Any agreement to combine Thomson Advisory Group L.P. with the money management units of Pacific Mutual Life Insurance Co. probably would be structured as a reverse merger.
Thomson, Stamford, Conn., would purchase the money management subsidiaries of Newport Beach, Calif.-based Pacific Mutual, but then sell itself back to Pacific Mutual, industry analysts say. Pacific Mutual then would become general partner of Thomson under such an arrangement, creating a firm with about $70 billion in assets. About $10 billion of that would come from Thomson, with the balance from five Pacific Mutual subsidiaries.
Two other reverse merger deals between a large insurance company and a master limited partnership-structured money manager took place last year. The Equitable Cos. increased its ownership of Alliance Capital Management L.P., and The New England Cos. bought Reich & Tang L.P.
Executives for investment banking firm Putnam Lovell Inc., New York, are involved in the current discussions, and were involved in the New England-Reich & Tang deal. They declined to comment.
In retaining Thomson's MLP status, Pacific Mutual would gain significant tax advantages through the end of 1997 and would gain access to the equity markets. Additionally, depending on how such a deal is structured, a reverse merger could boost the balance sheet capital of Pacific Mutual by putting its money management firms on the books at market value instead of book value, and allow principals in its management subsidiaries to take ownership stakes of the firms they have helped build. A spokesman for Pacific Mutual said the insurance company owns all of Pacific Financial Asset Management Corp. and the money management subsidiaries within it.
Analysts also see strategic advantages to such a merger in that Pacific Mutual's potential market for fixed-income money management would be opened up to Thomson's retail mutual fund distribution network.
An MLP-deal "makes sense as a structural matter," said tax analyst Robert Willens, managing director for Lehman Brothers, New York, although the tax benefits will be there for a relatively short time. As an MLP, Thomson does not get taxed at the company level and pays out all earnings to unitholders. That advantage would only last a few years because the tax-free status of MLPs expires Dec. 31, 1997.
Although a consortium of MLPs is lobbying Congress to extend the tax status, some are preparing for MLPs to become taxable.
Dave Williams, chairman of Alliance Capital, said the MLP structure has worked well for his firm, although the stock market appears to value its shares as more of an income stock than a growth stock because of its expected tax-status change. At the close of trading March 2, Alliance's shares were priced at 235/8 and carried a 12-month dividend yield of 6.3%. At the same time, non-MLP managers such as T. Rowe Price Associates Inc. and Colonial Group Inc. had dividend yields of 1.7% and 2.3% respectively.
Even without the tax advantages of an MLP-structure, a reverse merger would give Pacific Mutual access to equity markets, something it didn't have before. Like any mutually owned insurance company, it is owned by its policy holders and cannot issue equity on stock exchanges.
But at this time, it appears that Pacific Mutual wouldn't have a financial need to raise capital through those markets. So although Pacific Mutual and Thomson announced the merger discussions following press reports that Pacific Mutual was seeking to raise capital through a sale of its largest money management subsidiary, Pacific Investment Management Co., analysts say the deal probably isn't being done directly to raise capital, although that may be a secondary benefit. (Thomson's publicly traded shares rose sharply after the announcement, ending Feb. 28 at 351/4, up 27/8 from the previous day's trading. Shares eventually drifted lower, and closed March 2 trading at 33).
"We view Pacific Mutual as being very well-capitalized," said Michael Albanese, assistant vice president with insurance company ratings agency A.M. Best Co. Inc., New York.
Whether Pacific Mutual needs to raise capital or not, industry observers say it is possible its balance sheet could get a huge boost from a reverse merger. In selling and then buying back its subsidiaries to Thomson, Pacific Mutual would assign a market value to its subsidiaries, which are currently held at book value. The book value of Pacific Mutual's subsidiaries is probably low, since Pacific Mutual funded these firms as start-ups, while their market value is probably high, given their growth.
Executives for the firms would not comment on any specifics of the talks beyond what was in a prepared statement, although a source familiar with the Pacific Mutual estimated the book value of the insurance company's money management subsidiaries to be about $200 million, while the source estimated its market value to be about $1 billion.
That same source said a reverse merger could give principals of Pacific Mutual's money management subsidiaries a means to gain ownership in the firm and cash out once they decided to retire. A mutual insurance company cannot not issue shares to its principals, while a master limited partnership can.
The top executives for PIMCO, including Chief Investment Officer William Gross and managing director James Muzzy, would be among those likely to benefit most from such an arrangement.
Mr. Albanese of A.M. Best declined to comment on whether creating ownership incentives could be a reason for doing a deal, but said the biggest reasons for doing the deal are strategic ones.
Pacific Mutual could pair up Thomson's established equity mutual funds with PIMCO's fixed-income funds and distribute them through Thomson's established channels, Mr. Albanese said. Once access to a distribution channel is gained, creating retail funds to mimic its existing institutional funds is not that difficult, Mr. Albanese said.
Similarly, investment banker Brad Hearsh, first vice president at PaineWebber Inc., New York, who is not involved in the merger discussions, said PIMCO was said to be looking to do retail business, while Thomson has been in the market seeking some kind of fixed-income capability.
"It's a good fit," Mr. Hearsh said.
PIMCO has 10 institutional funds that carry minimum investments of $500,000. Four of those funds have a long enough track record to be rated by Morningstar Inc., Chicago., and three carry its highest rating. Thomson has 20 funds - including front-end and back-end loaded funds - of which four carry Morningstar's highest or second-highest rating. In addition, assets poured into both firms' mutual fund complexes in 1993, according to data provided by mutual fund consultant Financial Research Corp., Chicago. PIMCO's funds grew 78% to $7.7 billion, while Thomson's grew 47% to $3.7 billion.
While PIMCO is by far the largest of Pacific Mutual's money management subsidiaries, four others, all owned through PFAMCO, are also involved in the talks, Pacific Mutual executives say. They are three domestic equity managers - Cadence Capital Management Corp., Boston; Parametric Portfolio Associates Inc., Seattle; NFJ Investment Group, Dallas - and international equity manager Blairlogie Capital Management Ltd., Edinburgh, Scotland.