TROW Struggles To Grow

In my previous BlackRock-related (BLK) guest post, I reference PwC’s ‘2023 Global Asset and Wealth Management Survey‘. One of the findings from that survey is that 1 in 6 asset and wealth management companies globally are likely to disappear or be acquired by 2027; this is twice the normal turnover rate.

In an industry where participants are heavily dependent on Assets Under Management (AUM) and performance track record relative to peers, T. Rowe Price’s (TROW) struggles are not encouraging.

While BlackRock (BLK), Blackstone (BX) and Brookfield Asset Management (BAM) have different business models from TROW, all asset managers compete for investor dollars. The fact these 3 firms have been able to grow their AUM more rapidly than TROW and that TROW decided to make its first major acquisition into private markets in late 2021, suggests TROW has its work cut out.

Compare the AUM growth of the following:

• BLK: ~$3.8T at FYE2012 to ~$9.425T at the end of Q2 2023 (148% growth).
• BX: ~$210.2B at FYE 2012 to just over $1T at the end of Q2 2023 (376% growth); and
• BAM: ~$175B at FYE2012 to ~$825B at the end of Q1 2023 (371% growth).

to that of TROW (142.5% during the 2012 – June 30, 2023 timeframe). Unless something drastic occurs, BX and BAM are likely to surpass TROW’s AUM within the next decade. TROW’s growth is similar to that of BLK but BLK was founded more than 50 years after TROW and it has $8T more in AUM.

Business Overview

TROW, founded in 1937, is a financial services holding company. In comparison, BX was founded in 1985 and BLK was founded in 1988. BAM, however, was founded in 1899.

TROW provides global investment management services through its subsidiaries to investors worldwide. This consists of a variety of US mutual funds, sub-advised funds, separately managed accounts, collective investment trusts, and other sponsored products. The other sponsored products include:

• open-ended investment products offered to investors outside the US;
• products offered through variable annuity life insurance plans in the U.S.;
• affiliated private investment funds; and
• collateralized loan obligations.

TROW also provides certain investment advisory clients with related administrative services, including distribution, mutual fund transfer agent, accounting, and shareholder services; participant recordkeeping and transfer agent services for defined contribution retirement plans; brokerage; trust services; and non-discretionary advisory services through model delivery.

An explanation of TROW’s business is found in Part 1 Item 1 in the FY2022 Form 10-K and the company’s website.

Oak Hill Advisors, L.P. Acquisition

Alternative credit strategies continue to be in demand from institutional and retail investors across the globe seeking attractive yields and risk-adjusted returns. This is an area of asset management where TROW is late to the party.

On October 28, 2021, TROW announced a definitive agreement to purchase Oak Hill Advisors, L.P. (OHA), a leading alternative credit manager; the purchase closed on December 29, 2021.

Under the terms of the transaction, TROW acquired 100% of the equity of OHA and certain other entities that have common ownership for a purchase price of ~$4.2B, with ~$3.3B payable at closing, of which ~74% was in cash and ~26% was in TROW common stock. An additional ~$0.9B in cash is payable upon the achievement of certain business milestones beginning in 2025.

The acquisition marks TROW’s first major acquisition into private markets as it looks to grow beyond its better-known mutual fund retirement business.

These entities make co-investments in certain affiliated private investment funds. In addition, a majority of the equity interests in these entities have interests in general partners of affiliated private investment funds and are entitled to a disproportionate allocation of income.

As of December 31, 2022, OHA had $57B of capital under management. This includes net asset value, portfolio value and/or unfunded capital.

CEO and NEO Compensation

I think CEOs and NEOs (named executive officers) are often obscenely compensated relative to all other employees. On page 76 of 103 in TROW’s 2023 Proxy Statement, we see that the compensation for TROW’s CEO and President in 2022 was $13,838,613. TROW’s median associate’s 2022 annual total compensation, however, was $137,347. Thus, the CEO and President’s 2022 annual total compensation was 100.8 times that of the median associate.

Most retail shareholders own so few shares in the companies to which they have exposure that their shareholder votes are irrelevant. Given this, we are unlikely to influence any changes to the compensation structure of senior executives. We must, therefore, determine if the compensation structures of CEOs and NEOs align with our long-term interests.

It is not necessarily how much but rather how executives are compensated.

In the May – June 1990 edition of The Harvard Business Review, Michael C. Jensen, the Jesse Isidor Straus Professor of Business Administration, Emeritus, at Harvard Business School in Boston, and the managing director of the organizational strategy practice of the Monitor Group and Kevin J. Murphy, an associate professor at the University of Rochester’s William E. Simon Graduate School of Business Administration present the findings of their in-depth study on executive compensation.

One of their key findings is that the dollar value of the CEO’s holdings or the value of his/her shares as a percentage of the annual cash compensation is far less relevant than the percentage of the company’s outstanding shares the CEO owns.

One problem with some compensation practices is that boards often reward CEOs with substantial equity through stock options. However, they:

‘stand by when the CEO undoes the incentives by unloading their stock holdings. Boards seldom provide contractual constraints or moral suasion that discourage the CEO from selling such shares to invest in a diversified portfolio of assets. One of the ironies of the situation is that the corporation itself often funds executive financial counselling by consultants whose common mantra is “sell and diversify, sell and diversify.” While this can be personally advantageous to executives, it is not optimal for shareholders or society because it significantly reduces CEOs’ incentives to run their companies efficiently.’

The percentage of shares owned by the CEO is key to aligning a CEO’s interests with those of shareholders. However, an important disadvantage of corporate size is that it is extremely difficult for the CEO to hold a substantial fraction of corporate equity.

It makes little sense to reward executives with equity if this equity can be sold in the very short term. Investors should, therefore, determine if a company’s executive compensation practices include conditions wherein a CEO and the NEOs must retain their equity compensation for a few years.

The following reflects TROW’s executive compensation practices.

If the long-term incentive component makes up a large percentage of the CEO’s and NEOs’ compensation structures AND executives must retain their equity compensation for several years, THEN I envision decisions will align with my interests.

Given TROW’s weak FY2022 performance, it is reassuring that compensation levels were much lower than in recent prior years.

TROW Struggles To Grow – Financial Results

Q2 and YTD2023

TROW’s Q2 and YTD2023 results are available in Form 8-K and Q2 2023 Form 10-Q.

Capital Allocation

Three key forms of capital allocation are:

• reinvesting in the company;
• dividend distributions;, and
• share repurchases.

Share repurchases, however, only make sense when done properly.

Looking at TROW’s stock price performance over the last few years, we see the share price spiked in 2021. Looking at the number of shares repurchased and the ‘Average Price Paid per Share’, TROW’s share repurchases did not truly benefit long-term shareholders.

TROW repurchased:

• FY2020: $1,192.2 to repurchase 10.9 million shares, or 4.6% of the outstanding common stock, at an average price of $109.30.
• FY2021: $1,136.0 to repurchase 5.9 million shares, or 2.6% of the outstanding common stock, at an average price of $191.20.
• FY2022: $855.3 to repurchase 6.8 million shares, or 2.9% of the outstanding common stock, at an average price of $126.69.
• In the first half of FY2023: $45.2 million to repurchase 420 thousand shares at an average price of $107.22.

If anything, TROW should have dialled back its share repurchase activity in 2021 – 2022!

FY2023 Outlook

TROW continues to forecast that 2023 adjusted operating expense growth, excluding capital allocation-based income-related compensation expense, will be 2% – 6% over the comparable FY2022 amount of $4.1B. Based on current market conditions, TROW expects to land at or below the midpoint of this range.

Business conditions are difficult and management is pursuing several efforts to proactively manage expense growth. This typically means ‘job cuts’.

In mid-July, TROW informed its workforce that it will be eliminating ~2% of existing positions globally. The hiring pace will slow and select open positions across the firm with be closed. However, TROW still expects the FYE2023 headcount to be modestly higher than at the start of the year, even with the proposed reductions.

Most of the costs related to the recent reduction in personnel will be incurred in Q3 and are already included in TROW’s expense guidance.

TROW is also evaluating other ways to be more efficient and drive a culture of continuous improvement. For example, it is evaluating its current real estate use in light of the new hybrid work approach; the objective is to slow occupancy and facilities expense growth. It will be some time, however, before TROW realizes any impact on expenses from real estate rationalization.

The expense efforts undertaken in FY2022 and FY2023 will have removed or reallocated $200+ million in operating expenses and the plan is for low-single-digit adjusted operating expense growth in 2024.

Credit Ratings

Although I look at a company’s credit ratings, the rating agencies are not infallible. We don’t have to go back to the Great Financial Crisis to find examples of how wrong they can be. The Silicon Valley Bank and Signature Bank failures are recent examples of how wrong their risk assessment can be.

This is why we can not take their assigned ratings at face value. We need to complete our credit risk assessment.

Having said this, as a retail investor with no ‘inside information’, I avoid companies whose domestic long-term unsecured debt is rated BBB- (the lowest investment grade) or worse. By doing so, I at least reduce my risk exposure.

TROW has no long-term debt so no major rating agency rates it.

Looking at the Q2 2033 Form 10-Q, we see that cash and cash equivalents amount to ~$2.250B, accounts receivable are ~$0.761B, and investments are $2.718B. Total liabilities, however, only total $2.170B. This should provide TROW investors with a reasonable degree of comfort that it can withstand a challenging business environment for some time.

Dividend Metrics

TROW’s dividend history of 38 consecutive years of dividend increases with the declaration of a $3, $2, and $1 special dividend in 2021, 2015, and 2012 is irrelevant. Instead, investors should focus on risk and an investment’s potential total return.

Supporting the company’s recurring dividend remains a top priority, and in the first half of 2023, TROW returned $562.4 million to stockholders in the form of dividends.

TROW is slated to distribute its 3rd consecutive $1.22 quarterly dividend on September 28. Based on the current ~$115.60 share price, the dividend yield is ~4.22%.

If you are a Canadian resident who holds TROW shares in a taxable account, you immediately incur a 15% dividend withholding tax . Suddenly, the dividend drops to ~$1.037 and the yield drops to ~3.6%. This must then be included on your annual tax return. Depending on your tax circumstances, you incur another ‘haircut’.

US residents incur no dividend withholding tax but must still declare this dividend income on annual tax returns.

On the other hand, suppose TROW retains funds in the company to grow the business in the hope of increasing the company’s value. In this case, a shareholder incurs no tax liability until the shares are sold.

Share Repurchases

The weighted average shares outstanding in FY2013 – FY2022 (in millions of shares) are 266, 267, 261, 250, 245, 247, 239, 231, 229, and 227. For the 6 months ended June 30, 2023, this had been reduced to 225.2.

As noted earlier, TROW should have dialled back its share repurchase activity in 2021! Had it done so, it might be able to repurchase significantly more shares in 2023 when the share price is much lower.

TROW Struggles To Grow – Valuation

In FY2016 – FY2022, TROW generated adjusted diluted EPS of $4.49, $5.43, $7.15, $8.07, $8.02, $12.75, and $9.58 and diluted EPS of $4.75, $5.97, $7.27, $8.70, $9.98, $13.12 and $6.70.

In the first half of FY2023, TROW generated $3.89 in diluted EPS and $3.71 in adjusted diluted EPS. The mean of the current broker estimates for Q3 and Q4 2023 are $1.82 and $1.76, respectively. These estimates suggest the second half of FY2023 will be somewhat weaker than the first half.

TROW’s forward valuation based on currently available adjusted earnings estimates and the current ~$115.60 share price is:

• FY2023 – 12 brokers – mean of $7.27 and low/high of $6.97 – $7.64. Using the mean estimate, the forward adjusted diluted PE is ~16.
• FY2024 – 12 brokers – mean of $7.53 and low/high of $7.12 – $8.04. Using the mean estimate, the forward adjusted diluted PE is ~15.4.
• FY2025 – 6 brokers – mean of $7.80 and low/high of $7.31 – $8.70. Using the mean estimate, the forward adjusted diluted PE is ~14.8.

A company’s valuation is of great importance in the investment decision-making process. In the case of TROW, however, it is at such a disadvantage relative to BLK, BX, and BAM that I do not want to be a shareholder.

TROW Struggles To Grow – Final Thoughts

A comparison of TROW’s Average Annual Total Investment Return to that of BLK and BX shows that TROW has been an inferior investment.

In the January 1, 2013 – June 30, 2023 timeframe, TROW’s Average Annual Total Return with reinvested dividends is 8.43% and $10,000 turns into ~$23,379. Meanwhile:

• BLK’s Average Annual Total Return with reinvested dividends is 14.75% and $10,000 turns into ~$42,364.
• BX’s Average Annual Total Return with reinvested dividends is 24.82% and $10,000 turned into ~$102,406.

If we shorten the time horizon to January 1, 2018 – June 30, 2023, TROW’s Average Annual Total Return with reinvested dividends is 4.96% and $10,000 turned into ~$13,045. Meanwhile:

• BLK’s Average Annual Total Return with reinvested dividends is 8.51% and $10,000 turned into ~$15,658.
• BX’s Average Annual Total Return with reinvested dividends is 26.79% and $10,000 turned into ~$36,811.

These returns, however, are historical. We must, therefore, try to determine how these companies are likely to perform in the future. By doing so, we can allocate our investment dollars to the companies likely to generate the best returns.

How asset management businesses earn their revenue is heavily dependent on performance and the total AUM.

TROW has just a fraction of BLK’s, BX’s, and BAM’s AUM. It is very difficult, therefore, to imagine how TROW could be a better long-term investment. In December 2021, TROW made its first big acquisition into private markets. The other 3 firms have been in this space for years!

In addition, TROW is unlikely to raise pools of capital from sophisticated investors to the same extent as BLK, BX, and BAM. This means it may be unable to do multi-billion dollar deals to the same degree as these 3 other asset managers. As a result, I expect the AUM at these 3 asset managers to exceed TROW’s AUM within the decade. This suggests their fee income will grow much faster than at TROW.

TROW has a decent reputation as an asset manager. It is not, however, immune to the pressures caused by the growth of low-cost passively managed products.

I envision TROW’s AUM will likely increase 3% – 5% on average annually over the next 3 – 4 years. This, however, is well below BLK’s, BX’s, and BAM’s expected growth rates. Given my outlook for TROW and these other 3 asset managers, I choose not to invest in TROW.

Author Disclosure: I have no exposure to TROW and am long BLK, BX, and BAM. I disclose holdings held in the FFJ Portfolio and the dividend income generated from the holdings within this portfolio. I do not disclose details of holdings held in various tax-advantaged accounts for confidentiality reasons.

Author Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your research and due diligence. Consult your financial advisor about your specific situation.

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