Description

We recently built a position in LPL Financial (“LPLA”), the largest independent broker-dealer in the United States and a top custodian with ~$1.2T in assets. LPLA provides a comprehensive set of front, middle, and back-office technology and service solutions for ~22,000 financial advisors. Founded in 1989 as a niche, regional provider of brokerage services, LPLA has been transformed by current CEO Dan Arnold into the highest quality, most flexible, full-service provider in the industry. Management has tripled technology investments over the last seven years, widening the firm’s competitive moat and expanding its addressable market. 

Asset management itself is a growing market (driven in part by the natural appreciation of assets), and financial advisors are one of the fastest growing subsegments of it.  LPLA enables financial advisors to move away from legacy financial institutions and helps them start their own independent businesses (RIAs), where they can increase their earnings and build “equity” value.  This ten-year trend is still in its early stages, as 75% of advisors remain affiliated with legacy financial institutions. We believe the market under-appreciates multiple elements of the LPLA story including its growth trajectory, macro-resiliency, and business quality which gives us the opportunity to own a far better-than-average business at a meaningful discount to the market.

Importantly, we believe that LPLA has structurally accelerated its organic new asset growth trajectory from low single digits pre-COVID to high single digits today by: (i) broadening its product portfolio to address more segments of financial advisors and (ii) investing in its technology backbone to improve the customer experience.  Net promoter scores have improved by 75+ points, and churn has declined from 5% to 2%. The business is winning in its historical core independent advisors market and has begun to penetrate new markets such as wirehouses, regional banks, and, most recently, insurance companies with a mega deal announced with Prudential in August. As a result, LPLA’s TAM has expanded meaningfully, and it is the fastest growing player in the industry.  Because assets themselves tend to appreciate 5%+ on average, we expect LPLA to grow organically at a low-teens rate (~7% asset growth plus 5% asset appreciation).

LPLA currently trades at ~12x 2025 P/E[1], which feels incredibly reasonable for a company with 98% asset retention (recurring revenue), double digit organic growth, 45% operating margins, and natural operating leverage, which implies that earnings will grow faster than revenue.  The market is rightly concerned that LPLA is currently over-earning on cash balances, with earnings set to decline as the Fed cuts rates.  However, those declines will be more than offset by organic growth.  Moreover, that concern misses important dynamics of the LPLA model that hedge interest rate changes. First, ~50% of client cash is currently held in long duration accounts.  Second, 20% of client cash is less rate sensitive. Third, and most importantly, the amount of client cash today is at an all-time low and will likely increase as interest rates decline.

We expect intrinsic value to compound in the high teens (organic growth plus operating leverage plus cash flow generation). While earnings are somewhat volatile due to exposure to market movements and interest rates, a business with these characteristics should trade at a much higher multiple. As this discounted multiple normalizes, we should earn returns above earnings growth. 

One modeling note - we assume rates below the current forward curve as an added element of conservatism. If the curve is actually correct this will be an upside driver to numbers although, as discussed above, the natural rate hedges in the business will mute the actual impact.

Catalyst

2024 earnings are depressed due to upfront 1 time costs from the Prudential win. As these roll off towards the end of the year, earnings will naturally accelerate and valuation will normalize from today's artifically elevated level.