If merger mania isn't sweeping the financial
advisory business, interest in it is. That was the message that Mark
Hurley, a consultant with JP Morgan Asset Management and a senior
advisor with Headwaters AB, a Denver Investment bank, had for attendees
at JP Morgan's annual wealth management conference in Chicago in early May.
Hurley and JP Morgan managing director Sharon
Weinberg are in the process ofupdating a study he authored five years
ago on the future of the advisory business. "The first ten people we
interviewed all asked how much they could get for their firm," he
remarked. If an advisor wants to sell his firm, it will probably take
from between six months and two years to complete a deal. Most
transactions are likely to be legacy deals, or sales to employees.
"These represent the lowest risk-adjusted prices you will get," said
Hurley, a former Goldman Sachs merger specialist who has consulted on a
few deals himself. "They (employees) think they deserve the business,
they know its strengths and weaknesses and they know you. If it blows
up, your firm is shot. It's almost a suicide pact." Furthermore, it's
quite possible that employees may purchase firms from the founding
partners and flip them.
If that's not enticing, getting acquired by a
financial buyer isn't much better. "This industry is besieged with
financial buyers," Hurley contended. "Why? Because there is a
disconnect between the public and private markets. They can get $15 for
the cash flow they pay you $5 for. The roller-upper adds no value but
gets 40% of the economics of the business."
Additionally, roll-up style financial buyers are
under heavy pressure to keep growing faster and faster to go public and
subsequently support their stock price. Otherwise, the deal will implode. And it gets worse. The
economics of financially driven acquisitions are stacked in favor of
the buyer, who typically uses a class of cumulative preferred stock to
acquire a majority, say 60%, of the firm, according to Hurley.
After dissecting the economics of a few
transactions, Hurley found some eye-opening details. "A financial buyer
will tell you that you are getting a 56% internal rate of return (IRR)
for the firm," he explained. "What they won't tell you is that that
they get a 118% IRR. They love all stock deals where they put down no cash,
keep most of the return and give you all the risk."
One of the biggest
risks for advisors who sell is that the acquirer never goes public, but
instead sells in desperation to another financial buyer who dilutes
everyone. "To go public you must do 70 to 100 deals," Hurley
claimed.
If one of those 70 firms turns out to be a rotten
apple, it can derail an entire IPO. "You sleep with everyone they (the
buyer) ever slept with," he quipped.
Hurley had one final prediction. "At some point,
custodians will have to start buying advisors' firms because they are
in a precarious position," he argued. "Big RIAs will be able to cut out
custodians."
Advisors May Be Selling Their Own Firms Short
May 31, 2005
-Evan Simonoff
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