Advisors May Be Selling Their Own Firms Short
If merger mania isn't sweeping the financial advisory business, interest in it is. That was the message that Mark Hurley, a consultant with JP Morgan Asset Management and a senior advisor with Headwaters AB, a Denver investment bank, had for attendees at JP Morgan's annual wealth management conference in Chicago in early May.
Hurley and JP Morgan Managing Director Sharon Weinberg are in the process of updating a study he authored five years ago on the future of the advisory business. "The first ten people we interviewed all asked how much they could get for their firm," he remarked. If an advisor wants to sell his firm, it will probably take from six months to two years to complete a deal.
Most transactions are likely to be legacy deals, or sales to employees. "These represent the lowest risk-adjusted prices you will get," said Hurley, a former Goldman Sachs merger specialist who has consulted on a few deals himself. "They [employees] think they deserve the business, they know its strengths and weaknesses and they know you. If it blows up, your firm is shot. It's almost a suicide pact." Moreover, it's quite possible that employees may purchase firms from the founding partners and turn around [and] flip them.
If that's not enticing, getting acquired buy a financial buyer isn't much better. "This industry is besieged with financial buyers," Hurley contended. "Why? Because there is a disconnect between the public and private markets. They can get $15 for the cash flow they pay you $5 for. The roller-upper adds no value, but gets 40% of the economics of the business."
Additionally, roll-up style financial buyers are under heavy pressure to keep growing faster and faster, to go public and subsequently support their stock price. Otherwise, the deal will implode.
And it gets worse. The economics of financially driven acquisitions are stacked in favor of the buyer, which typically uses a class of cumulative preferred stock to acquire a majority, say 60%, of the firm, according to Hurley.
After dissecting the economics of a few transactions, Hurley found some eye-opening details. "A financial buyer will tell you that you are getting a 56% internal rate of return (IRR) for the firm," he explained. "What they won't tell you is that that they get a 118% IRR. They love all-stock deals where they put [in] no cash, keep most of the return and give you all the risk."
One of the biggest risks for advisors who sell is that the buyer never goes public, but instead sells in desperation to another financial buyer who dilutes everyone. "To go public you must do 70 to 100 deals," Hurley claimed.
If one of those 70 firms turns out to be toxic, it can derail an entire IPO. "You sleep with everyone they [the buyer] ever slept with," he quipped.
Hurley had one final prediction. "At some point, custodians will have to start buying advisors' firms because they are in a precarious position," he argued. "Big RIAs will be able to cut out custodians."
SEI To Open Franchises Targeting The Affluent
SEI Investments has introduced a new franchise business model that it says will be focused on the special needs of affluent clients.
The SEI Wealth Network franchise program will include expanded resources and expertise in areas touching upon branding and marketing, case management, operations and technology, and practice management, according to the company.
SEI officials say they've opted to pursue a franchise strategy-a model not normally seen in the financial advisor market-in an effort to leverage its brand, operating platform and practice management expertise.
"It was really the perfect business model for the scope of the relationship we were striving to achieve," says Michael Farrell, the SEI vice president heading the franchise program.
SEI has launched with four franchise advisors in Little Rock, Ark.; Bala Cynwyd, Pa.; Long Meadow, Mass., and La Jolla, Calif.
"We've developed a solution that independent advisors can seamlessly implement to reach and serve the most desirable clients possible," says Carl Guarino, head of the SEI Advisor Network. "Although other companies may claim to provide this kind of solution, research has shown that the needs of wealthy clients are still largely unmet."
The new business model, according to SEI, is based on an emerging new "wealth code" that is more focused on life goals and problem-solving rather than just asset growth.
The company says it hopes to roll out 200 Wealth Network franchises over the next four to five years.
Acquisition Fever Hits Advisory Business, As Edelman Sells
The sale of a majority interest in Edelman Financial Center, a Fairfax, Va.-based financial planning firm headed by planner, author and media talk show host Ric Edelman, to a Houston-based financial services holding company is the latest in a series of acquisitions of advisory firms in the past nine months. Other recent deals include Wachovia Wealth Management's acquisition of Waltham, Mass.-based Tanager Financial Services last fall, and Compass Bancshares' acquisition of Stavis, Margolis Advisory Services in Houston earlier this year.
What surprises some observers is that many of the largest firms in the business are engaged in acquisition negotiations. Edelman manages $2.6 billion in assets, Tanager manages $2 billion and Stavis Margolis oversees $500 million. Other firms reportedly seeking to acquire advisory businesses include Boston Private Financial Holdings and Focus Financial, a New Jersey firm affiliated with the Summit Financial Group and with Jessica Bibliowicz's National Financial Partners. In recent months, there have been unconfirmed reports that former Charles Schwab & Co. CEO David Pottruck has explored raising a fund to roll up advisory firms, although sources say he decided against it.
Edelman's purchaser, Sanders Morris Harris Group Inc., a publicly held company listed on the Nasdaq, has purchased a 51% interest in the firm and will buy the remaining shares over the next five years, according to a recent announcement by both companies.
The value of the acquisition could be up to $128.5 million, depending on whether or not certain financial targets are reached over the next five years, says Edelman, who owned 100% of the company before the deal. The value would be about an equal mix of cash and SMGH stock.
The purpose of the deal was to bring in a partner to help the Edelman Center pursue aggressive growth strategies, Edelman says. Edelman has a staff of about 82 and about 7,200 clients.
"We recognized about a year and a half ago that for me to continue being able to grow I needed the resources of a larger partner-someone with management experience and capital that could apply it to the growth and development of our business," he says.
Edelman has signed a four-year employment agreement that will have him continuing to operate the company as chairman and chief executive and become one of SMHG's largest shareholders. However, he expects to remain longer. "They've expressed an interest in my staying beyond four years and I have no plans to do otherwise," he says.
In an open letter to clients, Edelman adds that Ed Moore will remain president of Edelman Financial Services and will take over as chief operating officer. Edelman says SMHG was chosen from a pool of 45 candidates that included big-name banks, insurance companies and brokerage firms.
Edelman also said it would be continuing its relationship with its broker-dealer, Royal Alliance, and that all EFS's planners have signed long-term contracts to continue working at the firm.
Edelman is among the largest firms in Royal Alliance's network. "I think it's fabulous," says Mark Goldberg, president and CEO of Royal Alliance. "It underscores and gives credence to the fact that independents have the ability to build equity and build a practice that has intrinsic value."
The deal brings SMHG's total assets under management to $10 billion. Edelman's 2004 revenues were $17.7 million and its pretax net income was $3.2 million, adjusting for one-time expenses. SMHG, whose CEO is former Prudential Securities CEO George Ball, provides investment banking services. Its operating entities are Sanders Morris Harris, Charlotte Capital, Kissinger Financial Center, Pinnacle Trust Co., Salient Partners, SMH Capital Advisors and Select Sports Group.