SEI Investments awaiting payoff from spending on new strategies

OAKS, Pa. — A modest investment in the 1994 startup of LSV Asset Management has been buoying SEI Investments' profits just as heavy spending on new strategies — which executives promise will "transform" the company and fuel future profits — is depressing core earnings growth.

The payoff could start coming through over the next year or two, but for now, the investment program SEI launched about a year ago remains more of a cost than a benefit. The Oaks, Pa.-based provider of outsourcing and multimanager investment services to financial institutions, registered investment advisers and corporate pension funds announced Feb. 1 that income before interest and taxes edged up only 1.2% for 2005, to $212 million.

SEI's new investments have been aimed at positioning the company to win more non-U.S. business. "We strongly believe the opportunities for outsourcing in the private bank space are enormous globally, and our current platform isn't equipped for non-U.S. activity on a large scale," said CFO Dennis J. McGonigle in a telephone interview. The "heavy build" period should continue "for the better part of this year," he said.

Investment — the bulk of which is aimed at developing a new global platform to be launched in Europe later this year — helped suppress profits in three of SEI's five business segments that together accounted for more than 60% of revenue: private banking and trust outsourcing, new businesses and money manager outsourcing.

Even so, net income for the year rose a healthy 11%, largely because of the contribution from SEI's 43% stake in LSV, which soared 64% for 2005 to $75 million. LSV's assets under management surged $16.4 billion, 46%, to $51.8 billion for the year.

A value-oriented quantitative equity shop grounded in behavioral finance theory, LSV has become an increasingly prominent money management success story in recent years. Consistent outperformance and the firm's willingness to close strategies to new money has resulted in institutional investors seemingly rushing to extend mandates before the doors close, consultants say.

Thomas McCrohan, an analyst with Philadelphia-based Janney Montgomery Scott LLC, said LSV accounted for just less than 80% of SEI's after-tax earnings growth during the latest year. It accounted for 64% contribution of growth in 2004.

But with almost all of LSV's strategies either closed or closing at the end of 2005, analysts say the money manager can't continue to be the high octane fueling SEI's profit growth.

Most analysts praise the parent company's strategy, but what separates the "buys" from the "holds" seems to be differing expectations of how quickly SEI's core earnings growth will pick up to cover for the expected slackening of LSV's contribution.

SEI is "going through a transition phase … heading in the right direction," but "it's less clear to me when you start seeing" the bottom-line payoff, said Robert Lee, a New York-based research analyst with Keefe Bruyette and Woods Inc.

In a Feb. 6 report, Rachel Barnard, an analyst with Chicago-based Morningstar Inc., applauded SEI's investment program but said "concrete results" may have to wait until 2007. "This is a company we'd love to own, but we'd wait for a discount to our fair value estimate (of $41) before buying," she said. SEI's Nasdaq-listed stock closed at $42.14 on Feb. 13.

Others are ready to buy now. Glenn Greene, a research analyst in Chicago with ThinkEquity Partners LLC, noted that while operating profits for SEI's largest segment, private banking and trust, dropped 14% from the year before, revenue for the fourth quarter rebounded 3% from the prior quarter, with revenue and margins for all other segments doing better than expected as well. He recommends investors "accumulate" the stock, with a price target of $48.

Janney Montgomery's Mr. McCrohan reiterated his "buy" recommendation this month, predicting SEI's earnings per share will grow 13% to 14% in 2006, with LSV's contribution to that growth moderating to only 20%. That trend of "more core earnings growth and less from LSV" should continue in 2007, as revenue growth from the new global platform begins to kick in, he said.

While momentum might wane, LSV's contribution to growth should remain strong for much of the coming year. LSV's $4.6 billion in net inflows for the October-December quarter won't begin buoying SEI's accounts until the first half of 2006, and already during January more than $3 billion in new money has come in, observers said.

Regarding LSV, SEI's Mr. McGonigle, said the firm is "a good partner" and the relationship has "paid off well." He expressed no concerns about the possibility that the unit's support for SEI's growth might flag before the parent company's investments kick-start core profit growth. "We feel positive about the solutions we offer today, and the ones we're building … and we're confident we'll manage it well," he said.