In this post, we have included the slide-deck from our presentation, “Valuing a Trust & Wealth Management Franchise” from Bank Director’s 2016 Acquire or Be Acquired conference. Even with the present market instability, banks have an interesting opportunity to expand their financial services while diversifying their revenue streams with asset management. We sense some growing demand for sophisticated trust services, and a lot of RIAs in the wealth management space see banks with existing trust departments as a complementary environment to sell into.
This post provides some brief thoughts about five topics, posed as questions, that can make or break the value of RIAs. These topics have longer term and more strategic implications than the day-to-day fluctuations in capital markets, and while equity research may be more fun, these are more reliably lucrative.
The Global Investment Performance Standards (GIPS®) were adopted by the CFA Institute in 1999 and are widely accepted among the international investment management industry. GIPS are a set of ethical principles based on a standardized, industry-wide approach that apply to investment management firms and are intended to serve prospective and existing clients of investment firms. While compliance by investment firms is voluntary, many investors consider GIPS compliance to be a requirement for doing business with an investment manager. Alternative managers have lagged behind the industry in claiming compliance with GIPS, but changes in the industry suggest GIPS compliance is becomingly increasingly important.
Despite the recent uptick, we believe the backlog of available deals remains fairly robust given the four year pause in transactions from 2009 to 2013 and the aging demographics of many investment management firms. The real threat to deal making would be a longer, more pronounced downturn or continued volatility in the equity markets that would crater AUM levels and investor confidence.
A quick look at year-end pricing of publicly traded asset managers reveals a continued skid in multiples for traditional RIAs and mutual funds with modest advancement for the alternative managers and trust banks.
Tri-State Capital Holdings, Inc. (traded on the Nasdaq as TSC) bought The Killen Group, a $2.5 billion manager of the Berwyn mutual funds, for about six times EBITDA. More specifically, TSC paid Killen $15 million cash up front (based on trailing EBITDA of $3.0 million), plus an earn-out paying 7x incremental EBITDA (which could add another $20 million to the transaction price). So, best case scenario for Killen is for them to deliver about $6 million in EBITDA and get paid $35 million (!).
Despite 195 nations signing onto the Paris Climate Conference commitment to clean energy last week, it looks like Santa will be stuffing most asset managers’ stockings with coal this Christmas. Hopefully it’s at least low-sulfur.
December has been a rough slog for the RIA space. So far it’s mostly been attributed to the cracks in high yield credit. With junk bonds stumbling shortly after Thanksgiving, managers with large high yield offerings are feeling the Grinch. One standout example: WDR. Waddell & Reed’s Ivy High Income Fund has suffered huge outflows this year. Pile outflows with asset devaluation and WDR’s stock has gotten crushed, losing almost a quarter of the company’s equity market cap so far this month (!).
The International Private Equity and Venture Capital Valuation (IPEV) Guidelines were developed in 2005 to set out recommendations on best practices in the valuation of private equity investments. The IPEV Board is made up of leading industry associations from around the world, including the National Venture Capital Association (NVCA) and the Private Equity Growth Capital Council (PEGCC) in the United States. In October 2015, the IPEV Board published draft amendments to the existing guidelines that, if approved, will go into effect at the beginning of 2016.
Investment managers who expected the Square IPO to settle the debate on high private equity valuations have been, so far at least, thoroughly disappointed. Square, Inc. went public on November 17 at just $9 per share and opened debate in a venture community wary of high valuations on whether or not investment terms can compensate for high prices. In other words, do special investor provisions designed to protect late round investors from frothy PE valuations do more harm than good? In our last post on IPOs, we discussed the current imbalance between the public and private markets, in which an exuberance of private equity capital has driven up private valuations and created a dislocation between the privately established value of the firm and the publicly achieved value available at IPO. As a consequence of this phenomenon, IPO activity fell to new lows in the third quarter, as 16% of IPOs downsized their debuts. Square is one of a growing number of companies resorting to equity protections in order to attract late-stage investors, often at the expense of employees and earlier investors.
As the dust settles in the aftermath of the third quarter, we take a look at several earnings calls from pace makers in the RIA industry. Changes in the character of the financial markets is driving change in firm business models, and out of this we see a few common themes that we expect will play a role in shaping the industry going forward.
Concurrent with Madeleine Harrigan’s post last week about IPOs being the new private equity downround, the financial reporting group at Mercer Capital published an interview with the head of the group, Travis Harms, on the difficulties mutual funds face in valuing level 3 assets (think Square). The following is an excerpt from that interview.
There’s something about nature that abhors a vacuum. Right now that vacuum seems to be the imbalance between the public and private markets, with the latter attracting maybe too much interest since the credit crisis, at the expense of the former. Blame fair value accounting or Sarbanes-Oxley or the plaintiff’s bar, but it has been some time since being public was actually considered a good thing. With interest running high in the “alternative asset space” and cheap debt for LBOs, the costs of being public have not been particularly worthwhile. This situation is not sustainable, and was never meant to be. Family businesses can stay private forever, but institutional investors eventually need the kind of liquidity that can only come from the breadth of ownership afforded by established public markets. Valuations are never really proven until exposed to bids and asks.
The shorthand method of valuation in many industries has long been some kind of “rule of thumb,” usually a multiple of some measure of gross scale or activity. In this post, we consider the pitfall of relying strictly on a rule of thumb.
Despite the recent setback in the markets, RIA transaction activity posted solid gains for Q3 and into the month of October. The market’s stabilization since the last correction has clearly boded well for sector M&A, and the future appears bright – as long as security pricing holds up.
Sometimes the fear of a thing is worse than the thing itself, and being haunted by proposed regulations may indeed turn out to be worse than compliance. The horror show of FinCEN may turn into a series with multiple episodes. In this post, we examine this proposed regulation and its implications.
Last week brought the news that PE firm Hellman & Friedman acquired a controlling interest in mega wealth manager Edelman Financial. Edelman is headed by radio-show personality Ric Edelman and manages about $15 billion for over 28,000 clients. While terms of the deal were not officially disclosed, the Wall Street Journal reported the transaction valued Edelman at a number north of $800 million, a nice pickup on Edelman’s going private deal in 2012, which transacted the company at $263 million. The financial press was practically hyperventilating over the price last week, but a little analysis on the number reveals pricing that is more normal than most would imagine.
A particularly rocky quarter for the equity markets precipitated huge market cap losses for most of the publicly traded hedge funds and PE firms. The lone bright spot and only sector component to generate a positive return over the last year is Blackstone, which benefited from strong performance fees on its portfolio company investments earlier this year. Still, the stock is down over 20% since its peak in May, which shows just how volatile the industry can be, particularly during times of market distress.
Q3 was an especially bad quarter for asset managers, with the group losing over $40 billion in market capitalization during a six week skid. Given the sector’s run since the last financial crisis, many suggest this was overdue and only pulls RIA valuation levels closer to their historic norms. The multiple contraction reflects lower AUM balances and the anticipation of reduced fees on a more modest asset base.
Few industries are as susceptible to market conditions as the typical RIA. With revenues directly tied to stock indexes (in the case of equity managers) and a relatively high percentage of fixed costs, industry margins tend to sway with market variations. While the concept of operating leverage is not new to anyone in the asset management industry, it is easy to forget how easy it is for margins to collapse in a market downturn.
Mercer Capital had a great time sponsoring the Southern Capital Forum on Lake Oconee last week. The annual gathering of the venture community is a favorite to check in with many of our clients and get a read on capital markets from some intentional listening. Beautiful weather and the bucolic surroundings of Reynolds Plantation helped, and on the second day of the conference, Janet Yellen kept her foot on the cost of capital. So what’s not to like? Despite the generally upbeat attitude of the sponsor community, and plenty of planned fund raisings, we heard one theme repeated over and over again that threatens the broader asset management world: stretched valuations.
In the two short years since Aileen Lee introduced the term “unicorn” into the VC parlance, the number of such companies has steadily increased from the 39 identified by Lee’s team at Cowboy Ventures to nearly 150 (and growing weekly) by most current estimates. Pundits and analysts have offered a variety of explanations for the phenomenon, with some identifying unicorns as the sign that the tech bubble of the late 1990s has returned under a different guise, others attributing the existence of such companies to structural changes in how innovation is funded in the economy, and the most intrepid of the group suggesting that the previously undreamt valuations are fully supported by the underlying fundamentals given the maturity and ubiquity of the internet, smart phones, tablets, and related technologies.
On May 20, 2015, the Securities and Exchange Commission proposed new rules and amendments to modernize and enhance information reported by investment companies and investment advisers. The proposed rules would be applicable to most investment companies registered under the Investment Company Act of 1940 and all investment advisers registered under the Investment Advisers Act of 1940.
In this week’s blog, we present a new whitepaper with some summary thoughts on the valuation of RIAs. Understanding the value of an asset management business requires some appreciation for what is simple and what is complex. On one level, a business with almost no balance sheet, a recurring revenue stream, and an expense base that mainly consists of personnel costs could not be more straightforward. At the same time, asset management firms exist in a narrow space between client allocations and the capital markets, and depend on revenue streams that rarely carry contractual obligations and valuable staff members who often are not subject to employment agreements. In essence, RIAs may be both highly profitable and prospectively ephemeral. Balancing the particular risks and opportunities of a given asset management firm is fundamental to developing a valuation.
Investment management firms too often mature as a cult of personality, as more than a handful of shops have built success around the talents, habits, and preferences of a strong-willed founder. But what builds success in an RIA doesn’t necessarily perpetuate it, and oftentimes the focus on the individual is at the expense of the institution.