Summary
- Avantax (formerly Blucora) has recently completed the sale of its tax software segment.
- The company subsequently announced a tender offer for 16% to 19% of outstanding shares at $27-$31/share.
- The stock is now trading close to the tender price range midpoint - 7% spread to the upper limit.
Note: In January 2023 Blucora's (BCOR) name changed to Avantax and the ticker was changed to AVTA. This write-up further refers to the company as Avantax.
Avantax (AVTA) was covered in detail to Special Situation Investing subscribers in early December as an interesting asset sale/large capital return idea. AVTA is a $1.4bn market cap wealth management company. Back in November, the company announced plans to sell its tax software segment TaxAct. Aside from repaying debt, the company intended to return a major part of excess capital ($400m-$450m) from the sale proceeds ($620m) to shareholders. Here's an excerpt on why the setup seemed attractive to me:
- The looming large capital return following a major asset sale. Historically, we've had good success with such setups, e.g. LAUR, BSIG, DII-B.TO, In all of these cases, the share price failed to efficiently adjust for the upcoming capital return right until the actual capital return announcement. Maybe the same pattern will play out here. BCOR shares are up only 10% since the announcement a month ago.
- Management really seems eager to promptly return the cash. They've mentioned it multiple times in the press release as well as the Q3 call. YTD BCOR has also repurchased about $35m shares at an avg. price around $18.4/share. One insider acquired $118k worth of stock in November at around $23.73/share.
- The timeline is relatively short. TaxAct sale close is expected by the end of 2022. An update on the capital return should follow promptly after that.
So, what happened? In mid-December, AVTA announced that TaxAct sale has been completed. The management concurrently announced plans to repurchase up to $250m worth of company's stock through a tender offer and authorized an additional buyback of $200m. Then, last week AVTA revealed the tender price range of $27-$31/share - materially above the prevailing trading prices. The market has reacted to these developments favorably, with AVTA price initially running up leading to and after the sale of TaxAct before jumping once again on the tender commencement.
What remains is a potential play on the tender offer. AVTA shares are currently trading in the middle of the tender price range. The upside to the upper limit of the tender price range is currently 7%. The tender offer expires on February 24. Odd-lot priority is included.
There are a couple of arguments here why the current tender might potentially be priced at the upper limit. Firstly, the ongoing tender offer is quite sizable as AVTA will potentially repurchase 16-19% worth of the company's stock. Moreover, management (owns combined 2.7% of AVTA) will not tender their shares. This could suggest that the leadership might still consider the company relatively cheap and are willing to increase their proportional stake in the company after the tender. A supporting point here is the fact that the company was also buying a decent amount of stock last year - $35m worth through the first three quarters of 2022 (though at prices lower than the current level). Moreover, a quick glance into other recent tender offers suggests that they generally tend to end up priced at the upper limit. Several examples of recent tender offers:
- Scholastic Corp ( SCHL ) - announced in Oct'22, 6% of market cap, tender range of $35-$40/share, priced at the upper limit.
- The Hackett Group ( HCKT ) - Nov'22, 17%, $20.50-$23.50/share, priced at the upper limit.
- Triumph Financial ( TFIN ) - Nov'22, 7%, $51-$58/share, priced at the upper limit.
- TriNet Group ( TNET ) - Nov'22, 6%, $63-$72/share, priced at the upper limit.
- Theravance Biopharma ( TBPH ) - Sep'22, 12%, $9.75-$10.50/share, priced at the upper limit.
- SuRo Capital ( SSSS ) - Aug'22, 7%, $6-$7/share, priced at $6.60/share.
- White Mountains Insurance ( WTM ) - Aug'22, 13%, $1250-$1400/share, priced at the upper limit.
In light of the authorized $200m buyback, the downside here might be somewhat protected for event-driven investors.
Having said that, relative valuation suggests that a bet on the tender at current share price levels is too risky. AVTA currently trades at 7.5x the estimated 2023 EBITDA (see our estimation below). This compares to a 7.2x multiple at which the closest publicly-listed peer LPL Financial Holdings (LPLA) is currently valued. However, LPLA is a much larger competitor ($19bn market cap) and therefore has a scale advantage over AVTA.
Another noteworthy caveat here is sustainability of AVTA's 2023E EBITDA. The company generates its revenues from advisory fees, commissions, transaction and fees as well as asset-based revenue (primarily cash sweep). Importantly, asset-based revenue is expected to generate the majority ($138m) of the company's 2023 EBITDA of $150m ($25m is unallocated corporate G&A). Cash sweep revenues directly depend on the level of interest rates. Given the number of interest rate hikes since 2022, asset-based revenues have risen materially - from $22m in 2021 to $21m in Q3'22 alone. Cash sweep revenues go directly to ATVA's bottom line (100% margins). Having said that, it is not clear if such high asset-based revenues/earnings will be sustainable going into 2024-2025 and beyond as the company might be forced to raise interest paid to its customers. In fact, between October and December the company has already started raising rates offered to customers on their accounts. The point I am trying to make is that AVTA's current earnings might be peaking in 2023 in which case the current 7.5x EBITDA multiple might be considered to be too high. For reference, competitor LPLA currently trades at 11.2x 2022 EBITDA compared to the historical average of 10x current year EBITDA. Considering this, the market might be normalizing the earnings across the industry.
While there is a possibility that the tender ends up priced at the upper limit given the arguments noted before, at the current stock price I am inclined to stay on the sidelines. Nonetheless, the situation could become interesting again if the share price fell to lower levels.
Avantax Business and Projected Financials
After the sale of TaxAct and the subsequent re-branding, Avantax has focused on the wealth management segment which contains an independent broker-dealer and an RIA businesses. The segment's revenues are primarily driven by interest rates, AUM and financial professionals. Four of the wealth management segment's revenue streams are discussed in more detail below:
- Advisory fee revenue . Advisory fee revenues come from advisory assets ($35bn as of Q3'22). These revenues are highly correlated with the performance of the S&P 500, i.e. each percentage point move in the S&P raises EBITDA by $2m-$3m. Assuming flat S&P over this year, the company is expected to generate $423m in advisory fee revenues in 2023.
- Commission revenue . This revenue source is correlated with the average number of finance professionals at AVTA. The estimate for commission revenue in 2023 is at $167m (down low single digits versus 2022).
- Asset-based revenue . Cash sweep revenue - which historically was among the least important - is expected to increase dramatically given this and last year's interest rate hikes. Cash sweep revenue has 100% margins. Asset-based revenue is modeled to reach $138m in 2023 (assuming the interest rates remain at 4.25% throughout 2023).
- Transaction and fee revenue . Similarly to commission revenue, transaction and fee revenues are correlated with the number of finance professionals at Avantax. It is modeled at $28m in 2023 (flat YoY).
Thus, revenues for 2023 are estimated at $756m. Gross profit margin excluding asset based revenues currently stand at 27%, meanwhile, operating expenses have equaled 21% of ex-asset based revenues. We assume $25m of unallocated G&A for 2023 ($30m in 2022). With these assumptions, the adjusted EBITDA for 2023 is modeled at $150m.
Conclusion
The large tender size and no participation from management could suggest the current tender offer might end up priced at the upper limit. However, relative valuation implies that AVTA might already be valued fairly versus the closest competitor. Given this, I am inclined to put AVTA on my watchlist for a potential entry later down the road if the share price retraces to lower levels.
For further details see:
Avantax: Large Tender Offer