Large targets shunned in favor of niche firms that help bottom line
Large publicly traded money managers are letting their investors know they're looking to take a twirl in the M&A market and spend some of their cash.
But when it comes to making a large purchase, they're being wallflowers, sources said, and instead are buying smaller niche managers or obtaining stakes in other firms.
"The problem is that M&A has been like a junior-high dance," said Benjamin Phillips, principal and investment management lead strategist with Casey Quirk, a practice of Deloitte Consulting LLP in New York. "Everyone is standing against the wall talking about dancing, but they're waiting to see who actually is going to ask someone to dance. There haven't been a lot of big closes."
CEOs at managers such as Franklin Resources Inc., San Mateo, Calif. — as well as multiboutiques like BrightSphere Investment Group, London; Affiliated Managers Group Inc., Boston; and Victory Capital Management Inc., Cleveland — said during their second-quarter earnings calls in July and August that they were actively looking to acquire managers that could provide accretive investment strategies to their offerings.
Those strategies include illiquid assets such as private equity, real estate, credit and infrastructure, but also strategies that can't be replicated by exchange-traded funds.
"The story hasn't changed, it's just become more defined," said Christopher Browne, managing director at investment bank Sandler O'Neill and Partners LP, New York. That's in large part, Mr. Browne said, because of "the centrifugal force that increasingly passive management by institutional investors has created. It has become, particularly in a post-crisis bull market, more difficult to allocate to active management and pay the higher fees. That's hard to justify. So for managers, it's become very important to add certain capabilities to manage money so that you can justify charging higher fees."
"Public company CEOs are preparing the market to let them know they might need to do deals that might look diluted," said Peter Nesvold, managing director, chief operating officer and head of strategic initiatives at investment bank Silver Lane Advisors LLC, New York. He said while the number of manager M&A deals in the first half of 2018 is up at least 20% from the same period last year, they have centered on smaller partial or full acquisitions.
That generally reflects Sandler O'Neill data that show there were 59 money manager deals in the first half of this year vs. 45 for the first half of 2017 and 53 for the second half of last year. However, the first-half 2018 transacted assets under management total of $621 billion was below the $926 billion in the first six months of last year and $1.305 trillion in the second half of 2017.
"They might be buying at multiples of where that firms' costs are currently. It could become accretive. But they're saying that they're not bottom-fishers. They're looking for successful strategies that gain over time. They will pay for that in the beginning. Big firms like Franklin, for example, their huge distribution capability allows for growth and brings incoming managers up to speed."
Mr. Nesvold said several reasons are driving the growth of M&A activity in the first half of this year. "It's hard to point out the exact light switch that set that off," Mr. Nesvold said. "It's an aggregation of a number of factors. For one thing, there have been continued outflows over the past several years. Cumulatively in active equity strategies, there's been a constant dribble of assets out, sometimes more than a dribble. The inflows have gone into quantitative strategies, credit and ETFs."
Lots of cash available
Casey Quirk's Mr. Phillips said larger managers also are sitting on large amounts of cash generated during equity rally, and their investors are asking what they'll do with it.
Added Domonkos Koltai, partner and co-founder at money management and financial services M&A advisory firm PL Advisors, New York: "Today the larger firms have two problems — their core business is shrinking and they're facing fee compression."
The solution, Mr. Koltai said, is either to go after larger firms like OppenheimerFunds Inc., whose parent, Massachusetts Mutual Life Insurance Co., is considering putting it on the block, or to find smaller managers with strategies "that are different and interesting and can't be replicated by ETFs or have a high growth potential."
The smaller full or partial acquisitions in recent months include:
In April, BlackRock (BLK) Inc. (BLK), New York, said it would acquire private credit manager Tennenbaum Capital Partners LLC, Santa Monica, Calif., with $9 billion in assets.
Also in April, Invesco (IVZ) LLC, Atlanta, acquired New York-based Guggenheim Investments' ETF business, adding $38 billion in AUM.
In March, Franklin Resources acquired Random Forest Capital LLC, San Francisco, an emerging money management firm that invests in marketplace, or peer-to-peer, lending by using machine learning and statistical algorithms.
But Casey Quirk's Mr. Phillips said CEOs today are more skittish about making deals along the scale of last year's Aberdeen Asset Management- Standard Life Investments tie-up, which created a combined firm with assets totaling £557.1 billion ($732.7 billion) as of June 30, or the merger of Janus Capital Group Inc. and Henderson Group PLC, combining $370.1 billion in AUM as of June 30.
Mr. Phillips said among the reasons managers aren't pulling the trigger on big M&A deals is that equity markets are still rising, so managers are less likely to take a chance on a deal when returns are good, and the view among CEOs that making such a move could put their careers at risk.
"Many CEOs are asking themselves if they want to take a chance on a deal or wait until the next person in the job comes in," Mr. Phillips said, adding that's the case with both buyers and sellers.
The next six months should see a continuing trend of smaller M&A deals, said Mr. Browne of Sandler O'Neill. "Most managers eventually will decide to build rather than buy," Mr. Browne said. "But that's tough to do when you're looking to expand and want to get to market quicker with existing strategies. That means acquisitions as we've seen are going to go on for a while. If you're a premium large fund manager, you'll live through many market cycles. If you're looking to fill a gap in product offerings, you'll probably be more active in the next six months."
Competition for niche firms
Messrs. Browne and Koltai agreed traditional managers will face competition for buying niche strategy managers, in part or in total, from private equity managers also looking to take advantage of institutional interest in illiquid strategies. "There's a lot of activity in this space," Mr. Koltai said. "Illiquid assets are doing great."
Among this summer's private equity deals for managers cited by Mr. Koltai were Dyal Capital Partners' minority stake acquisitions of U.S. credit manager Golub Capital LLC and U.K. real estate manager Round Hill Capital LLC.
He also pointed to Blackstone Group LP's minority stake purchase with Goldman Sachs Asset Management of tech private equity firm Francisco Partners, and to Orix Corp. USA's acquisition of structured finance manager NXT Capital LLC, both also announced this summer.
"Dyal-type transactions are driven by private firms' need to invest dry powder," Mr. Koltai said. "A lot of the deals firms like Dyal are doing goes directly into the general partners' co-investment pool."
Casey Quirk's Mr. Phillips said overall deal flow "is more strategic-driven than ever before. It may be to cut costs, add capital, diversify to other revenue streams, but it's still corporate strategy. In this current cycle, a lot of the discussions have been strategic."