In every deal there's a sucker and if you can't figure out who the sucker is, there is a very good chance it's you. These days, many supposedly shrewd executives at the big Wall Street firms that were making billions slicing and dicing dubious mortgages and selling the pieces to institutions around the globe are finding that this favorite aphorism of Warren Buffett is hitting a little too close to home.
Ever since the subprime tsunami reared its hydra-like head late in July 2007, the financial advisor community has found reason to thank the powers that be for allowing most of the mortgage-related problems to sidestep their clients and their businesses. But as the credit crisis keeps metastasizing from one fixed-income sector to the next, one of the hottest trends in this business in 2007, advisory firms' own merger and acquisition activity, is suddenly becoming a victim of fixed-income market paralysis.
Of course, uncertainty in the financial markets and instability in the credit markets have triggered a dramatic slowdown in M&A activity across a wide range of industries. When Wall Street investment banks suddenly fail to sell six-month asset-backed commercial paper and auction-rate municipal securities that reset their interest rates every seven to 35 days, the notion of financing highly leveraged acquisition transactions over a period of several years appears fanciful. Add to that the swooning prices of equities in financial services companies and the financial alternatives grow even slimmer.
Registered investment advisors (RIAs) "have no subprime exposure but merger activity is going to be affected by what happens in the overall marketplace," says David DeVoe, strategic director of M&A at Schwab Institutional. Moreover, subprime problems have damaged the debt and private equity markets acutely and both are major sources of acquisition financing.
Frothy valuations of RIA firms-like most other businesses-are disappearing for the most part. "The cost of capital has gone up for everything" from homes to businesses, DeVoe adds. Debt financing, which frequently can play an important role in many advisor transactions, is in increasingly scarce supply as lenders focus on shoring up their balance sheets.
A weak equity market also is prompting many acquirers to view lofty valuations for RIA firms as dubious. Like it or not, many advisory firms' revenue streams is highly correlated to their assets under management (AUM). "It seems that the [equity] market will be flat to declining for the near term and perhaps for one or two years," DeVoe says. Take that steady annual market appreciation factor of 6% to 8% out of the equation, and whopping valuations become harder to justify.
Virtually every single breed of advisory firm acquirer-ranging from consolidators and roll-up artists to regional banks to larger RIA firms-is wrestling with its own set of financial issues these days. The two biggest publicly traded consolidators, National Financial Partners (NFP) and Boston Private Financial Holdings, have seen their market capitalizations cut in half over the last 12 months, albeit for very different reasons. But the net effect is that the value of their stock as acquisition currency has lost some of its luster-and most regional bank shares are in a similar position.
None of these developments mean that the economics of advisory firms have experienced a permanent, intrinsic loss of value. Indeed, the basic fundamental attractions underlying the advisory business remain as compelling as ever. But as the shine temporarily dims for financial assets of all stripes, RIA firms and others are feeling some of the ill winds.
Both NFP and Boston Private have managed to achieve something other consolidators have yet to do; they have taken their firms from private equity-backed acquisition vehicles into full-fledged public companies. Founded in the late 1990s, NFP acquired more than 200 insurance/estate planning firms, benefits provider businesses and financial planning firms and went public in 2003. Boston Private is an older business and was established as a hybrid regional bank/wealth management firm.
In its latest fiscal quarter, Boston Private, which traditionally paid top-dollar prices for high-quality advisory businesses, recorded financial results that were impaired by significant real estate loan writedowns, much of it on land loans in Florida and California. As with most real estate-related problems, the equity market clearly is wondering if Boston Private has adequately reserved against potential losses.