HUNT FOR HEDGE FUNDS MOVING INTO HIGH GEAR: MATCHMAKERS SNIFFING OUT HOT DEALS IN VOLATILE FIELD RIPE FOR CONSOLIDATION

Murat “Hal” Davidson was “flabbergasted” when an investment banker approached him recently about selling $200 million-asset Regan Partners LP, the New York hedge fund firm he serves as managing director. “We’re just a speck on the map.”

Mr. Davidson declined the offer, but he’s part of a little-noticed trend: The once-exotic hedge fund has become a tempting acquisition target among Wall Street investment bankers who are hot for fresh fees as mutual funds, brokerages and insurance firms consolidate. And there’s plenty of pickings: Hedge Fund Research Inc. in Chicago estimates there are 3,000 such funds, including offshore ones.

One New York investment banking boutique, Berkshire Capital Corp., believes a few deals are imminent. Berkshire already has brokered a sale this year for a firm that derives about 30% of its revenues from hedge fund fees: Client Essex Investment Management Co. — a mutual fund firm known for managing the personal account of President Clinton — announced last month plans to sell a 68% stake to another Boston company, Affiliated Managers Group, for $120 million.

Peter Bain, a managing director at Berkshire, says the investment bank also is negotiating the sale of two firms that manage hedge funds. He declines to name the firms, but did say he’s trying to get the deals done in a month.

“Once you have three deals announced in the first quarter, people tend to take a look,” he says.

The hedge fund industry is ripe for takeovers, as many of the owners are approaching retirement age. And though assets in hedge funds are growing rapidly (to $368 billion through September of last year, compared to $39 billion at yearend 1990), most lack the marketing support a large firm could provide.

At the same time, mutual funds, securities firms, banks and insurance companies that cater to the wealthy and institutions want to expand their own asset management capabilities. Plus, they know that hedge funds can make almost obscene fortunes by charging
a 1% management fee, plus 20% of a client’s annual total return.

“Therein lies the attraction for acquirers,” Mr. Bain says.

Firms likely to prowl: large private banks, such as Northern Trust of Chicago and New York-based U.S. Trust Corp.; New York white-shoe investment banks Goldman Sachs & Co. and Morgan Stanley & Co.; and institutional firms with large mutual fund businesses, such as San Diego’s Nicholas-Applegate Capital Management, Alliance Capital Management LP of New York and Pacific Investment Management Co. LP of Newport Beach, Calif.

the dealmakers

And the usual suspects probably will broker the deals: asset management specialists like Berkshire Capital, Goldman, Lazard Freres, Putnam Lovell & Thornton and Merrill Lynch & Co.

Although few foresee a plethora of deals, experts agree the industry will see consolidation, following the merger wave that has swept the rest of financial services.

Interest among acquirers also has been spurred by recent changes in regulations that allow hedge funds to attract more than the old limit of 99 shareholders. The industry is “facing the same maturation issues their counterparts — conventional asset managers — are facing,” says Bradford I. Hearsch, a managing director with PaineWebber Inc.’s investment banking department.

Mr. Hearsch acknowledges that PaineWebber is currently not involved in any potential hedge fund transactions. However, many of his asset management clients view hedge funds as a hole in their businesses that they want to fill.

Several problems have stalled action so far. Evaluating hedge funds is tough. They are far more volatile than traditional mutual funds. Bidding is likely to start at nine or 10 times pretax earnings, the going rate for mutual funds, but then the prices figure to go down depending on the target’s volatility. Jeffrey Lovell, managing director in the Los Angeles office of Putnam Lovell & Thornton, points to such problems as reasons why he is far less optimistic that deals will be announced this
year.

As Regan’s Mr. Davidson puts it: “You’re buying the potential revenue stream of some fickle genius who’s up one year and down another.”

Besides, he says, hedge funds are only successful when they are run by “egomaniacs” — maverick entrepreneurs unlikely to sell out simply because of pride. He’s skeptical about acquisitions heating up, suggesting investment bankers are blowing smoke trying to generate deals.

Investment bankers acknowledge that the feature of the performance fee, which doesn’t kick in when hedge funds lose money, is unusual and makes pricing a fund difficult. And they agree that deal-hungry but stodgy executives at a huge institutional company or bank may lose their appetite once they consider the substantial risks — or simply meet hedge fund firm owners.

most-admired men

Many are men who emulate megastars like George Soros, chairman of Soros Management, who was accused of multibillion-dollar currency speculation that brought down the Asian markets and whose bet against the pound almost broke the Bank of England, and Jeffrey Vinik, the former manager of Fidelity’s market-moving Magellan Fund who now runs his own firm, Vinik Asset Management.

Persuading such owners to sell might take some orchestration. But investment bankers thrive on a simple motto: Every man has his price.

“A lot of people believe (hedge funds) are one-man bands, so dependent on the personality of the owners,” Mr. Bain says.

“That sentiment is accurate,” he continues, “but people said that about Michael Price and John Templeton” — two of the best-known mutual fund entrepreneurs, who sold out to Franklin Resources Inc.