Matching merger enthusiasm to reality

Asset managers have a strong urge to do deals but this isn’t feeding through to actual transactions. For fast-expanding Asian and Latin American managers, as well as their counterparts in Europe and the US, the rationale for strategic deals is as strong as ever before. Access to new markets, diversification of products and the potential need for industry consolidation are all compelling motivations. Yet differences over price, regulatory challenges in developing countries, lack of strategic ambition and other obstacles mean that only the proactive and well-prepared are likely to succeed.

Some 63% of asset management CEOs want to enter into a merger, joint venture or strategic alliance in 2013, according to PwC’s 2013 CEO Survey (compared with just 45% for banking and capital markets, and 48% for insurance).¹ But their enthusiasm contrasts with the low number of deals. In 2012 there were only 32 deals worth $14.4 billion globally, and in 2011 there were 27 deals worth US$5.4 billion. By comparison, the 2007 peak year for mergers saw 72 deals worth US$73.0 billion (see table below).

In the first part of 2013, deal activity has been slightly higher than the previous two years (10 deals worth US$7.5 billion in the first four months). Private equity managers such as Blackstone have acquired businesses to diversify their product ranges in the US, while Asian asset managers have bought substantial footholds in Europe.² But, all the same, ambition is far from matched by reality.

In the developed world, availability of suitable acquisition candidates who are willing to sell, and differences in valuations between the buyers and the sellers, are the biggest hurdles for buyers. For the fast-growing developing nations, understanding and dealing with the regulatory limitations is also a very significant challenge to getting deals done.

As the economic cycle matures in the developed world, it’s likely that more sellers will enter the market, the increased number of deals will aid price discovery and so the differences between buyers’ and sellers’ valuations will diminish. But expanding successfully through acquisitions, mergers or transactions of any other type is far from straightforward. Most importantly, asset managers must have clear strategies (based around a combination of product, distribution, operational efficiency and geography) and robust deal processes in order to stand the best chance of success. When looking to expand in fast-growing southern hemisphere countries, where regulatory hurdles make full-scale acquisitions difficult, alternatives such as joint ventures, alliances and distribution agreements are often the best way to achieve strategic goals, as they allow buyers to address key issues such as distribution and limits on foreign ownership of local businesses.

The urge to merge

Asset managers have compelling strategic reasons to forge deals. In Europe and the United States, profitability remains under pressure in spite of rallying equity markets, as lower margin products such as ETFs take market share from actively managed portfolios. What’s more, during the financial crisis many institutional investors negotiated lower fees and better transparency, which in turn increased the cost of operating asset management businesses. Entering faster-growing Asian and Latin American markets is naturally attractive, and a deal of some sort is likely to be more practical than setting up a ‘greenfield’ operation. Within European or US home markets, acquiring a local rival can build scale in an increasingly competitive environment, improve the ability to build ‘outcome-driven’ products and diversify product ranges into higher-margin alternative asset classes.

As is well known, some of Europe’s banks have looked into selling their asset management arms to bolster their capital ratios, particularly ahead of the implementation of the capital rules in the EU Capital Requirements Directive IV, due for implementation from 1 January 2014. A number of the continent’s banks have put ‘for-sale’ notices over their asset management subsidiaries in recent years. In 2013, for example, Rabobank sold its 90.1% stake in Robeco to Orix, the Japanese financial services company, and Dexia offloaded its asset management arm to GCS Capital, a Hong Kong-based private equity firm.³

In Asia – where investment assets have been growing fast – there’s also often a desire to do deals. Many Asian firms covet a European or US asset manager in order to buy asset management capability (both portfolio managers and distribution), diversify their investment products and boost brands. European asset managers have particular appeal, as recent Asian-European deals have shown. In particular, a European asset manager can deliver valuable infrastructure in Luxembourg or Ireland for administering UCITS funds, which carry a quality kite-mark in Asia. But for most of these managers, it’s important to agree a deal at a competitive valuation.

Overcoming the obstacles

The main obstacle to the mergers and acquisitions that have been attempted in the past few years is price. Just as fewer house sales complete when prices are low, so owners of asset management companies are less willing to sell at valuations significantly lower than they were a few years previously. Given time and greater confidence, this obstacle is likely to diminish as the new price norms are established, and sellers understand that the inflated valuations achieved prior to the financial crisis are unlikely to come back anytime soon.

But in the fast-growing markets of Asia and Latin America, the obstacle of regulation appears to be here to stay. In China, for example, foreign firms cannot own more than a minority stake, while in Brazil the central bank has become more reluctant to issue financial services firms licenses to operate. International firms looking to enter Brazil might view an acquisition as an easy of way obtaining a license, but the central bank can take considerable time to approve a deal, and then presidential approval can take still further time.

What’s more, an acquisition is unlikely to deliver the local distribution that Western asset managers desire. In most developing countries, including Brazil and China, the large banks control local distribution. So a foreign asset manager needs to be sure that if it does acquire a local company it has a way to sell into the fast-growing retail and high-net-worth markets. Where smaller asset managers do have distribution agreements, these generally incorporate a change of ownership clause.

For this reason, joint ventures or alliances are practical in developing markets. In Asia, for example, a US firm could contribute the product to a joint venture and the Asian partner could bring distribution, and vice versa. But joint venture agreements are notoriously hard to negotiate, as they often involve considerable detail about the future performance of each side. Straightforward distribution agreements are another way forward. It might be possible, for example, for a foreign asset manager to have its funds included on a Brazilian bank’s ‘open architecture’ platform.

Putting M&A processes first

But there’s no magic solution. Striking a successful deal – whether a merger, acquisition, joint venture or strategic alliance – is difficult to achieve in reality. Both buyers and sellers need to have clear strategic aims backed by strong M&A processes. Without them, good deals fall through and bad deals go ahead. External advisers can help by reviewing processes objectively, including valuation models, a range of due diligence (commercial, financial, legal, regulatory, IT/operational, carve-out), sale and purchase contracts and so on.

There’s no doubting the compelling logic for asset managers seeking profitable growth through deals of different types – whether mergers and acquisitions, joint ventures, alliances or distribution agreements. European and US firms need deals in order to defend profitability and access growth, while Asian managers want to diversify their product ranges. Increasing business confidence is likely to lead to more deals, closing the gap between enthusiasm and reality, particularly as Chinese and other developing-country managers come of age and look to deploy surplus capital. Yet even then a clear strategy and solid M&A processes will make the difference between a deal that fulfils a strategic ambition and one that does not.

Asset management M&A: Activity at a low level

YEAR NUMBER OF DEALS TOTAL VALUE
2013 (Jan-May) 10 $7.5bn
2012 32 $14.4bn
2011 27 $5.4bn
2010 38 $21.5bn
2009 41 $53.4bn
2008 37 $50.0bn
2007 72 $73.0bn
2006 29 $11.1bn

¹‘PwC 16th Annual Global CEO Survey (2013): Dealing with disruption – Adapting to survive and thrive’ (www.pwc.com/ceosurvey).
²Blackstone buys Credit Suisse unit, Financial Times, April 23, 2013
³Japanese secure Robeco 'love match', Financial Times, Feb 24, 2013