For RCS Capital Corp., the acquisitions keep on coming. Thanks to a rapid-fire series of takeovers at rich valuations, the firm, commonly known as RCAP, has grown into the second-largest independent U.S. broker-dealer in just two years since it opened its doors.
On August 13 New York–based RCAP announced an agreement to purchase Girard Securities, a fellow independent brokerage with more than $10 billion in assets under administration and 250 financial advisers using its platform. The addition of San Diego–based Girard brings RCAP’s total number of advisers to 9,700, its assets under management to $3 billion and its assets under administration to $214 billion.
Earlier in the month RCAP picked up another advisory platform, VSR Group of Overland Park, Kansas. In July it closed a merger with Lynnfield, Massachusetts–based Investors Capital Holdings. So far this year, it has bought ten firms.
RCAP is swiftly gaining on LPL Financial, the Boston-based firm whose roughly 13,400 advisers make it the biggest independent U.S. brokerage. Now the firm aims to use its distribution muscle to bring alternative investments to mass-affluent investors. Can it maintain such a torrid pace, and is it paying too much to swallow smaller rivals?
RCAP is still shopping for the right opportunities, says president Michael Weil: “Our acquisition strategy will continue to focus on high-quality firms for which the advantages of our platform can be captured very quickly.”
This buying spree should come as no surprise: It’s in the firm’s DNA. RCAP was launched in 2012 by veteran real estate investors William Kahane and Nicholas Schorsch, co-founders of American Realty Capital. Boston-based ARC specializes in sponsoring public and private real estate investment trusts and managing open- and closed-end real estate funds.
The firm’s subsidiaries include private REIT sponsor Cole Capital Advisors and mutual fund manager ARC Income Funds. A July document on ARC Income Funds’ flagship real estate fund, which is managed by subadviser National Fund Advisors, lists Schorsch as a member of the fund’s board of trustees and RCAP subsidiary American National Stock Transfer as the transfer agent; RCS Advisory Services, also owned by RCAP, acts as the fund’s administrator. The document also specifies that the fund does invest in private REITs but not those sponsored by Cole Capital or other ARC subsidiaries.
Launched in 2007, ARC expanded aggressively in the wake of the credit crisis, taking advantage of low property valuations and individual investor appetite for higher-yielding products as the U.S. Federal Reserve Board kept its benchmark interest rate at historic lows. The REITs sponsored by ARC’s subsidiaries also typically carried significantly higher sales commissions and other fees than those of publicly traded REITs, making them popular with brokerage advisers.
When the news broke last year that RCAP had moved into wealth management, industry chatter focused on the possibility that it was aiming to boost distribution of ARC’s core unlisted REIT franchise. RCAP’s website lists the firm’s investment banking division as having advised on more than 30 transactions involving ARC subsidiaries in 2013 and 2014. Although ARC will be part of the mix, the adviser platform due diligence process for alternative investments will be run independently and offer best-in-class products, “irrespective of their sponsor,” Weil says.
The independent broker-dealer business model is unique to the wealth management segment of the securities industry. These firms allow advisers to operate as quasi-independent contractors under their regulatory umbrella. Besides LPL and RCAP, other dominant players include Ameriprise Financial, AXA Advisors and Northwestern Mutual.
Kahane and Schorsch entered the retail financial adviser business in 2013 by purchasing several midsize independent brokers and merging them into holding company RCAP, whose business lines also encompass investment banking and wholesale securities distribution.
This January the expansion took a big leap forward with the $1.15 billion buyout of Cetera Financial Group from Lightyear Capital, the financial services–focused private equity firm founded by Donald Marron, former CEO of full-service brokerage Paine Webber Group, now part of Swiss bank UBS. The price tag for El Segundo, California–based Cetera roughly equaled the firm’s 12-month trailing revenue, a valuation much higher than for comparable recent deals.
Since RCAP went public in June 2013 to create a capital structure better suited to roll up additional companies, industry observers have questioned whether the firm is overpaying for smaller competitors. Unlike their counterparts at major banks, independent broker-dealers manage their commission-generating activities at the branch level, with a degree of autonomy for the individual advisers who operate under their own brands.
Also, they typically earn a higher percentage of commissions than they would at a full-service brokerage; advisers at independent broker-dealers also tend to generate lower gross commissions on average than those at full-service firms. With advisers who produce smaller revenue streams but earn a larger piece of the pie, the business model would seem to hold limited appeal for broker-dealers.
RCAP isn’t throwing money away, according to Kenneth Hill, a New York–based equity analyst with Barclays. “I think that they are aware that they paid the full price, but the reason why they did is what is important,” Hill says. “Scale is critical for the business they are in, and these acquisitions put them firmly in the position of the second-largest player in the market segment.”
The synergies created by the mergers will lead to higher earnings, Hill predicts. Currently he rates RCAP stock — which was trading in the $21 range in late August, well below its peak of almost $39 this February — at overweight. In May, Barclays was joint book runner with Bank of America Merrill Lynch for an RCAP secondary offering that raised more than $460 million.
One clue as to why RCAP is willing to pay hefty valuations to achieve scale may lie in another recent acquisition. In July the firm completed the takeover of Hatteras Funds, a Raleigh, North Carolina–based manager of alternative-investment-focused mutual funds with $2.7 billion in assets.
The liquid alternatives fund category has seen tremendous growth in the past three years as wealth managers have embraced products designed to lower portfolio volatility with hedge-fund-like strategies at a mutual fund cost and liquidity. Recently the Securities and Exchange Commission began closely scrutinizing this expanding mutual fund category; in a May speech, Andrew Bowden, director of the Office of Compliance Inspections and Examinations, raised doubts over its appropriateness for some individual investors.
“Liquidity and alternatives are not typically used in the same sentence,” says Charlotte Beyer, founder and former CEO of the Institute for Private Investors, a New York–based peer-to-peer community for accredited investors. “Investment marketers, in their exuberance, have married the two into an alluring product — one that may or may not work out.”
RCAP also has a subsidiary called SK Research that provides investment analysis of nontraditional investments, including unlisted business development corporations, private REITs and oil and gas partnerships. Columbia, Maryland–based? SK distributes through RCAP’s internal network of advisers and via the broader wealth management community. Many established independent broker-dealers are divisions of insurance companies and banks that distribute proprietary products through their adviser channels, but RCAP is the first heavily alternative-investment-focused firm to enter the independent arena.
Although alternative investments are generally seen as a positive addition to an adviser’s toolkit, some concerns remain. “If done with care, selling private placements to retail investors is fine,” Beyer says. “Yet how many advisers will take the time to educate their clients and be sure the tax and liquidity constraints are crystal clear?”
The combination of a fast-growing RCAP adviser base and a large and increasing appetite for alternatives in the mass-affluent market will help the firm’s asset management business expand rapidly, president Weil says: “We are confident that with our established relationship and experience with ARC Income Funds and Hatteras Funds, we have all the necessary pieces to achieve significant organic growth over the next 18 months.”
