When David Devoe talks about mergers and acquisitions among RIA firms, advisers pay attention. A few months ago, Mr. DeVoe, director of M&A for Schwab Institutional of San Francisco, drew a packed house at a New York hotel when he addressed registered investment advisers about first-quarter deals.
He held his audience in thrall as he punctuated his crisp PowerPoint presentation with a dry wit and then answered no shortage of questions from the floor.
At the time, Mr. DeVoe thought it unlikely that the M&A market would reach last year's record high of 80 transactions involving registered investment-adviser practices.
A poorly performing stock market, the credit crunch and a scarcity of capital did not augur well for mergers and acquisitions, he observed.
"I think a lot of frothiness is coming out of the market," said Mr. DeVoe, who has also been director of practice-management programs at Schwab Institutional and responsible for product strategy for Schwab Private Client.
Indeed, the pessimism in the room was almost palpable.
Speaking of conditions at that time, Douglas Ramos, senior vice president and portfolio manager at TBP Advisors Ltd., a Purchase, N.Y., firm with $300 million under management, said: "Deals are getting delayed or not getting done. People are on the sidelines right now."
But it is funny how quickly a market can change. M&A activity in the second quarter proved much stronger than expected.
And in the final analysis, Mr. DeVoe thinks that 2008 may be a record year after all.
Q. What do your M&A numbers for the first half of the year show?
A.: The first quarter was actually weak, with only 10 deals, but that was offset by the second quarter, which saw 23 transactions. The total of 33 deals [through the first two quarters] is a record, surpassing last year's 30 deals. If we continue at this pace, we should have a record year.
Q. In light of what we are seeing in the market, doesn't that seem hard to believe?
A. Overall structural changes in the industry are likely to drive continued increases in mergers and acquisitions for the next five to 10 years. But market and industry events can affect any given quarter or year.
Q. What would those be this year?
A. The subprime situation has affected the cost of capital as well as access to, and the cost of, debt. It has also affected capital available to private access. And a volatile and declining stock market can conspire to put downward pressure on valuations.
Q. So why could we be looking at a record year for M&A activity?
A. The [type] of acquirers has changed over the first quarter. Holding companies have stepped back.
The assets-under-management holding companies like Boston Private [Financial Holding Inc.] and [Rockville, Md.-based] Convergent [Wealth Advisors LLC] acquired in transactions increased from less than 10% of the industry total in 2003 to more than 40% last year. But year-to-date, they've only acquired 15% of assets sold.
By contrast, activity by investment managers and other categories have increased dramatically. RIAs are acquiring or merging with other RIAs. And we're seeing more private-equity firms invest directly in RIAs.
Q. What happened to the holding companies?
A. Some are publicly traded, and their stock price has been pushed down, so it doesn't make sense for them to use that depressed stock price to finance acquisitions. That is taking some players off the table. Many sellers are also thinking in terms of 2007 valuations, while buyers are thinking in terms of 2008 valuations. And some holding companies are being patient to negotiate the right deal. I wouldn't be surprised to see holding companies become more dominant in the second half of the year.
Q. Why have the other categories picked up?
A. RIAs are becoming sophisticated in terms of their understanding of mergers and acquisitions. Consequently, you're seeing more transactions — and more-creative transactions.
Q. Can you give an example?
A. I think the merger of [San Francisco-based] Kochis Fitz [Tracy Fitzhugh & Gott Inc. and [Los Angeles-based] Quintile [Wealth Management LLC to form Aspiriant] is a good example. They wanted to solve some strategic issues, and it looks like they can accomplish that goal.
Q. Can you elaborate on that?
A. This transaction provided a succession plan and increased the pool of equity partners, thereby enabling the principals to achieve their goals of financing growth and staying independent. Additionally, the complementary value propositions of the two organizations is expected to enable each firm to serve their current clients better and eventually penetrate a broader set of clients in each of their original geographic markets.
Q. Why is the RIA market so attractive for private-equity firms?
A. There aren't too many industries that have 20% growth rates and 25% margins.
Q. In March, I interviewed a principal in an RIA firm who said that the lousy market has placed a "higher risk premium" on deals. If anything, the stock market appears to be getting worse. Will this hold back activity in the second half?
A. Ultimately, valuations boil down to three key concepts: cash flow, growth and risk.
The volatility of the stock market is a risk buyers may take into consideration. The industry is tied so closely to the stock market that it does have an impact on valuation.
But other factors will drive continuing activity, such as solid business, steady cash flow and high client- retention rates. And many firms see an opportunity to pick up clients from wirehouses and others whose clients may be shaken by the markets.
Advisers tell clients not to time the markets, and they shouldn't try to time the markets either. The decision to sell should be driven by strategic goals and objectives and what they hope to achieve with that transaction.
So is there downward pressure on valuations? Yes. Will it make or break a deal? Probably not.
In strategic terms, there is likely to be more to doing a deal than getting the top dollar.
E-mail Charles Paikert at [email protected].
