March 2009

MERGERS & ACQUISITIONS: these are crazy times

There are a number of drivers for asset management M&A at present, including hedge funds that want to build product – and a slight dollop of corporate lunacy, finds Fiona Rintoul... Recent merger deals, such as between Credit Suisse’s asset management division and Aberdeen Asset Management, or the Henderson and New Star deal in the UK, might seem to herald a flurry of M&A activity in the asset management sector. But do they?

The answer, broadly, is: No. “Despite the apparent rush of consolidation or mergers/rescues, the number of transactions is in fact quite small,” says Ray Soudah, founder of Millennium Associates, an M&A advisory firm.

And one thing is absolutely certain: there is nothing much doing in terms of strategic M&A in the asset management industry at the moment.

A report by Jefferies Putnam Lovell, a US corporate advisory firm, notes: “Following robust activity in the first six months of 2008, transactions in the latter half of the year dwindled to a near-halt as the credit crunch intensified.”

“There’s generally not a lot of activity in M&A at the moment,” confirms Nigel Wightman, a former State Street Global Advisors man and now CEO of Titanium Asset Management, a special purpose acquisition company. “Most of the fund management M&A people I talk to are not doing much.”

The deals that are taking place “are the result of market dislocation”, says Wightman. There may be more of them since “the bancassurance model is pretty badly broken”, but it’s very hard to point to the candidates.

However, it seems logical to assume there will be more sellers on the banking side than on the insurance side since insurance companies have proprietary assets that require management and are therefore “much more attached to the mother ship”.

Raj Mehta, head of corporate finance at KPMG’s investment management practice, says: “A number of banks are considering whether they should dispose of non-core businesses, including fund management. If you take a 30,000-feet view of the industry, the issue facing a number of players is scale as funds have received significant redemptions and delivered poor investment performance. That’s been the catalyst for some of the transactions in the last couple of months.”

The way those transactions are being viewed in the market varies from desperate but rational moves for desperate times, to something approaching corporate lunacy. A supporter of the corporate lunacy argument is Millennium Associates’ Soudah. His argument runs like this. Companies that wanted to divest their asset management arms should have done so in 2007 when they would have obtained higher values than they will now and would have had a much wider choice of partner. Instead, the opposite happened.

“These people were buyers at the top of the cycle,” says Soudah.

This may smack of the benefit of hindsight. But Soudah, who believes that asset managers have got away lightly on client protest, counters that for an asset management firm not to recognise the top of the cycle is “quite shocking really”.

“We got into this situation by a great majority failure on the part of investment management companies to protect capital,” he says.

A buyers’ market
Today, Millennium Associates advises buying rather than selling. “Today is the time to be acquiring these managers because we are in the middle of a correction,” says Soudah. “But it’s not urgent because this situation will persist for some months.”

Everyone can agree that it’s a buyers’ market, but who are the potential buyers? Prominent among them, according to KPMG’s Mehta, will be large alternative and traditional investment managers – for example, GLG Partners, which acquired Société Générale's UK fund management business. 

Of particular interest to other alternative investment managers will be fixed income houses or teams, according to KPMG.
“Across the hedge fund industry there is interest in acquiring product specialities, particularly on the fixed-income side where there’s a feeling that traditional asset managers who are used to investing long only have the requisite skills to be part of an alternative firm,” says Mehta.

This all mitigates in favour of a trend already well established before the global financial crisis began: the blurring of the lines between traditional and alternative players. For alternative investment managers that can afford to go shopping it may be a shrewd and indeed necessary move because the immediate future for alternative asset classes does not look particularly rosy.

“Traditional long-only asset classes will gain inflows at the expense of alternatives, from the ‘denominator effect’ and a back-to-basics approach among skittish private client investors,” according to a Jefferies Putnam Lovell report (which is called: Are We There Yet? A review of M&A activity in 2008 in the global asset management and financial technology industries).

Alternatives will continue to play an important role, particularly among institutional investors, and the long-term growth trajectory of alternatives managers remains strong, Jefferies Putnam Lovell believes. But the alternatives sector will be reshaped in 2009 as investors reconsider fee levels, demand more flexible capital lock-up periods, and insist on greater transparency. This will do little to improve margins, while increased regulatory oversight will also raise the cost of doing business.

The other candidates to be buyers in today’s straightened circumstances are pure-play asset managers.

“Pure-play asset managers, acting alone and in concert with private equity firms, will increasingly take advantage of this unique situation as commercial banks and insurance companies shed non-core investment businesses to raise capital,’’ says Aaron Dorr, a managing director at Jefferies Putnam Lovell. “In asset servicing, we see a wave of consolidation looming, as undercapitalised companies look to divest operations, while small- and mid-sized independents seek shelter within better-capitalised partners.’’

Aberdeen AM is an excellent example of such a player. The Scottish firm has taken advantage of market conditions to increase its AUM with a speed and significance that would otherwise have been impossible. But the Aberdeen AM/Credit Suisse deal also highlights the mismatch between what sellers want and what buyers want.

In broad terms, sellers want cash, but very few firms have cash. Aberdeen AM certainly didn’t, which is why Credit Suisse has been paid in shares. This is good for Credit Suisse because it means it gets to participate in the upside when investors come back. And in a sense it’s good for Aberdeen AM too because a cash payment would have been impossible.

“The likes of Aberdeen AM is very small in terms of market capitalisation,” says Soudah. “It doesn’t have the capacity to make significant acquisitions. In a sense this is a merger.”

How many more pure-play companies like Aberdeen AM are there out there? Possibly not that many. Buyers need to have cash and/or have a solid share price and a willingness to issue shares. There’s not much cash about and a firm such as Schroders, which does have cash, is not willing to release stock, according to sources.

Similarly, though hedge fund firms may like the idea of shopping around to fill product gaps, and it may be a good idea to do so, how many of them will be able to come up with the necessary goods?

“The bigger hedge fund firms are certainly looking at this space, but the quoted ones are struggling with very depressed share prices,” says Wightman.

This all means that what we are likely to see over the coming months is more of the same, in other words distressed deals rather than strategic deals. “The trend in M&A will not be high and most of it will be distressed to a greater or lesser extent,” says Wightman.

Mehta says: “Sellers won’t maximise value at the moment. They need to have an extraneous reason to sell whether it be because they are distressed, the business has become subscale and is a distraction to management, or they need to raise capital.”

Cashflow problem
There will be banks exiting the asset management space and some firms with a heavy equity bias may struggle to survive – or to find a saviour. If a white knight does come by, he may only take the business on in an extremely pared-down form. And where a deal is struck, it is unlikely to be for cash, although cash is what everyone wants.

“Transaction structure will take on a significantly greater role in deal completion, with few buyers willing or able to close cash deals,” according to Jefferies Putnam Lovell. “Asset swaps, joint ventures and complex earn-out provisions will become more commonplace. Stock will be used more frequently as acquisition currency.”

As for how the industry will look at the end of this process, it will probably be smaller and in some sectors, such as alternatives, there will be less competition, but whether it will be any better structured is a moot point.

You could look on current circumstances as an opportunity to achieve some needed consolidation. But if that consolidation is feverish and ‘desperate’, to use the mot du jour, it is unlikely to produce an intelligent result.

For the gloomiest of all views we return to Soudah. He has two recommendations. One is to buy and the other is for management to take a stake in asset management companies. They’ll get a good price and this is “a huge opportunity for them to put their money where their mouth is”.

But Soudah has little hope that his recommendations will be followed. “Looking at the next months that’s what we would recommend, but what’s likely to happen is not that. In all three previous cycles people who should be sensitive to market trends have done the precise opposite of what they should. Maybe this, basically, is not an intelligent industry.”

A more sober assessment can be found in the Jefferies Putnam Lovell report, which anticipates that the outcome of the current meltdown will be increased globalisation. Ultimately, a small number of well capitalised firms will go shopping in the global marketplace.

“Better-capitalised international institutions will be increasingly active and cross-border deals will represent a disproportionate share of deal flow as non-US buyers seek to globalise via acquisition at historically low pricing levels,” the firm says.

©2009 Funds Europe

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