RJ buy may be tough sell to Keegan reps

MAR 09, 2012
During a conference call with analysts and reporters last Thursday, executives from Raymond James Financial Inc. made their case for acquiring Morgan Keegan & Co. Inc. Now they have to persuade Morgan Keegan's brokers of the virtues of the deal — and that might be a tougher sell. Industry observers agree that the key to the $930 million buyout is getting the brokers to buy into it. How they react to the merger over the next few weeks — and how many choose to stay or leave the firm — will largely determine whether the acquisition proves successful. “They have to make sure they bring over the revenue generators,” said Joel Jeffrey, an analyst with Keefe Bruyette & Woods Inc. who is maintaining his “market perform” rating on Raymond James. Moody's Investors Service is similarly concerned about the risk of defections. It cited the potential that financial advisers might flee as a reason for putting Raymond James on review for a possible ratings downgrade. “I think most advisers here want to stay,” said Eddie Lyons, a managing director for Morgan Keegan in Shreveport, La., and an adviser with the firm since 1991. “If Raymond James makes an acceptable offer, they will stay. If they lowball it, there may be some key people who move.” The firm has earmarked $215 million for retention purposes — a figure that “seemed a little low,” according to Mr. Jeffrey. However, Morgan Keegan has $200 million in retention money already in place, bringing the combined pool to about 50% of the brokers' total revenue, which seems more reasonable to Mr. Jeffrey. About $140 million of the new money will target advisers, with the remainder going to traders and managers of Morgan Keegan's other businesses. Raymond James executives acknowledged that they have their work cut out for them. “The piranhas of the recruiting world are attacking from all directions,” said Tom James, Raymond James' chairman and the son of one of the firm's co-founders. “Our position is that we have to earn the affiliation of our financial advisers every day,” he said. “Everyone will benefit from this merger, but it will be a frenetic time of uncertainty and we'll have to do our best to deal with that.” Recruiters, who have managed to move only a few Morgan Keegan advisers out of the firm since it was put up for sale in June, aren't throwing in the towel.

RETENTION MONEY

“The retention money [Raymond James] is offering the advisers looks significantly lower than what their competitors are offering,” said recruiter Rick Peterson, who has been in discussion with seven Morgan Keegan advisers. “If they offer 65% to 70% of production to the top producers, it will pale in comparison to what they can get in the market. Raymond James will have to make a compelling case to brokers on why they should join.” Raymond James isn't taking any chances. The firm's chief financial officer, Jeff Julien, indicated that adjustments were built into the deal that would lower the purchase price if key revenue producers in the wealth management and capital markets businesses didn't stay with the firm. A spokesman declined to provide additional details.

OUT OF CHARACTER

Raymond James has been known as one of the most conservative firms in the brokerage industry since its founding in 1962. But the Morgan Keegan acquisition is admittedly out of character. “This transaction is a little different from what Raymond James is known for,” chief executive Paul Reilly said during the conference call. “But every 10 or 20 years, you find a unique opportunity.” The price tag isn't exactly conservative, either. Raymond James is paying $930 million for Morgan Keegan — a $230 million premium over the book value of the firm. Keegan's parent, Regions Financial Corp., also will pay itself a $250 million dividend from the brokerage before the deal closes. Raymond James plans to finance the purchase with a $900 million bridge loan that it will pay off with the proceeds from a $600 million bond offering and a $300 million sale of stock. The deal solidifies Raymond James as one of the largest non-Wall Street firms in the industry and a bona fide powerhouse in the Southeast. “It's as close a fit culturally as you can find in the South, and we're very pleased about that,” Mr. Lyons said. The combined firm will have 6,147 financial advisers with annual revenue of $4.2 billion and pretax income of $587 million. The deal also beefs up Raymond James' capital markets business, making it the eighth-largest underwriter of municipal bonds in the country. The deal introduces a whole new element of execution risk to a firm known for its dependable growth in revenue and earnings over the years. “The history of mergers in our industry has not been good,” Mr. Reilly said. True to form, Raymond James has mapped out a conservative model for the combined companies, projecting no earnings accretion from Morgan Keegan this year, and just 2% to 3% next year. Those estimates are based on the dismal market environment, but if the equity markets improve and the yield curve steepens, the upside from the transaction will be “tremendous, “ Mr. Reilly said.

REASONABLE PRICE

Mr. Jeffrey said that at 1.3 times tangible book value, the price seems reasonable. Regions Financial has agreed to retain the potential liability for $1.5 billion in losses suffered by investors in the Morgan Keegan mutual and closed-end funds that were heavily invested in mortgage-backed securities through the financial crisis. The firm paid $200 million to settle Securities and Exchange Commission charges last year, and class actions against the firm remain outstanding. “If they hadn't gotten indemnification on the liability, I would have been more concerned,” Mr. Jeffrey said. Raymond James' management is estimating cost synergies from the deal of between $50 million and $80 million but said that it is in no rush to realize those savings or to push Morgan Keegan advisers to a new operating platform too rapidly. “We'll get costs out deliberately, but we'll start with strengthening the platform and integrating people into the firm,” Mr. Reilly said. [email protected]

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