In a move industry insiders say indicates that consolidation of the money market fund industry is a sure bet, Federated Investors of Pittsburgh last week announced it was buying $29 billion in money market funds sponsored by Alliance Capital Management of New York. As of Sept. 30, Alliance had $487 billion in assets, while Federated had $178 billion.
The acquisition, under which Federated will acquire 22 money funds carrying the AllianceBernstein banner and sold through broker/dealers, is being structured as a multi-year financial arrangement valued at $128 million. Federated will initially pay Alliance $25 million and make additional payments over the next five years contingent upon future revenue levels. Based upon current rates, these annual payments would collectively total $103 million, the net revenue the funds would have contributed to Alliance's bottom line.
In the first nine months of 2005, Federated plans to absorb each of the Alliance money funds into existing money funds with similar objectives, and launch three new money funds.
A multiple-year revenue deal could be good news to Alliance, which still faces approximately $70 million in annual give-backs over five years beginning January 2004, as part of its market-timing settlement with regulators. The deal also allows Alliance to shed a business that in recent years had become ancillary and that has suffered $2.8 billion in outflows this year alone, company executives said. "Cash management has no strategic significance to this firm," said Lewis Sanders, CEO.
Instead, Alliance executives want to focus on the firm's blended growth and value competency, which it acquired through its purchase four years ago of research firm Sanford C. Bernstein in a cash and stock deal valued at $3.5 billion. The sale also allows Alliance to focus on its international investment prowess and offshore clients, as well as build its private client division, which has grown from $2 billion in assets in 1999 to $57 billion as of Sept. 30.
For Federated, the acquisition allows the firm to increase its omnipresence in the money fund business. Currently, Federated is the fourth-largest money fund provider with almost $107 billion in U.S. money fund assets across 82 funds, according to iMoneyNet of Westborough, Mass. The acquisition boosts Alliance's U.S. money fund assets to $136 billion and vaults it to the second-largest spot with a 7.2% market share, just behind the $182.2 billion in money fund assets held by Fidelity Investments of Boston, which has a 10.1% market share of the almost $2 trillion money fund marketplace.
In a recent conference call with analysts, Federated President and CEO Christopher Donahue admitted that the currently rising short-term interest rates are making it hard to attract more money from existing clients. But, he continued, the acquisition "brings us new customers we can do a lot of exciting things with." In fact, Federated may make similar acquisitions and develop new applications for its existing money funds, Donahue said, noting that in recent months, Federated has added a trio of new clients to both its institutional and broker/dealer cash management business lines.
Federated is also hoping to offset its dwindling third-party fund administration business, which is set to lose another two clients shortly, bringing current assets of $36 billion down to $18 billion. One will be bringing its fund processing in house, while another client will be lost through an acquisition, company executives said.
"This is really the first big deal. It is the largest non-bank, pure cash management transaction," said Pete Crane, vice president at iMoneyNet. People have been talking about and expecting consolidation for a while now, he added. "A number of others will be thinking about whether they have critical mass," he predicted. Size and scale can make a difference, especially when it comes to researching securities and having the financial ability to withstand security blow-ups, he said.
In 1997, several money fund sponsors had to infuse cash to prevent them from having to price fund shares under the $1 net asset value, or "break the buck," when Mercury Finance Corp. defaulted on $17 million of commercial paper. Then, in 1999, several money funds, including four from Alliance Capital, were caught holding General American Life Insurance Co. when it defaulted on $6.8 billion in funding agreements. Metropolitan Life subsequently assumed all liabilities and made owners whole. More recently, in 2001 at least a handful of money funds had to bail out their funds when the California energy crisis caused Pacific Gas & Electric and Southern California Edison to default on their commercial paper securities.
"I see a lot more consolidation coming," agreed Bruce Bent, chairman and founder of The Reserve Funds of New York, and architect of the very first money fund. The old adage used to be that "anyone can run a money fund," but many have realized only a few can do it successfully, he noted. "It is a thin-margin, high-velocity business."