A weekly update on issues important to the Investment Management industry
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.
Mercer Capital’s asset management valuation practice is run from our main office in Memphis, Tennessee, and this time of year here means one thing: Death Week. Every year since his death on August 16, 1977, the city of Memphis spends a week memorializing Elvis Presley, the King of Rock and Roll. From all the press lately, you would expect that a similar wake was being held for active management, and with it, much of the RIA community. Elvis is dead, and so too must be active management. We live in the age of auto-tune and robo-advisors, a time when big vocal chords and beating the market have become anachronisms – or are they?
Smaller asset managers outperformed their larger brethren over the last year. Still, it’s important to remember that our smallest sector of asset managers (AUM under $10 billion) is the least diversified and therefore most susceptible to company-specific events. Its strength is more attributable to DHIL’s (~80% of the market-weighted index) outsized gain in market value rather than any indication of investor preference towards smaller RIAs.
On April 29th, 2015, Simmons First National Corporation.(NASDAQ ticker: SFNC), announced it has entered into an asset-purchase agreement to acquire Ozark Trust and Investment Corporation (OTIC) and its wholly owned subsidiary, the Trust Company of the Ozarks (TCO), a Registered Investment Advisor (RIA) headquartered in Springfield, Missouri. The Trust Company of the Ozarks administers over $1 billion in client assets for over 1,300 clients with a 16% AUM compound annual growth rate. Simmons First National Corporation has agreed to a purchase price of $20.7 million, with a consideration of 75% stock and 25% cash. The deal is to close in quarter 3 of 2015. Unlike most acquisitions of closely held RIAs, the terms of the deal were disclosed via a conference call and investor presentation; the details of which are outlined here.
Our process when providing periodic fair value marks for venture capital fund investments in pre-public companies is described. This process includes examining the most recent financing round economics, adjusting valuation inputs the measurement date, measuring fair value, and reconciling and testing for reasonableness.
As noted in Mercer Capital’s presentation to the 2014 Acquire or Be Acquired conference sponsored by Bank Director entitled Acquisitions of Non-Depositories by Banks, the relatively high margins associated with asset management is one of the many reasons that banks and other finance companies have been so interested in RIAs over the last few years. Powered by a fairly steady market tailwind over the last few years, many asset managers and trust companies have more than doubled in value since the financial crisis and may finally be posturing towards some kind of exit opportunity to take advantage of this growth.
So, as always, the outlook for mutual fund providers hinges on market performance and asset flows. Any continuation of the recent market momentum would certainly be a bonus for mutual fund providers whose net-of-fee performances are competitive with comparable ETF products. Another market downturn, on the other hand, would likely hasten asset flows out of equities and into fixed income or money market funds with lower fees to their sponsors.
