US wealth management becomes hotbed of M&A
Buyout groups drive record dealmaking in fragmented industry catering for the rich
Private equity managers are driving rapid change across the US wealth management industry by turning multiple small providers into a few multibillion-dollar players.
America’s dynamic and entrepreneurial economy has produced a huge number of rich private investors who require sophisticated financial advice, which has led to the development of a vast but fragmented wealth management industry.
About $83tn is overseen by 12,578 wealth management companies, also known as registered investment advisers (RIAs) and including the likes of BlackRock and Vanguard, all authorised by the Securities and Exchange Commission, the US financial regulator.
Most RIAs are small businesses employing 50 or fewer non-clerical staff, according to the Investment Adviser Association.
“It has proved challenging for many RIAs to build businesses of real scale. Many have remained small franchises built around a single individual or a tight team,” says Allen Thorpe, a partner with Hellman & Friedman, the private equity manager.
Hellman & Friedman paid $3bn last year to buy Financial Engines, the largest US independent investment adviser with assets of $169bn. Financial Engines has been integrated with Edelman Financial Services, a $21.7bn provider of financial planning services to more than 35,000 clients which is majority owned by Hellman & Friedman.
“Wealth management is a growth area. There is more to do,” Mr Thorpe says in a clear signal more deals are likely.
More than 500 US wealth managers have assets of at least $1bn and most of these companies generate annual underlying earnings of at least $3m, according to Echelon Partners, a California consultancy.
“Given wealth managers’ ability to generate consistent cash flows and high rates of [asset] growth, private equity interest in the industry should continue to drive large scale M&A activity,” says Daniel Seivert, Echelon chief executive.
Many wealth management companies have been constrained over decades by a shortage of financing. Many banks avoided RIAs that own few in-house assets to pledge as security in the event of a default.
Banks also tended to overlook the recurring revenue streams provided by wealth managers and this allowed private equity managers to move in.
“Scale matters more than ever,” says Mr Seivert, adding that larger wealth managers benefit from cost savings and can afford better technology. They can also hire and better retain management talent.
The client base of the US wealth management industry is also growing rapidly. The number of investors receiving advice from RIAs has swelled by a fifth in five years, according to the IAA.
“Wealth management is an industry where we expect to see steady growth,” says Mark Vassallo, managing partner at Lightyear Capital, a private equity manager. “Retirement challenges, healthcare expenses and educational costs are all issues where Americans need financial advice.”
Lightyear acquired a majority stake in Wealth Enhancement Group in 2015.
Jeff Dekko, Wealth Enhancement Group chief executive, expects to see several $100bn national players emerge.
“The future growth opportunity is enormous and the runway is long,” says Mr Dekko. Wealth Enhancement Group has completed 10 deals and expects to close an 11th — Wiley Group in Philadelphia — in early June.
The number of acquisitions of US wealth managers rose from 57 in 2017 to 77 last year, according to Sandler O’Neill, the New York investment bank that maintains a proprietary mergers and acquisitions database. Smaller deals made up a bigger share of M&A activity — transactions involving RIAs with more than $1bn in assets fell to 19 from 24 in 2017.
Chris Shutler, an analyst at William Blair, the Chicago financial services provider, says that ageing leaders of wealth management businesses will look for ways to cash out of their business.
“We do not expect a tidal wave of activity but consolidation should be a consistent, gradual tailwind,” says Mr Shutler.
Mercer Advisors was bought in 2015 by the San Francisco-based private equity manager Genstar Capital. Since then, Mercer has acquired 21 wealth managers and boosted assets to about $15bn. Genstar has provided Mercer the capacity to acquire eight to 10 more RIAs annually.
Dave Welling, chief executive of Mercer Advisors, says that a larger RIA firm can provide in-house services that are unavailable at smaller boutiques, such as tax and estate planning. They can also secure lower transaction costs for clients when placing orders with broker dealers.
“One of the biggest constraints on growth for wealth managers is retaining talented people. We can offer better career opportunities so employees can move across the country to join other teams or to run new offices,” he says.
The most active acquirer is Focus Financial Partners, which was majority owned by Stone Point Capital and KKR until its stock market listing in 2018. Focus has completed more than 160 deals, including transactions in the UK, Canada and Australia, since it was founded in 2006. It has already closed 12 deals this year and signed a further 10 agreements. Focus has a $650m war chest after raising fresh capital during last year's market listing.
Rudy Adolf, Focus co-founder and chief executive, says it has identified about 1,000 new potential partners and these companies together could pursue about 5,000 mergers.
Although KKR and Stone Point helped Focus grow, Mr Adolf questions whether marriages between private equity and wealth management companies are stable long-term relationships.
“The wealth management company has no control over the transaction when the private equity manager decides to sell. Focus is providing permanent capital. This ensures an alignment of interest and allows Focus and our partner firms to share in the rewards of future growth,” says Mr Adolf.
Mr Shutler says potential partners could be attracted to Focus as a publicly traded company because they know they will not be sold on at a later date.
“As one of the best-known acquirers of RIAs, Focus is positioned to at least get a look from most sellers and has plenty of room to grow from here,” he says.
Private equity-backed acquirers face competition from specialist strategic buyers such as Captrust Financial Partners, Wealth Partners Capital, Mariner Wealth Advisors, Savant Capital, Bronfman Rothschild and Dakota Wealth Management.
These players can lack PE’s financial firepower but they can offer deal terms that may appeal more to sellers.
Captrust has acquired 33 small wealth managers in 12 years, taking its assets under management close to $10bn. Wealth Partners Capital has teamed up with California-based EP Wealth Advisors to do four deals. EP Wealth, which has about $4bn in assets, aims to reach $20bn by 2022 through a combination of organic growth and acquisitions.
Most transaction prices stay secret as number of deals soars
Frenetic deal activity has raised questions about the valuations being put on wealth management companies but detail about transaction prices is rarely disclosed.
In the largest RIA acquisition of last year, Hellman & Friedman paid $45 a share when it bought Financial Engines, a 32.5 per cent premium to the stock’s closing price just before the bid was announced. This translated into an enterprise value multiple to earnings before interest, tax, depreciation and amortisation of about 16.2 (based on 2018 consensus earnings forecasts) — a high valuation.
Mr Vassallo says deal prices have definitely gone up, materially cutting the prospect of immediate value creation from acquisitions.
“Given higher valuations, buyers need to think more strategically now about how to achieve economies of scale,” he says.
Higher valuations have also helped attract more sellers into the market.
“It is more challenging to make the deal numbers work now,” Mr Thorpe says.
But Mr Dekko counters it is “not clear” that valuations have risen to unreasonable levels.
“Deal multiples today are more consistent with the intrinsic value of wealth management businesses which command high levels of client loyalty and produce solid recurring revenues,” he says.