Overall M&A deal values in the asset management industry surged last year to $12.7 billion compared to $2.6 billion in 2013, according to a new report from PwC. However, much of the growth was largely driven by a few mega-deals, and the total number of deals remained flat, with 86 deals last year compared to 84 in 2013.
The three biggest deals in 2014 were TIAA-CREF's acquisition of Nuveen Investments for $6.5 billion, the London Stock Exchange's acquisition of Frank Russell for $2.7 billion and RCS Capital's acquisition of Cetera Financial Group for $1.2 billion.
PwC is "cautiously bullish" about the M&A outlook for this year. It expects the increase in deal activity this year to primarily come from transactions involving alternatives, ETFs and managers that offer customized solutions.
"Now that we're three and a half months into the year, we're seeing an increased level of M&A activity, which is part of the encouraging story," says Sam Yildirim, U.S. asset management deals leader and a partner in the transaction services practice at PwC. "The deals that we have anticipated coming into the market have come into the market.
"When we talk to buyers and sellers, common themes are coming out," she says. "Buyers feel optimistic for the future and sellers feel better about their valuation. Another common theme is something supporting the deal logic beyond just growing assets, either the buyer getting access to an asset class or a skilled investment team or the seller getting access to better distribution."
While there are some encouraging signs, there were last year at this time too. Based on the general stock-market increases, PwC expected deal activity in 2014 to be more robust than what it ended up being. Some deals got delayed - a number of mergers and acquisition are taking longer to complete than expected, Yildirim notes.
"Bubble talk is coming from the buyers rather than the sellers. Some sellers are still proceeding with caution and are still trying to figure out if the market is good for them to take on a strategic investor or acquirer.
"It's human emotion - when you own something, you think the business is worth a lot to you and you think that value should translate to market value.
"Sellers are projecting healthy performance fees and growth, whereas the buyers are concerned about acquiring a business, then the market tanks and they end up with something less than they paid for."
Before the financial crisis of 2008, many banks and insurance companies were trying to grow their asset management presence and aggregators were trying to grow their assets via M&A. In addition, there was very healthy deal activity coming from the multi-boutiques.
Now, the M&A activity is a lot more deliberate and tends to be more driven by pure-play asset managers rather than the banks and insurance companies, according to PwC. In the current environment, potential buyers are looking for value drivers beyond simply growing their assets under management.
While many asset managers' AUM values have recovered, EBITDA margins of most managers have declined since the financial crisis, PwC notes. The main reasons are the higher cost of compliance and increased downward fee pressure.
The PwC report highlighted the level of variance analysts see in the EBITDA multiples that buyers are paying. Some deals are getting done at six times the seller's EBITDA and some at 16 times EBITDA.
"That's a pretty wide gap - historically the gap wasn't as wide as that," Yildirim says. "There used to be a lot deals scattered around one valuation multiple.
"Now the valuations are a lot more robust. Buyers are doing a lot of work judging growth rates, looking at the scale, track record, knowhow and margins of the business, and many are willing to pay top dollar for businesses that are growing in the right asset class."
In addition, some managers have found it difficult to differentiate themselves from the stiff competition across the industry.
The PwC report suggested that such headwinds indicate the industry is ripe for further consolidation. "There are certainly things that managers can do to differentiate themselves, some associated with infrastructure, others associated with distribution channels," Yildirim adds.
"Even those managers that have certain capabilities in a particular asset class need to decide if they are going to stay as they are or try to grow into different asset classes and investment strategies and try to differentiate themselves that way."
Yildirim said that large asset management firms are getting the bulk of asset inflows while many small and medium-sized managers are losing assets.
Further exacerbating the situation is the well-known fact that a number of strategies - previously managers' bread-and-butter - are losing assets to passive investments.
"If you think about how fragmented the asset management industry is, particularly alternative managers, there is an opportunity to improve efficiency as a business scales up," Yildirim says. "There is definitely room for M&A activity to build that scale, but we're not seeing a lot of deals getting done based on that logic, because industry is fragmented.
"A lot of [small to medium-sized] managers are owned by the chief investment officer driving the investment decisions - it almost becomes a personal business, so it's like letting go of your baby."