14 November 2005

"Mergers & Acquisitions of a new type shape the future"

By AMIN RAJAN

"Truth is rarely pure and seldom simple" mused the nineteenth century playwright Oscar Wilde. The same applies to the current wave of consolidation in the global fund management industry. Under the surface, it involves neither a creative destruction of excess capacity nor payments of "clean" cheques with no strings attached.

Furthermore, data from New York-based Freeman & Co show that the number of mergers and acquisitions worldwide has fallen since 2000, with the average value tumbling by a staggering 75 per cent, despite the bear market.

Valuation has been a major factor. Nine in ten fund managers in Europe and two in three in the USA are now owned by bancassurance groups. Having paid top dollar in the bull market, many are ready for face-saving offers after painful write offs.

Trade sales are few; prices have tumbled. For example, Prudential paid 10.3 per cent of funds under management for M&G in 1999; Insight paid 0.4 per cent for Rothschild Asset Management a mere three years later.

"To make today's acquisitions work, you often need a slash and burn strategy whilst at the same time scaling up the assets. After acquisition, the whole must be worth more than the sum of the parts," says Douglas Ferrans, chief executive of Insight, the fund arm of HBOS.

The 2004 merger between F&C and Isis is another exception that blends deal- making skills with hard nosed attitudes to integration. Its architect Robert Jenkins observes: "There is no shortage of industry opportunities to achieve economies of scale. There is an industry-wide shortage of the management ability and will to do so."

Deals that slaughter the sacred cows are still rare. But the "third way" is emerging in two well publicised cases. It shows that you don't have to own a cow to sell the milk.

The first of these covers the deal between UBS and Julius Baer. Bundling GAM with three private banks, UBS has divested its fund of hedge funds business in a complex deal that also leaves it with a 21.5 per cent stake in Julius Baer, which will either grow GAM through distribution synergy or streamline it.

The second one is the landmark Citi-Legg Mason deal. It proves that manufacturing and distribution no longer have to be joined at the hip: they can be swapped within a complex alliance of the type commonly seen in oil and auto industries.

In the wake of regulatory brush offs, Citigroup has eliminated perceived conflicts of interest in two bold strokes: moving research out of investment banking and manufacturing out of fund management; thus focussing on distribution and back office services. It will also take a 17 per cent stake in Legg Mason which, in turn, will become a pure play manufacturer, backed by its new partner's distribution network of 13,500 brokers.

Over time, each side will doubtless rationalise its chosen area. But Legg Mason's task will be the harder, despite paying less than 1 per cent of funds under management. Front office integrations have proved far more daunting than the mid office ones, if examples of mergers that created Merrill Lynch Investment Management or Morgan Stanley Investment Management are anything to go by.

Legg Mason faces five challenges: how to streamline its vastly expanded product portfolio; how to create a boutique model that harnesses the talent of its front office teams; how to ensure that its renowned investment culture is not overly diluted by newcomers; how to integrate support functions; and how to maintain performance in the transitional phase.

Aberdeen Asset Management's acquisition of Deutsche Asset Management's UK business is another landmark deal: acquiring expertise rather than scale or market position, and linking the price to customer retention.

It, too, faces formidable challenges in retaining and motivating the top fixed income managers at the centre of the acquisition. Leap frogging competitors in the league tables comes at a price, as does the buccaneering leadership style which served it well when it had Pounds 28bn in funds under management. Scale creates complexity where the old ways of doing things rarely work.

Amvescap, another quoted pure play manufacturer, has stumbled from pillar to post in the last three years. It, too, made daring acquisitions in the 1990s but hubris prevented it from revitalising the senior executive gene pool and adopting new ways of doing things.

Yet, it would be naive to suggest that the old ways of acquisitions are over. The recent takeover of the Framlington Group by Axa Investment Managers shows that a price premium (3.5 per cent of FUM) is justified, if it guarantees skills that run with the grain of market needs.

Prof. Amin Rajan is the CEO of CREATE, a research consultancy: amin.rajan@create-research.co.uk.

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