Asset management industry merger and acquisition activity picked up significantly in 2003, but the size and scope of the deals plummeted, in part, due to concerns arising from the scandal engulfing the fund industry, according to a recent study released by Putnam Lovell NBF Securities of New York.
In all, the industry saw a record number of deals, 137, during the year, up 23% from the 111 in 2002, according to the report "The Age of Scandal: M&A Activity in the Money Management Industry." While the raw number increased, the overall assets under management changing hands slipped to $430 billion, the lowest level since 1996. This is because buyers made modest moves, for the most part, with fund adoptions making up a fair share of the activity.
The mutual fund scandal, which was unveiled to the public in a Sept. 3 press conference by New York Attorney General Eliot Spitzer, has pushed back bigger deals and caused some firms to put transactions in limbo.
"We are still feeling the effects of the investigations that began last September," said Richard Chimberg, a senior advisor at Putnam Lovell and one of the study's authors. "We're not at the end of the restitution, fines and penalties to be imposed by regulators."
A number of fund firms have settled with regulators, including Alliance Capital, MFS, Putnam Investments, Bank of America and FleetBoston Financial, but many have yet to face the regulatory music, which has made some buyers weary. Janus Capital, Strong Financial, Federated Investors, Franklin Resources, Amvescap, BancOne, Pilgrim Baxter and Pimco/PEA Capital all have been tainted by the scandal and could wind up facing charges and possible fines.
The scandal has proven extremely costly to some firms, even those that have not yet been charged. Strong was named in the original complaint against hedge fund Canary Capital, but has yet to be formally charged.
Following accusations of wrongdoing by founder Dick Strong, the firm went on the block, looking to unload its assets by the end of 2003, with a price tag of around $1 billion. However, as of press time, a deal had still not been completed. The contest to purchase Strong's assets had reportedly been narrowed down to two suitors. Wells Fargo & Co. is the frontrunner, with Nuveen Investments still in the race. And Strong is now likely to fetch less than $500 million for its assets, according to recent reports.
Putnam Lovell estimates that the scandal has costs firms $4 billion in fines, settlement costs and lost revenue. However, that large sum is just the beginning, as a host of new measures pending at the Securities and Exchange Commission will ultimately jack up the cost of doing business in the fund industry, the paper concludes.
In addition, numerous other regulators are entering the fray, and even Congress is weighing in with its own solutions. The outcome will result in extensive costs that spread to all areas of the investment management industry, including hedge funds, consultants, institutional money managers and investors.
Legislation will transform the industry with better oversight and tighter controls of fees emerging. The elimination of trading allocations and the controversial soft dollars will slice into industry profits and "spur the growth of new wrap products," according to the study.
Without strong market gains, industry profit margins will contract. Firms are still going to have to pay a premium in compensation for highly qualified talent. Additionally, lower technology costs won't be enough to counteract the increased burdens caused by new compliance requirements. The elimination of soft dollars will also leave a gap, according to the study.
"The mutual fund scandal has caused deals to be delayed and derailed and due diligence to be extended," Chimberg said. "But once the situation is under control, the fund probe will accelerate the restructuring of the industry and lead to consolidating mergers and divestitures."
Chimberg said a very rough estimate puts the number of deals in the first quarter of 2004 at 20, significantly below this year's rate. However, Chimberg expects the year to be just as active as last year, only with a slower start, due in large part to the scandals in the fund industry.
Areas for Consolidation
Areas that could see consolidation include outsourcing, processing and financial technology firms, because they will feel the bite of increased regulatory costs and pressures on profits. Targeted acquisitions, including fund adoptions and product add-ons, will continue to fill in the gaps at firms looking to revive sagging business. Elsewhere, firms outside the U.S., mainly in Europe and Canada, will look to make large acquisitions inside the U.S. market as organic growth and local takeovers subside.
"If you are a small, mid-sized, or large retail money manager and you don't have great performance, you are far more challenged today than you were a year ago," Chimberg said. "Those firms, more than the strong performers, will feel the effects of the new regulatory environment and be at the center of industry restructuring."
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