"It's a key trend," said Bruce McEver, chairman of Berkshire Capital Corp., New York. "Companies are beginning to outsource mutual fund businesses. They're getting rid of investment products and taking an interest in the asset management companies. Minnesota used its funds as a chip to acquire an interest in Waddell, and we're going to see more of these in 2004. That deal was just the tip of the iceberg," he predicted.
Going forward, companies will be looking to diversify, Merrill's Mr. Heaton said. In a world of 7% to 8% market appreciation, in order to achieve 12% to 15% earnings per share, companies will need to focus on innovative growth strategies and access new distribution channels. They will seek alliances with other prominent players so they can rationalize their cost structures.
Mr. Heaton also expects that U.S. firms will be more interested in accessing potential distribution in Europe and the United Kingdom. "More people are looking at that now than they did two years ago, because of potential implications from pending regulation and legislation. Europe is still a relatively closed market dominated by banks selling proprietary products."
Mutual fund investigations will also impact the M&A business, because they will put pressure on operating margins at asset management firms, predicted Mr. Heaton. "Some companies will be forced to rethink their current fee structures. In addition, they will face more competition from alternative products, such as closed-end funds, managed accounts and exchange traded funds. These products aren't as profitable as open ended mutual funds have been, which will also contribute to increased margin pressure," he said.
However, Mr. Heaton believes that once the regulatory issues have been resolved, asset managers will be trying to acquire each other. Previously banks and insurers were buying asset managers.
Additionally, he noted, consolidation will be the driving force, even though there will always be a role for the single-strategy boutique. But having scale will give a firm a competitive advantage. "Firms will now need a solid reputation, depth of products, breadth of distribution alliances and large technological infrastructures."
"There is likely to be a mix of sellers, particularly firms that don't have the scale to make the investment required and smaller firms with generational transition issues. But for every firm that is sold, new firms will start up, created by employees who leave," said Mr. Heaton. He also expects pricing to be more rational, with multiples in the low teens rather than mid- to high teens.
Chas Burkhart, founder of Rosemont Partners, West Conshohocken, Pa., predicts that a notable wave of divestitures will occur in 2004, particularly as a result of the Bank of America-FleetBoston merger. "Between the two of them, they own eight to 10 asset management units, some of them acquired in the last three to five years. It will be a massive organizational challenge, and some consolidation will occur. There could also be some liftouts and start-ups," he said.