With the sixth successive record year of M&A activity in the registered investment advisor space, hitting yet another new record has essentially “become the expectation,” according to David DeVoe, founder of San Francisco-based investment bank and consulting firm DeVoe & Company, in the company’s fourth quarter 2019 Deal Book, released Wednesday.
With 132 transactions last year, a 31% increase over the 101 deals signed in 2018, mergers and acquisitions are not "more of the same,” DeVoe said. 2019 deal velocity accelerated to nearly three times the historic annual increases of 10% to 15%.
The past five quarters have each reached more than 30 transactions, and the increasing volume suggests the emergence of "a new normal,” DeVoe said. “There will be ebbs and flows of activity, but the evidence suggests that one might expect continued activity in the zone of ~30+ transactions per quarter, and perhaps a breakthrough into 40+ at some point” in 2020.
DeVoe said the pace of deals was a testament to the health of the industry, better than "a deluge of sellers flooding the market in a given year.”
Given that the industry boasts over 5,000 firms registered with the SEC with assets under management of over $100 million, there is room for 250 to 300 annual transactions, given principals' succession planning issues alone, he said. “That doesn’t account for the gravitational force of moving for scale,” a stated strategy that fueled half of the deals concluded over the past two years, DeVoe said.
One potential danger, particularly if the steady upward trajectory of the markets falters or the cost of capital increases, is that deal volume could overwhelm the current pool of capable buyers, crushing valuations and leaving many sellers without a ready buyer. “It would get ugly pretty quickly,” he said.
“Today’s M&A situation is reminiscent of that old scientific experiment with a frog sitting in a pot of water on its way to a boil. If you plan to sell, take note. Don’t be the last one out of the pot,” DeVoe said.
in 2019, RIAs and consolidators led the pack as “buyers of choice,” with a portion of deals rising 10 percentage points over the past four years to represent 83% of all transactions. RIAs led the pack with 60 transactions, or 45% of the total, up from 41 in 2018.
Banks, meanwhile, represented only 2% of the transactions in 2019, falling from 8% in 2017 and 2018; but bank acquisitions picked up slightly at the end of the year, accounting for 12% of deals in the fourth quarter.
DeVoe said banks were still spooked by “the psychological impact” of the breakup between $17 billion AUM Luminous Capital from First Republic Bank, which acquired the firm only seven years ago for $125 million, seen at the time as a rich valuation for an RIA.
DeVoe said that situation would likely have a “chilling effect” on banks' interest in the space “for years to come.” That, and another high-profile deal between a $1 billion RIA and a bank that unraveled at the last minute in 2019, are "a cautionary tale to anyone contemplating M&A,” adding that “although M&A has the potential to be a game-changing event, successful RIA mergers can only be achieved with deep strategic underpinnings for the transaction and true alignment of business and personal/professional gains." Otherwise, the company said, such a move “is the business equivalent of a time bomb.”
While the major deals of the year, the $26 billion Charles Schwab-TD Ameritrade merger and Goldman Sachs’ $750 million deal with United Capital, made the biggest headlines, the long-term effects of the deals on the RIA landscape are still up in the air, DeVoe said. The impact of the Schwab deal on advisors, particularly smaller firms who fear being left out in the cold after the merger is complete, is “overblown,” said DeVoe, while the Goldman deal was "underblown" and “should be causing all advisors to assess the evolving competitive landscape.”
Meanwhile, the AUM involved in the top 10 transactions shrank year over year to $233 billion, a “steep free-fall” from the $391 billion in 2018's top 10 deals.
Private equity investors emerged as a significant player in 2019 as well. Mercer Advisors and Wealth Enhancement Group put new PE capital to work by making over five deals each during the year, but it was publicly traded Focus Financial that did the most deals in 2019, inking more than 20 firms. HighTower, CAPTRUST and Wealth Partners Capital Group also put together more than five deals each.
DeVoe managing director Vic Esclamado said that these experienced acquirers “are benefitting from a virtuous cycle, related directly to their M&A success. Potential sellers are seeking the power of scale. Buyers with “M&A wear and tear on their tires” are also favored by sellers, many of whom look for buyers who have transactions under their belt, said DeVoe, with confidence that client transitions and business continuity will be successful.
2019 was also a record year for subacquisitions, or those made by firms that have themselves been acquired, with 31 transactions for the year, up nearly 35% over 2018. Focus Financial's model is driving that trend, and the model will benefit smaller RIAs who have no internal buyer or succession plan available to them, DeVoe said.
For deals with firms between $100 million and $5 billion in AUM, that trend toward smaller sellers contributed to a drop in average size of the subacquisition trend, DeVoe said.
The drop in size was also fueled by consolidators buying more advisors with less than $500 million in AUM. Seventy of the total 132 transactions undertaken in 2019 were in that category, and of those, 36 were in the $250 million to $500 million AUM range.
Seller size in the $1 billion to $5 billion category also shrank by 29% to just over $2 billion in 2019 from $2.9 billion in 2018, though there were more such transactions—25 in 2019 compared with 17 in 2018. The largest transactions stayed flat year over year.
Canadian firms made a bigger splash in the U.S. RIA M&A market in the second half of last year, with Canadian Imperial Bank of Commerce buying $1.8 billion AUM Lowenhaupt Global Advisors in St. Louis in the third quarter. It had previously acquired Atlantic Trust in 2013, with $8 billion in AUM, PrivateBank in 2016 and Geneva Advisors, with $8.6 billion in AUM, in 2017.
CI Financial of Toronto, a diversified investment and wealth management firm, purchased One Capital, with $1.6 billion in AUM, and $370 million AUM Surevest Wealth Management in December.
Bank of Nova Scotia could be another acquirer, as it announced plans in November to grow its wealth management business in the U.S. through acquisitions.
DeVoe said there has also been some cross-border activity initiated by U.S. firms; Focus Financial acquired three wealth management firms in the U.K. in 2019 after first making an acquisition in that country 12 years ago. “I think in many regards the (U.S. firms are) demonstrating the optimal way to help individuals manage their wealth and plan for the future, and Focus is bringing to this equation the ability to export some of the philosophical investment management principles that we have found helpful here.”
While overall valuations are at record highs, DeVoe said, the range of prices has expanded. “Not all buyers can ‘turbo charge’ the growth or margins of an acquired business, and in those cases, extremely high valuations are unjustifiable and less likely to occur.” Consequently, while it may be a good time to sell, a seller should not assume that buyers are paying record valuations across the board.