TCW anted up 50% premium for MetWest

Under pressure to make a deal to replace star money manager Jeffrey Gundlach, TCW Group Inc. executives decided to pay $300 million to acquire rival bond manager Metropolitan West Asset Management LLC, a 50% premium over what TCW's investment banker said the business was worth.

Terms of the December 2009 deal between TCW and MetWest, as well as the banker's opinion, are part of testimony in the trial between TCW and Mr. Gundlach, TCW's former chief investment officer. The trial is offering an inside view of a major money management merger-and-acquisitions deal.

While due diligence on the MetWest transaction was being done in October 2009, TCW's investment banker already had concluded that the price was too high, according to a document at the trial.

“It's already clear that their stand-alone business is not worth the $300 million nominal value they are asking for,” wrote Gary Shedlin, a consultant with Citigroup, in an Oct. 5, 2009, e-mail to Jacques Ripoll, head of global investment management and services for Societe Generale, TCW's owner. “My initial guess is that it's worth closer to $200 million.”

MetWest had $30 billion in assets at the time; TCW had $100 billion, about $65 billion of which was in fixed income.

But Mr. Shedlin told Mr. Ripoll in the e-mail that “one needs to decide if a $100 million premium (50%) is too expensive an `option' to preserve near-term value at TCW.”

In his response, Mr. Ripoll called it a “fair vision of where we stand and where we should go.”

TCW Chief Executive Officer Marc Stern testified that by early September 2009, he thought TCW could be destroyed if he did not move swiftly to replace Mr. Gundlach, TCW's star money manager, who Mr. Stern suspected was plotting to leave to join a rival or start his own firm. Trial testimony shows Mr. Gundlach's mortgage-backed securities team was responsible for at least 50% of TCW's revenue.

Mr. Shedlin, then chairman of Citigroup's global financial institutions group, also wrote in the e-mail: “I strongly believe that terminating JG and having a credible "replacement plan' to execute will preserve significantly more value than reacting to his departure.”

TCW began termination proceedings against Mr. Gundlach on Dec. 4, 2009, after officials said they uncovered a plan by Mr. Gundlach and associates on his mortgage-backed securities team to download millions of TCW documents.

TCW is charging in the lawsuit that those trade secrets helped Mr. Gundlach launch his rival money management firm within days of leaving TCW. Mr. Gundlach is countersuing for more than $500 million in back and future compensation.

In a statement to Pensions & Investments, Mr. Stern said the MetWest deal has turned out well for TCW.

“We think it was a fair deal when we made it, and in retrospect it has turned out to be a great deal,” he said in a statement.

“Given the serious challenges TCW faced in late 2009 when we were forced to terminate Jeffrey Gundlach, the MetWest acquisition has exceeded my expectations by every single measure,” Mr. Stern continued. “The group's investment performance has been outstanding, and MetWest has significantly broadened our offerings in core fixed-income and high-yield products, allowing us to better serve our clients.”

While the trial is only highlighting the TCW-MetWest deal, paying a premium for managers occurred with regularity between 2005 and 2008, a period of heightened demand in the asset management business, said John Temple, president of Cambridge International Partners, a New York firm specializing in money manager M&A.

What's unique about the TCW-MetWest deal is that TCW officials were reportedly overpaying for a defensive reason, the seller contributing to the buyer's business instead of the normal buyer adding to the seller's business, Mr. Temple said. “It doesn't happen often.”

Mr. Stern in his trial testimony characterized the acquisition of MetWest as a “defensive move,” but said as negotiations proceeded and he got to know the MetWest team, it became more strategic in nature because of MetWest's broad-based fixed-income expertise as opposed to the Gundlach team's specialty in mortgage-backed securities.

One top money manager M&A dealmaker who requested anonymity said TCW didn't have many choices as far as partners, so any premium was relative. “TCW was either going to fire Mr. Gundlach or he was going to quit, and they needed a replacement manager.”

He said there aren't many independent fixed-income managers with assets between $25 billion and $75 billion, giving TCW only a limited number of partners that would fit with its then-$65 billion fixed-income business. Smaller managers wouldn't have added much to TCW's investment capabilities, and bigger managers would have been too costly and difficult to acquire, he said.

MetWest, with its $30 billion in assets, was a perfect fit, he said. MetWest also happened to be in Los Angeles, just a few miles from TCW's headquarters, making integration of the two companies easier, the dealmaker said. “There aren't a lot of managers who could have solved TCW's problems,” he said.

Even with its announcement that it had acquired MetWest, TCW lost $25 billion in institutional business following Mr. Gundlach's departure. The company also contends it lost more than $300 million in incentive fees from funds and strategies managed by Mr. Gundlach.

Mr. Stern had testified that he asked Mr. Shedlin to find managers to possibly replace Mr. Gundlach and his team following a contentious Sept. 3 meeting between Mr. Stern and Mr. Gundlach.

Mr. Shedlin testified that the acquisition of a money management firm can take months, but in e-mails disclosed at the trial, he and an associate on Citigroup's M&A team discussed that TCW wanted to close the deal by Oct. 19.

That would have been only a month and a half after Mr. Stern asked him to find a replacement for Mr. Gundlach. “It was a race against time through the entire process,” Mr. Shedlin.

Mr. Stern said on the witness stand that the final plan to terminate Mr. Gundlach had to have an element of surprise so Mr. Gundlach wouldn't have time to leave TCW in the lurch.

Mr. Shedlin said in the Oct. 5, 2009, e-mail that another possibility was to replace Mr. Gundlach and team members with another fixed-income team from another firm.

But Mr. Shedlin said that could not have been done quickly. “While a lift-out is also possible, identification of teams and discussions will take some time and, given the time of year (being so close to year end), definitely makes this a next-year process.” he wrote. “I am concerned that if JG leaves first, the prospect of trying to bring a new team into TCW will become even more difficult.”

Mr. Stern testified that he waited until he signed the agreement with MetWest — paying $300 million, which included a $75 million retention fee — before starting termination proceedings against Mr. Gundlach. Of the total, $180 million was in cash and the remainder in TCW stock.

Besides MetWest, another winner in the deal was Mr. Shedlin's unit at Citigroup. Trial documents show Mr. Shedlin's group earned e2.4 million, or about $3.25 million.

In a statement to P&I, David Lippman, group managing director and head of fixed income at TCW, said: “The MetWest acquisition has helped stabilize TCW and put it back on a path of steady growth”

Mr. Lippman, who had been MetWest's CEO, said TCW's assets have risen nearly 20% since the end of 2009 — to $119.5 billion as of June 30, 2011.

Mr. Lippman said MetWest products at TCW have benefited from increased exposure because of access to TCW's international distribution platform. He said MetWest has been able to boost its mutual fund assets to $18 billion from $9 billion since the acquisition.

The MetWest acquisition is an issue in the trial because Mr. Gundlach is maintaining he was fired because TCW didn't want to pay him hundreds of millions in incentive fees. His lawyers have continually pointed out that TCW is paying MetWest officials less than one-third of what they paid Mr. Gundlach and his team. Testimony shows that MetWest team members are receiving a 10% fee share from TCW vs. the 35% fee share that TCW agreed to pay Mr. Gundlach's team.

TCW officials have testified at the trial that lower fees are offset by the $300 million TCW had to pay to acquire MetWest, as well as the assets under management losses following Mr. Gundlach's departure. n