Debt-financed M&A may push firms to shed assets: Tibergien

The debt-financed, $1.2 billion acquisition of Avantax Inc. and its 3,100 financial advisors that Cetera announced last week is not only an indication of firms' interest in nabbing more and more wealth management assets, but also shows how using debt to fuel such deals could further reshape the financial advice industry landscape, according to one senior industry executive.

"Some debt is short and some of it is long, and keeping that in balance is a stress test for borrowers," said Mark Tibergien, who retired as CEO of Pershing Advisor Solutions in 2020 and is now a management consultant. "The implications are that some of these firms may think of divesting pieces of an acquisition to focus on core businesses.

"For example, say a firm did most of its acquisitions with firms that have clients in the middle market but wound up with an ultra-high-net-worth business, or clients with $30 million or more," said Tibergien, whose comments were about broad industry trends in the wealth management industry and not specifically about Cetera. "That’s a logical decision. Once a firm has been acquired, it has to be integrated and then grown or expanded. That means more resources will be consumed."

Cetera Holdings, a huge network of broker-dealers with 9,000 financial advisors and $341 billion in client assets, said last Monday it was going to buy publicly traded Avantax for $26 per share. The acquisition is expected to close by the end of the year, with Avantax operating as a stand-alone business under the roof of Cetera.

Following the announcement of the deal, two ratings agencies put the debt of Cetera's parent, Aretec Group Inc., on review. That means the company faces potential downgrades to its debt, which could drive up the costs of servicing its current debt and of borrowing more in the future.

"In deals like this, it is common for credit ratings agencies to place a company on watch or review, and even more common when a public company is involved due to the amount of information that is in the public domain," a Cetera spokesperson wrote in an email. "This is standard procedure to notify the public that the deal has yet to be reviewed, and to be clear, there is no change to our credit rating or our rating outlook at this time."  

Last Wednesday, Moody's Investors Service said it was reviewing Aretec debt for a downgrade, with its former outlook being stable.

"The $1.2 billion transaction value will likely require Aretec to issue a significant amount of debt to fund the purchase of Avantax, and could lead to a worsening in its debt leverage, interest coverage, leading to an overall weaker financial profile," according to Moody's.

But it wasn't all bad news for Cetera's parent company, the ratings agency noted. "The planned acquisition would add significant scale to Aretec's existing platform, since Avantax currently has over 3,000 financial professionals with almost $84 billion in client assets," Moody's reported. "Increased scale and the possible synergies that could exist from the transaction may provide credit benefits."

Last Thursday, S&P Global Ratings put Aretec's debt on its "CreditWatch" list.

"The CreditWatch placement reflects our expectation that Aretec's credit metrics could potentially deteriorate following its mostly debt-financed acquisition of Avantax," according to the ratings agency.

"Aretec has secured $2.7 billion of debt financing to fund the $1.2 billion acquisition of Avantax," S&P Global Ratings noted. "While Aretec's relatively low leverage (of four times debt to EBITDA, or earnings before interest, taxes, depreciation and amortization) provides some flexibility to take on additional debt compared with our downside threshold (of six times debt to EBITDA), we expect a meaningful deterioration in our adjusted leverage and interest coverage metrics given the large size of the Avantax acquisition.

"However, we cannot yet ascertain the full impact on the credit metrics because of the potential for changes to the funding structure and the uncertainty over the final cost of funding," the ratings agency added. "Furthermore, the company's plan to realize potential synergies from Avantax has not yet been fully detailed."

"The cost of money has risen so it's more expensive for firms to borrow," Tibergien added. "That said, there's quite a bit of capital in the market and debt is not permanent financing. But if it puts the balance sheet at risk, the ratings agencies will have something to say about it."