While mergers and acquisitions among asset management companies were down significantly during the first half of 2009, many M&A experts predict this decline will flatten out or reverse by the end of the year, driven by renewed faith in the profitability of asset firms and banks' continued need to raise capital.
"Activity across financial services has decreased significantly because of the crisis, with asset management transactions down 35% by number," said Eric Weber, managing director and chief operating officer at Freeman & Co. "We expect financial industry deals to stay at these subdued levels as the industry plans how to compete in the future."
In the first half of 2009, there were only 72 announced transactions in the investment management industry, down from 109 deals in the same period a year earlier, according to a report from Jefferies Putnam Lovell.
There were just 35 deals in the second quarter of 2009, compared with 52 a year earlier, but thanks to the June 11 mega union between BlackRock and Barclays Global Investors, total assets transacted surged from $227 billion to $1.7 trillion and deal value jumped from $2.3 billion to $13.7 billion, Jefferies said. Credit Agricole Asset Management's acquisition of Societe Generale Asset Management also bolstered the early 2009 numbers.
"Activity should increase in late 2009 through 2011 as firms reposition themselves for the new competitive framework ahead, and we will see more deals like those with Morgan Stanley/Smith Barney and BlackRock/BGI," Weber said.
"We expect divestitures to remain the driving force in M&A activity through the second half of the year as the asset management industry faces its most radical reshaping on record," said Aaron Dorr, managing direct at Jefferies Putnam Lovell.
Divestitures represented 47% of all the deals in the first half of 2009, including three of the five largest transactions by assets under management, Jefferies said, compared to only 26% of deals during the same time in 2008.
Dorr predicts there will be a steady flow of global asset management M&A activity during the second half of 2009 as pure-play asset managers seek to add scale.
Brent Beardsley, a partner at the Boston Consulting Group's Chicago office, said a number of factors could lead to an increase in M&A activity in the second half of the year.
While the asset management industry is still a very fragmented market with low barriers to entry, Beardsley said many marginal players will exit the business or choose to focus on one specific asset class. He said consolidation makes sense for many of the industry's top players who want to focus on larger-scale operations.
"About 80% of asset managers suffered profit declines in 2008, while about 70% witnessed revenue decreases," said a Boston Consulting Group report titled "Conquering the Crisis: Global Asset Management 2009." Boston Consulting expects the worst-performing institutions to seek to exit the business via sales or mergers.
Lowest Profit Ever
At the end of 2008, the average profit margin for asset managers fell to the lowest level in five years - 34%, down from 38% the year before - and the report predicts that 2009 profits could fall to 30% or lower.
"Deteriorating industry economics will force asset managers to live with lower profits in the future," the BCG report said. "Subscale players or those with weaker value propositions will have no option but to leave the business. This situation will allow some asset managers to consider M&A options in order to reinforce core businesses or move into markets that were previously seen as too expensive or closed."
Many large financial groups will look to exit the asset management business in order to focus on other activities or to increase their capital, Beardsley said. In order to take advantage of industrialization and scale, larger managers will turn their traditional range of funds into fund factories.
"We will see a higher degree of industry consolidation as more large financial groups exit the asset management business in order to focus on other activities," the report said.
Beardsley said banks may consider selling their asset management arms to raise capital and private equity firms will be poised to sweep in and scoop up deals, but Weber said he thinks many banks may resist selling until they get a fair price.
"Private equity firms have been scouring the earth looking for opportunities, but there haven't been as many sellers that are willing to transact at levels private equity would like," he said. "In the past, private equity firms did a lot of levered plays and borrowed money. Now, the only way to get returns they want is to lowball bids."
As long as credit markets remain tight, banks will look for other ways to shrink their balance sheets, Weber said. Asset management arms don't consume regulatory capital and are pretty efficient for banks to own, he said.
"There is an unwillingness to sell their money management business significantly below fair value," Weber said. "Maybe 10% below fair value is OK, but nothing worse."
In a survey of distressed M&A activity conducted by mergermarket, nearly 92% of respondents said the current economic downturn is producing more steeply discounted distressed assets than previous downturns. Many distressed targets will be overleveraged companies forced to liquidate in the face of mounting debt, and many expect the velocity to pick up in the second half of the year, as buyers try to identify where the bottom of the market is going to be.
Thirty-eight percent of respondents think financial services will experience the highest volume of distressed M&A this year.
"This combination of eager sellers and opportunistic buyers will undoubtedly provide fuel for distressed activity, especially since both groups stand to gain unique benefits from distressed deals," the mergermarket study said. "Fifty-five percent of respondents believe strategic buyers will be the most active buyers in the year ahead, with several respondents commenting that this is an ideal time for companies to improve their businesses and expand their product offerings by acquiring attractively priced distressed assets. At the same time, 52% of respondents expect private equity groups to emerge as the buyers of choice, due to their extensive restructuring experience," the report continued.
"In the short term, the ability to quickly provide needed liquidity is likely to be a primary consideration for both buyers and sellers as opposed to bidding wars driven by different views of longer term intrinsic value," said Duff Meyercord, a partner at Carl Marks Advisory Group LLC. "In other words, cash is again king."
(c) 2009 Money Management Executive and SourceMedia, Inc. All Rights Reserved.