influence (no growth, despite being SEI’s highest grossing end market). Overall growth has been stronger in AUA, which has put some minor pressure on margin; 26.8% GAAP operating margin in 2016 versus 27.9% in 2014.
Macro headwinds on margin (AUM fee contraction, product mix, pressure from large clients to cut costs) likely has disguised some very strong incremental margin at SEI. There is likely very little cost to supporting new revenue, so new contract wins are important to driving earnings. Q2 2017 was an excellent quarter in all these respects, with revenue up 8.5% compared to the prior year period. This was big, and was one of the largest y/y jumps in revenue in several quarters. Margins moved back in a positive direction, and given the active buyback program, second quarter diluted earnings per share increased 16%.
Like most businesses in the financials space, this is asset light and cash generation is quite high. Operational cash flow has expanded annually, both from trends in net income and positive moves in working capital. Capital expenditures have been on the rise ($56M in 2013 to $82M in 2016), but free cash flow has been solid. Assuming $50M in capital expenditures as a maintenance level, free cash flow peaked at $375M last year, or 4.2% free cash flow yield. A large portion of this free cash flow has been dedicated to share buybacks, and SEI is on track to buy back another $240M worth of stock this year.
Given the healthy net cash position ($683M in cash, no debt) and resilient end markets, there isn’t much to fear here. It is a quality company with a rock solid balance sheet, and that is going to attract a lot of risk-averse investors, particularly institutions (80% of the float excluding insider shares is controlled by institutional investors). At 26x trailing earnings, the company isn’t particularly cheap, but earnings are expected to grow measurably over the next two years as development expenses roll off and the company begins to build a little more scale.
With the company trading at 20x 2018 earnings estimates, there is a little bit of leeway here for price expansion given historical trading multiple norms, but it is light: 15% or so. This one looks like a solid hold to me at current prices.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.