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Independent broker-dealer M&A market is heating up

Jan 19, 2014 @ 12:01 am

By Bruce Kelly

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After a blistering year for mergers and acquisitions among independent broker-dealers in 2013, this year has already seen robust deal making.

Last week, RCS Capital Corp., whose chairman is industry upstart Nicholas Schorsch, said it was buying Cetera Financial Group Inc. for $1.15 billion and J.P. Turner & Co. for $27 million.

The two deals will add 6,925 registered reps and advisers to Mr. Schorsch's network of B-Ds when completed later this year, for a total head count of about 9,300.

More Info: The 50 largest broker-dealers ranked by head count

And earlier this month, SWS Group Inc., a clearing and retail securities firm with an independent-contractor broker-dealer, said it had received a takeover bid from one of its biggest investors, Hilltop Holdings Inc.

The hot start to buying and selling this year comes after five large independent-broker-dealer acquisitions were an-nounced in 2013. The firms totaled 1,960 reps and investment advisers, and had a combined $539 million in gross revenue (based on 2012 numbers — the last year fresh revenue and rep head count numbers were available).

Two smaller but noteworthy broker-dealer acquisitions were announced in June: Symetra Investment Services Inc. with 280 reps by John Hancock Financial Services Inc., and tax preparer Gilman Ciocia Inc. with 160 independent financial reps by National Holdings Corp.

Compare this with 2012, when three significant acquisitions of independent broker-dealers oc-curred. At the time those deals were announced, the three firms had $420.4 million in gross revenue and 3,530 reps and investment advisers.

MAJOR ACQUIRERS

Companies controlled by Mr. Schorsch — known as a nontraded REIT czar — along with Cetera Financial Group Inc. and Ladenburg Thalman Financial Services Inc., have been the three major acquirers in the marketplace with a tightening supply of firms, said Steven Insel, an industry veteran M&A attorney and partner at Elkins Kalt Weintraub Reuben Gartside.

“There are a lot of buyers chasing fewer sellers,” Mr. Insel said. “The question for sellers is if they are willing to sell because they have a distressed situation, like bad reps” that cost the firm because of arbitration awards that favor investors, he said.

“Often deals are done when the seller has problems or there is a succession issue,” Mr. Insel said. Insurance companies, which have tended to refocus on their core businesses since the credit crisis, also continue to look for buyers for their broker-dealers, he added.

“It's a comparative dearth of targets,” Mr. Insel said. “All of a sudden, buying [broker-dealers with $20 million in revenue] is attractive because there are so few candidates.”

NEW PLAYER

The biggest force driving the M&A boom is Mr. Schorsch, a newcomer to the independent-broker-dealer marketplace. He is chief executive of American Realty Capital as well as chairman of RCS Capital.

Through various businesses he controls, Mr. Schorsch last year engineered three broker-dealer acquisitions, pushing his way into a business that has long been dominated by major players LPL Financial, Ameriprise Financial Services Inc., Raymond James Financial Services Inc. and Commonwealth Financial Network. His aggressive start to this year shows he is far from done, said John Rooney, managing principal of Commonwealth Financial.

“We're seeing a couple of groups planning to take advantage of favorable capital markets and are buying assets,” Mr. Rooney said. “Through consolidation and scaling, a group can create an entity that can be a publicly floated financial company. Regarding an aggregator [executing that strategy], it remains to be seen if one can pull it off.”

After the announcement of each deal, Mr. Schorsch repeated his belief in the business model of independent broker-dealers and financial advisers, and the advantage of buying businesses that would benefit from a rise in interest rates. He also stressed that he wanted to acquire three broker-dealers, First Allied Securities Inc., Investors Capital Corp. and Summit Financial Services Group Inc., as part of a broader strategy to diversify his core real estate business.

Critics knocked the flamboyant Mr. Schorsch's newfound desire for broker-dealers as simply another outlet for him to sell his nontraded real estate investment trusts. Mr. Schorsch has repeatedly refuted such speculation.

Along with Mr. Schorsch, the other big buyer last year was Cetera Financial Group, which in 2013 acquired from MetLife Inc. two broker-dealers: Walnut Street Securities Inc. and Tower Square Securities Inc. Valerie Brown, CEO of Cetera Financial, was not available to comment on the deal with Mr. Schorsch.

With Cetera in Mr. Schorsch's pocket, the landscape for deal making potentially will shift.

Regardless, Mr. Schorsch said he expects another busy year in 2014 for independent broker-dealer mergers and acquisitions, with eight to 10 such deals during the year.

He said acquisitions will have two distinct characteristics.

The first group will be large companies such as insurers that continue to restructure and sell assets that are not a core part of their businesses. The second will be the industry upstarts such as RCS Capital and Ladenburg Thalmann Financial Services, which want broker-dealers that can fit together and work as a long-term bet on the financial advice industry, Mr. Schorsch said.

“I do think [M&A] activity will increase,” he said. “The economy is better, assets under management are growing and businesses have cleaned up their balance sheets.”

Conditions this year for a continued strong pace of mergers and acquisitions continue to resemble those in 2013, executives, recruiters and analysts said. Financing remains historically cheap. But business conditions are difficult.

Record-low interest rates have erased former profit centers of firms' lending on margin and pocketing spreads on client money in money market funds. And small to independent broker-dealers — those with fewer than 100 independent-contractor reps — and midsize firms with 101 to 500 reps continue to face high costs per head for compliance, supervision and technology.

RISING COSTS

Those costs have risen in the wake of changes by regulators after the 2008-09 credit crisis. Combined, the market collapse and rising costs have caused a shakeout in the securities industry. In 2008, the Financial Industry Regulatory Authority Inc. counted 4,895 broker-dealer members under its regulatory watch. As of last month, there were 4,180 registered broker-dealers, according to Finra's website.

“I expect similar issues going into 2014, and that will lead to continued consolidation in the marketplace,” said Dennis Gallant, president of GDC Research, a consultancy.

“The challenge for these small organizations is the question of: How do we get bigger faster?” he said. “Now there's a quick solution, and doing an acquisition or selling is a good alternative. That isn't changing.”

Since the credit crisis, insurance companies have been looking to sell their broker-dealers, and private-equity firms have been ready to buy. Mr. Schorsch's aggressive entrance into the business has upset that balance, said Jodie Papike, executive vice president with industry recruiting firm Cross-Search.

“The trend for the past year with larger broker-dealers is that ARC has been picking them up,” Ms. Papike said. “Before, we didn't have ARC with deep pockets to do deals quickly and pay top dollar. That changes the landscape.”

And Mr. Schorsch has been outspending his rivals, on a relative basis, when he buys firms. One multiple used in broker-dealer acquisitions is the price paid in comparison with the firm's prior-year revenue, or gross dealer concession, known as the firm's “trailing 12.”

In November, Mr. Schorsch's broker-dealer, RCS Capital Corp., said it was buying Summit Financial and its broker-dealer, Summit Brokerage Services Inc., for $49 million in cash and stock. That sum equated to paying about 67% of Summit's trailing 12, clearly on the higher end of the scale, which has ranged historically from 15% to 20% of trailing 12 up to 80%.

The multiple RCS Capital will pay for Cetera Financial Group is even higher, at 100% of the firm's estimated 2013 trailing $1.14 billion in revenue.

“I don't know if anyone can compete [with ARC and Mr. Schorsch] in 2014,” Ms. Papike said. “I'm sure they will continue.”

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