A Bull Market In Money Managers
In August, the pace usually slows at Berkshire Capital Corp., an investment bank that specializes in brokering deals between money managers. But not this year. That's because earlier this summer, Morgan Stanley & Co., the global investment bank, agreed to pay $1.1 billion for mutual-fund manager Van Kampen/American Capital Inc. Berkshire wasn't involved in that deal, but it has stirred up business anyway. "People are saying, `If a knowledgeable buyer like Morgan Stanley is buying a big fund family, maybe we should, too,"' says H. Bruce MacEver, president of Berkshire Capital. "Morgan raises the ante for everyone."
Actually, the stakes have been rising for some time. In 1995, mergers and acquisitions activity in the investment management business--including not only mutual funds but also institutional management--hit a record 78 deals worth $5.9 billion. Through Aug. 5, 54 deals worth $4.8 billion have been announced or completed, leaving little doubt that 1996 will set a record.
No question, the bull market is feeding this merger wave. But there's more. Buyers are attracted by the high profit margins, strong growth prospects, and the economies of scale inherent in the business. They're also making strategic acquisitions, adding new products or opening new distribution channels.
WILLING SELLERS. Industry insiders expect demand from foreign institutions to be especially robust as they look to globalize and tap U.S. investment expertise. "You have to buy something, you can't develop it yourself," says Lothar Gries, a spokesman for Germany's Dresdner Bank, which purchased institutional money manager RCM Capital Management. "It's too expensive and would take too long."
U.S. buyers show no sign of backing off, either. Brokerage firms are expected to plow bull market profits into money management because of its steady revenue stream. First Union Corp., a North Carolina-based superregional bank that bought Evergreen Funds several years ago, is also said to be in the market. And of course, so are most of the publicly traded companies, which can pay with stock or partnership units. Among the most acquisitive is United Asset Management Corp. (UAM), a holding company with 45 investment shops--soon to be 46--that together manage over $160 billion.
Who are these buyers after? Almost any willing seller. Most of the money management firms are privately held, with ownership limited to the founder and perhaps several top associates. Hostile deals are out. Oft-mentioned sellers include Eaton Vance, Lord Abbett, Federated Investors, AIM Management, Columbia Management, Neuberger & Berman, and Trust Co. of the West.
All investment management acquisitions are delicate, as performance may suffer and key managers or clients defect. "One of the most fragile things in the world is an investment organization," says Ronald D. Peyton, CEO of Callan Associates, an investment consulting firm. Peyton's firm studied the investment returns of 58 money managers sold since 1982 and found that on average, performance fell slightly in the five years after the sale.
For sure, the bull market on Wall Street has had enormous impact on money manager profits. Their fees are a percentage of the assets under management. So when stock prices go up, so do revenues--and most of that drops right to the bottom line, even if they don't get any new customers. But in a rip-roaring market, investors throw additional dollars at money managers, which also generate fees. Fund companies don't pay a portfolio manager 10 times as much when he's managing a $1 billion mutual fund as when the fund was $100 million. And although the mutual-fund business is competitive, funds are not competing by lowering fees. Despite a tripling of mutual-fund assets over the past six years, the ratio of expenses to fund assets has barely budged. Economies of scale are not being shared with investors.
All told, margins are plump in the asset management business. Among the handful of publicly traded investment management companies, the average pretax margin is 25%, according to analyst Carol Festa of Smith Barney Inc. That far outstrips the profitability in other financial-services businesses such as banking, insurance, and even securities brokerages. It's also why the investment managers fetch rich prices--around 9 to 11 times earnings before interest, taxes, depreciation, and amortization. That's nearly twice the norm for most service businesses.
Banks, insurance companies, and brokerage firms will pay up for money managers because the growth rate is much higher than that of most of their other businesses. Putnam, Lovell & Thornton Inc., another investment bank specializing in money managers, projects 13% annual growth in assets under management through 2000 and more than 20% annual growth for such segments as equity mutual funds and 401(k) plans. Those projections are based on a 7%-to-8%-a-year increase in market value, not on double-digit gains. The growth will also be fueled by increases in disposable income and investment as baby boomers reach their peak saving years. Finally, they project more and more people will turn to professional money management as their portfolios grow.
Industry executives and analysts say that if the markets cooled, so too would the prices that buyers might pay. But the deals would continue to be struck. "Many transactions are driven by strategic reasons," says Jeffrey D. Lovell, a principal at Putnam, Lovell & Thornton. "They're done to gain additional products, distribution, or access to overseas markets and customers."
Consider Liechtenstein-based LGT Group, the main business of which is the G.T. mutual funds. LGT purchased U.S.-based Chancellor Capital Management, a midsize money manager with $32 billion in assets, which gives it entree to the U.S. institutional investor market. Likewise, Merrill Lynch & Co., a powerhouse in mutual funds for individual investors, adds institutions as clients from its planned purchase of Hotchkis & Wiley.
THINK BIG. Some sellers see their deals as strategic moves, too. Dale B. Krieger, founder of Carnegie Hill Co., primarily a muni-bond manager, said his clients needed to own stocks. But building an equity investment capability cost too much. So merging into Pitcairn Trust Co., which manages equities for high-net-worth clients similar to his, made a good fit.
Even collectors of money management firms such as UAM, Affiliated Managers Group, and New England Investment Cos. make acquisitions with diversification in mind. UAM includes emerging-growth-stock managers such as Pilgrim, Baxter & Associates, value-stock buyers such as First Pacific Advisors Inc., and managers of bonds, international equities, currencies, real estate, and even timberlands. Peter S. Voss, chairman and CEO of New England Investment, says his firm's purchase of Houston-based Vaughan, Nelson, Scarborough & McConnell Inc. fit several strategic considerations: It added equities to its heavily fixed-income asset base, diversified the business mix by bringing in foundations and endowments, and gave the New England company a door to the Southwest.
So where's all the dealmaking heading? A Goldman, Sachs & Co. study, much debated among money managers, says within five years the industry will be dominated by 20 to 25 giants with at least $150 billion in assets. That's what it will take to be able to compete for investment talent, technology, and distribution globally. There's something to that. UAM, for instance, opened an office in Japan to market its firms' services. "A firm with $5 billion in assets would have a hard time getting an appointment," says Franklin H. Kettle, a senior vice-president at UAM. "With $150 billion, you stand a chance."
The message from Goldman: Get big or team up with a big player. Most money managers don't buy that notion, arguing that it's investment results that count. Perhaps so, but with demand so strong and the deals so sweet, before long, those $150 billion giants may just come to pass.