With every day bringing greater media focus on investment advisors fees and conflicts of interest, its certainly not a bad thing to be a company on the other side of that trend - and thats where retirement plan advisor Financial Engines (NASDAQ:FNGN) finds itself. Although some believe the recently passed fiduciary rule didnt go far enough, I do believe it will underpin the growth story for Financial Engines over time.

The challenge, unfortunately, is that as much as I like the companys position in the advisory market, I dont particularly like its double leverage (on both investment performance and fund flows) to the performance of domestic and international equity markets. I wouldnt call myself a bear, but I also dont think market valuation multiples have tremendous room to expand. With FNGNs valuation pricing in pretty decent continued growth, I would personally prefer to wait to consider this business until a more significant/prolonged market downturn.

They Wouldnt Recommend A Leveraged ETF... But Are They One?

The growth story at Financial Engines is multi-layered - the company attracts new assets from plan participants ongoing, automatic 401(k) contributions, in addition to market growth. On top of that, Financial Engines can grow its penetration within existing sponsors (it currently only provides services to about a tenth of participants in plans with which it partners), and it can add new sponsors (such as the Wells Fargo deal its working on).

This all adds up to pretty robust long-term growth prospects, but its not entirely automatic. During the first quarter, the companys AUM declined about 1% on an organic basis, driven partially by negative returns, but also by a small net outflow of client assets.

In and of itself, I actually dont view this decline as particularly concerning. Higher-than-normal cancellations drove some of the decline - the company states that it encountered a timing issue with two sponsors who left for Nationwide and Merrill Lynch, but believes its still on track for its usual 98% retention rate. While this is obviously a factor that bears monitoring, I dont think one outlier quarter is cause for alarm.

What is more concerning is the other half of the story, and what it implies for the companys performance in a significant bear market. FNGN noted that market volatility leads to higher voluntary cancellations by plan participants who wish to pull their money out of the market.

I believe a significant downturn would lead to an even more severe version of this, which is corroborated by financial crisis-era data provided in the companys S-1 from way back when. Financial Engines would likely recover relatively quickly, but the interruption to growth would be a decided negative in light of the robust valuation multiple.

The Mutual Fund Store - Right Strategy, What About Execution?

FNGNs acquisition of The Mutual Fund Store was pricey, but as Ive discussed before, it makes strategic sense in light of where the world is going. Retirees obviously have to roll over their 401(k)s into IRAs, and Millennials seem much less likely than previous generations to stick with employers for decades (and thus generate big 401(k) balances). At either end of the age spectrum, then, the trend seems to be towards IRAs, making it important to have a strong presence in this market.

At least off the bat, though, there are a few questions about performance at the acquired business. While the company initially guided to 2016 Adjusted EBITDA of $125-130 million excluding market gains, that range had fallen a little bit as of the May 6th market performance (which wasnt all that bad). Managements original explanations on the February call didnt particularly convince me, and I do wonder if Warburg Pincus engaged in a little bit of window dressing.

Those questions aside, the moves the company is making - particularly offering seminars and holistic on-site planning beyond the 401(k) - would seem to drive stickier relationships over time. The real revenue synergies will hopefully come from rollovers staying with Financial Engines when employees move on to greener pastures, as well as picking up other accounts that employees may currently have.

Bigger Picture, Still A Strong Story

Everyone (including active managers) loves to hate on active management these days. The fees are too high, returns are too low, and so on and so forth.

Theres another angle, though. The more I look at Financial Engines, the more that I think its actually a beneficiary of these trends rather than threatened by them. Ive discussed before that most investors still value professional advice, and data from Financial Engines (as well as unbiased third parties) makes a case for advisors on a purely behavioral level - if you can simply counteract investors tendency to sell high and buy low, you create more than enough value to offset fees.

With Financial Engines fees quite low in the broader context of the advisory landscape, and investors increasingly knowledgeable (and annoyed) about the fees theyre paying to advisors, I think it has a more favorable long-term outlook than many in the space. Financial Engines professional management revenue represents a modest ~25 bps of its AUM, comparable to popular robo-advisors such as Betterment and Wealthfront, and substantially lower than traditional advisory fees, which can often exceed 1% for small accounts.

Obviously, Financial Engines model is somewhat lower-touch than many advisory relationships, and the number I cited is a blended average. The company is not going to be immune to fee pressure, but its certainly better positioned than retail stockbrokers who charge clients high fees for the privilege of being sold the banks own products. (Looking at you, JPMorgan (NYSE:JPM)!)

The recently passed fiduciary rule should hopefully do two things - first, raise investor awareness about the pervasive and rampant conflicts of interest in the financial advisory industry. Second, make it less profitable for banks to be in the business, leading to them putting their capital and marketing dollars elsewhere (similar to whats going on in fund administration and numerous other markets). These regulatory pressures, combined with ever-increasing investor attention on the fees they pay should continue to benefit low-fee, no-conflict advisors like Financial Engines.

Valuation: As Always, Heres Where I Get Hung Up

While I like the story on many levels, the big challenge for me is valuation. Even assuming some help from the market, I have trouble getting to a high enough 2016 Adjusted EBITDA target to make the current stock price ($26.50) equate to a multiple much below 12x. Making matters worse, Adjusted EBITDA excludes over $20 million of stock-based compensation, so real EBITDA is likely to be much closer to $100 million than $130 million, and the real EBITDA multiple is probably closer to 14x-15x (depending on exactly where stock-based comp comes in).

A higher-than-average EBITDA multiple can be supported in context of growth and the fact that this is not a particularly capital-intensive business, although there is some capitalized software and so on. Still, the current multiple requires pretty robust growth - which just didnt happen in Q1 on an organic basis, and may be a challenge if market volatility continues.

The risk factor is what happens if a downturn materializes - not only will Financial Engines take a hit on AUM from market movements, but also from flows, and the recently acquired Mutual Fund Store business appears to be more sensitive here (per management commentary). Falling earnings plus multiple compression could lead to a material decline in the share price. With a pretty good chunk of growth already priced in, Im not eager to take on that risk.

Final Thoughts

Despite relatively soft results early this year, I still like the long-term story at Financial Engines in light of macro trends in the investment advisory landscape. Everythings a function of price, though - and at an aggressive multiple that leaves little room for error, I think investors should be patient with this story and wait for a better entry point.

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