P&I Roundtable: Money manager M&A to increase

NEW YORK — The money management industry will see more — and more interesting — mergers and acquisitions in 2006, as earlier deals predicated on elusive synergies between manufacturing and distribution continue to unravel, a Pensions & Investments roundtable of industry experts predicted.

Click here for complete roundtable transcript The number of deals of all sizes in 2005 was little changed from the year before, but 2006 should see both more transactions and more that are memorable. "There were 15 to 20 deals of note (in 2005) … I think we'll see 40 to 50 deals of note" in 2006, said Donald H. Putnam, managing partner of Grail Partners LLC, Boston.

The roundtable was held Dec. 13 in New York. The other panelists were: Matthew Barger, deputy chairman of San Francisco-based private equity shop Hellman & Friedman LLC; Sean M. Healey, president and CEO of Boston-based consolidator Affiliated Managers Group Inc.; Elizabeth Nesvold, managing director with Berkshire Capital Securities LLC, New York; and Kevin Quirk, managing director of Casey Quirk & Associates, Darien, Conn.

The bulk of this year's deals should involve midsize firms, with annual pre-tax income of about $50 million. After a year dominated by Legg Mason Inc.'s swap of its brokerage assets for Citigroup Inc.'s money management arm, a few megadeals could hit the headlines in 2006 as well, participants said.

The range of factors motivating sizable deals makes them hard to predict but, "I think the stars, the moon and the sun are aligned to see one or two pretty big transactions," said Mr. Barger.

A keener focus on capital structure, aimed at ensuring a proper alignment of interests, will guide the coming round of M&A, participants said.

A disproportionate share of the deals done in the '80s and '90s left no equity on the table for key principals or the next generation of investment professionals, giving them a limited shelf life beyond their earn-outs, said Ms. Nesvold.

This year's M&A activities should be more focused on what makes an asset management firm tick, with buyers taking care to set free, rather than smother, the geese laying golden eggs.

That environment will favor "financial buyers," such as Mr. Barger's firm, which prefers to own a smaller chunk of equity than the management teams it backs, over "strategic buyers" seeking to integrate an acquired firm into their own operations, several participants said.

Transactions driven by a buyer's focus on its own needs have overwhelmingly failed, said Mr. Healey. AMG's formula — buying a majority interest in midsize firms, with a revenue share — starts by focusing on what the firm it is looking to acquire needs, he said.

Mr. Putnam predicted M&A activity this year will be dominated by firms, including AMG, that "know how to organize money management companies into a proper capital structure … by lightening up a founder, by getting away from an institutional owner, by creating a team that owns its business." That "affiliation logic" is trumping the failed "conglomerate logic" of past years, he said.

Increasingly savvy clients are providing a tail wind for that trend. Whether you're in Sydney or Tokyo or Frankfurt, more clients "understand what a quality investment manager looks like," said Mr. Quirk. The global success of firms such as Capital GuardianTrust and Pacific Investment Management Co. reflects that rise in sophistication, he said.

Some panelists predicted that leading buyers of asset management firms in 2005 are likely to remain on the hunt in 2006. BlackRock Inc.,Mellon Financial Corp, Eaton Vance Management and even Legg Mason, still digesting its huge Citigroup additions, could be in the market this year, predicted Ms. Nesvold.

Mr. Healey said AMG will be looking this year to make further acquisitions of midsize firms, both in the U.S. and abroad, that invest overseas, as well as at hedge fund firms.

Participants agreed hedge funds would also be a major focus, as well as one of the trickiest areas for buyers to craft successful deals.

The need for pension fund clients to garner investment returns of 8.5% or better — in a landscape where public equity and bond markets look set to disappoint during coming years — is pushing money managers to add alternative strategies such as hedge funds to their mix, Mr. Quirk said.

Mr. Putnam predicted that big investment banks — such as Lehman Brothers Inc., Morgan Stanley, and Merrill Lynch & Co. — will all be looking to assemble or expand multistrategy hedge fund capabilities this year through acquisitions, leaving them poised to take "the lion's share" of organic growth in that sector's next phase.

The hedge fund field should be strewn with land mines, however. For example, Ms. Nesvold cited the difficulties of buying businesses where performance fees, as opposed to straight management fees, account for such a big piece of the earnings pie. If a talented hedge fund manager is willing to share his performance fees, "you should flee the room," agreed Mr. Putnam.

Mr. Barger said hedge funds are tricky for his firm as well. Hellman & Friedman focuses on helping "wrongly owned firms" gain more equity or independence, improving their alignment of interests. With so many hedge funds, it's a matter of buying a stake from an owner-operator, he said.

Demand for hedge funds is so frothy right now "there's a real risk over the next couple of years for bad deals to get done," said Mr. Quirk. Mr. Putnam figures investment banks he sees dominating the buying in coming years have a 50-50 chance of getting it right.

The panelists agreed that owners of mutual fund families not in the small circle of firms enjoying double-digit asset growth should be on the list of potential sellers this year. The recent decision by the Clipper Fund to replace the fund's incumbent adviser with Davis Selected Advisers might well add some momentum to that trend, said Mr. Barger.

Ms. Nesvold noted that M&A activity in the wealth management area, while involving relatively small transactions, accounted for just almost half of overall deals in 2005, and that sector should see continued consolidation in 2006.

Participants also noted — with some concern — the way equity markets embraced money managers in 2005, as illustrated by highly successful initial public offerings for Calamos Asset Management Inc. and New Star Asset Management Ltd. With 24 publicly traded firms worldwide, "I wouldn't at all be surprised to see public players of one form or another become important here," said Mr. Putnam. The strength of those recent IPOs suggests investors are more focused on the opportunities than the challenges these firms face, he said.

AMG's Mr. Healey agreed, saying midsize firms would do well not to underestimate the distractions that a public offering can entail for management teams that had previously been able to focus exclusively on managing money.

Still, despite frothy demand for hedge funds and money management firms going public, some participants predicted the coming crop of deals could, on balance, represent an improvement from previous years.

The industry "is much better developed today," with firms such as Asset Management Finance Corp., Rosemont Investment Partners LLC and Lovell Minnick Partners LLC serving as "specialty intermediate financiers," said Mr. Putnam, who predicted that, on balance, this year transactions will be "more thoughtful" and "properly priced."