Financial services companies will start unraveling their asset management conglomerates in earnest in 2002, after years of manic buying.
Industry observers fully expect teams of investment managers to either buy themselves out or walk away from companies like AMVESCAP PLC, Citigroup Inc., ING Group NV, Mellon Financial Corp., Barclays PLC and J.P. Morgan Chase & Co., where closely matching the performance of the individual asset management unit with financial compensation through equity ownership is very difficult because of the parent's public stock.
And some public financial services companies might be willing to "get a bump (to their stock) from analysts by divesting a depreciating asset, like an asset manager," said Christopher J. Acito, managing partner, Casey, Quirk & Acito LLC, Darien, Conn. "If they don't do something radical and soon, they might not get their money out of an acquisition. The multiple on current business is not really the way these companies should look at it. Some should be looking at their asset managers as a depreciating value," Mr. Acito said.
Plans and rumors
Some of the deals will be planned, as in the case of the divestiture by Zurich Financial Services AG, Zurich, of Zurich Scudder Investments Inc., New York, or announced or rumored intentions by Commerzbank AG and Deutsche Bank AG, both of Frankfurt; and Barclays to divest all or part of their asset management businesses.
Or it may be the result of a walkout, like that of Sarah Ketterer and Harry Hartford who left Merrill Lynch & Co., New York, last year before it could sell the Hotchkis & Wiley unit it purchased in 1996 to a third party. Ms. Ketterer and Mr. Hartford formed their own firm, Causeway Capital Management LLC, Los Angeles.
Investment bankers said a more common divestiture scenario will be the management buyout, carrying a significantly lower price tag than would be received from an outright sale.
These deals are only the beginning of what some predict will be a long and possibly painful series of regurgitations of asset management companies by financial services companies in 2002 and 2003.
In the face of disappointing markets, abysmal investment banking revenues and flat to negative growth, the world's biggest banks, insurers, brokers and credit companies are being forced to look critically at their businesses and focus on core competencies. Asset management units are among the likeliest victims, said John F. Casey, chairman of Casey, Quirk & Acito, because they tend to contribute only between 4% and 6% to the earnings of their parent companies and have little impact on share price.
"It's a math thing," Mr. Casey said. "You just can't make it work. This trend of regurgitation will happen because rational people are going through their businesses right now, and when they see flat revenues, compensation pressures that really haven't abated, expensive and not always easy to work with money managers in the middle of a tight market, they realize that their core business is not in asset management manufacturing."
Many acquirers were naive about the asset management business when they bought in during the heady buying spree of the mid- to late 1990s, said Alan Johnson, managing director of compensation consultants, Johnson Associates Inc., New York.
"The assumption was that this was an easy business, that you could instantly grow assets and that costs wouldn't rise, that markets wouldn't drop. But in poor markets, these are expensive businesses to maintain, with a lot of infrastructure," Mr. Johnson said.
`Market gods got mad'
Every company Mr. Johnson consulted during boom times expected their assets under management would increase 25% to 30% per year. "When you see enough of these models, you realize that they just can't all do it. Everyone showed me the same pie chart with the same size pie. Then the market gods got mad and shrunk the size of the pie," Mr. Johnson said.
Parent companies of asset managers have "their own set of problems. They don't want to hear about portfolio manager problems. The strategic reviews are going on as we speak. There will be sell-offs, but no one will call it that. They'll call it `repositioning,' " he said.
"The adage that you had to be in asset management just is not true," said Mr. Acito. "It is not true that you could buy asset managements and crunch them together into a scale business. It is not true that you can cram any product through any distribution channel.
"What is true is that there is a new asset manager business model, a better way to do it in which you act more like a venture capitalist or a private equity investor and put your money in and stand back - remain a passive investor." Mr. Acito added that many large financial services companies will remain asset gatherers even if they divest their asset managers, they likely will retain a minority stake and will continue to send assets to those portfolio management teams on a subadvisory basis.
Sean Healey, president of money management holding company Affiliated Managers Group Inc., Boston, said he would not be surprised to see strategic buyers from the last three to five years taking a step back. "I think many will realize they didn't understand the business they were buying, didn't structure the deal properly and some ultimately saying, `Gosh, we should get out.' "
Mr. Healey harkened back to a similar period of divestiture in the mid-1980s. Commercial banks had built big asset management businesses in the early part of the decade. When the market turned down, their own businesses were so bad many banks ended up divesting their asset management units, creating independent managers such as Brinson Partners, Chicago, from American National Bank Co., Chicago, for example. European banks acted similarly in the mid-1990s, buying American asset management companies they now find disappointing and might be looking to sell, Mr. Healey said.
While Mr. Johnson said he expects deal structures to "take any and all forms," he doesn't expect the real wave of divestitures to begin until the end of the year. "After people are done desperately scratching around for strategies and revenues and assets, they'll get serious," he said. "There will be some stupid moves. Some will sell at the bottom of the market, which is not a bad strategy for an MBO team. If the parent company waits long enough, the MBO team can get their business back as cheap as they can."
Lull before storm
Chas Burkhart, founder of private equity investor Rosemont Partners LLC, West Conshohocken, Pa., agreed the asset management industry is in "the quiet before the storm. The industry was eerily quiet in 2000, 2001 and the beginning of 2002. ... Divestitures - forced or reasoned - will form a significant portion of the M&A activity over the next three years."
Mr. Burkhart said many financial services companies have been such bad managers of asset management merger integration that the value of their acquisitions have fallen significantly, making it even more likely that they will sell off the unit.
"The biggest firms have lost a lot of their luster as an ideal destination for the best young talent. Arguments about the currency of ownership - true performance incentives and ownership vs. incentives represented by the performance of the parent company's stock - will always be a major issue. The challenge is to maintain key personnel and to grow the business organically," said Mr. Burkhart.
"The major cultural issues of acquisition are still out there and are not being addressed - like treating people as investment managers and leaving them alone to do it. The cash component is third most important (to employees) after confidence in leadership and performance," said manager consultant Jeanette Schreiber, the Chicago-based executive vice president of Capital Resource Advisors Business Strategy Group.
But cash and stock ownership still are important, and many acquirers have not added adequate value-sharing plans, Ms. Schreiber said. "Portfolio managers were on a tear as far as compensation for a while and they still have an air of free agency, a Michael Jordan attitude. ... This, combined with perhaps working at larger companies they don't like as much (as their old companies) will lead to fragmentation."
The search for control, for adequate compensation and ownership likely will lead to creation of new boutique managers, especially once the economy and market improve, she said. Some of the investment management teams that are disassembled as financial companies eliminate unprofitable investment strategies likely will stay together and form their own firms, rather than look for work in existing companies. "I've noticed that the portfolio management mentality is pretty well-synched with the entrepreneurial mentality. ... Will more people go back to more entrepreneurial environments in order to be more focused on investment management?"
For individual portfolio managers or management teams that lack an entrepreneurial spark, Rosemont's Mr. Burkhart said independent, established firms - such as Turner Investment Partners Inc., Berwyn, Pa.; Artisan Partners LLC, Milwaukee; and even a larger firm like BlackRock Inc., New York - are likely destinations. "A lot more people will want to become part of a larger firm that's better resourced than a startup, but is not huge," Mr. Burkhart said. And even if a team wanted to move over to a big asset manager, "bigger firms like to home-grow their talent or don't want to pay the premium to bring in someone from the outside," he said.
At least one investment banker does not agree that fragmentation is likely.
"It is far, far more difficult to attract assets than it was 10 years ago, when the flow was much larger," said Andrew Hoover, managing director and co-head of the global asset management practice at Merrill Lynch Financial Institutional Group, New York. "More likely, there will be changes to equity ownership, not of whole financial services companies, but specifically within the asset management units. You will see compensation and ownership more closely tied to the performance of the individual unit through phantom equity plans, profit participation and real equity."