RIA merger and acquisition deals continue to be executed at the record pace that was set in the first quarter of this year, according to data compiled by Schwab. During the first three quarters of 2010, a total of 70 deals have been executed versus the high of 59 deals set during the same period in 2008. The YTD deals are also just one transaction shy of the 71 deals closed during the entire year of 2009.
(See a feature article from Investment Advisor on trends in advisor M&A from Mr. Devoe.)
So, why are we experiencing record M&A numbers, especially at a time when valuations are still below the historic average? Moreover, why is this happening at a time when so many buyers are on the sidelines (most banks are not engaged in RIA acquisitions and a few consolidators have suspended their M&A activity)?
This heavy flow is likely the result of a broader M&A trend surging through the industry, which is being further buoyed by a short-term surge of pent-up supply.
The industry is potentially halfway through a ten-year cycle of increasing M&A. This trend is the result of several factors including aging principals approaching retirement, investment from private equity firms, and the proliferation of consolidators. The fourth major driver, the growing M&A sophistication of RIA principals, is underscored by 2010 being the fourth successive year in which RIAs themselves have been the dominant acquirer category.
In many cases, the 2010 deals that would have occurred naturally are being supplemented by a number of 2009 transactions that were essentially delayed. Many principals stepped away from the negotiation table to tend to clients during 2008/2009 market decline (and rightly so),
but also did because of depressed valuations. Now that advisors are back to a ‘normal schedule’ they have time to invest in M&A strategy. As important, because valuations are off their recent nadir, advisors’ willingness to sell is improving.
Valuations will likely continue to increase if the growth rates of RIAs demonstrate a steady climb toward the high-teens or higher. As growth rates – and consequently cashflow – increase, valuations tend to swell. And there will likely be more potential sellers.
Further rationale for the surge of new negotiations that have recently taken place is reflected in the composition of sellers in each successive quarter of 2010.
Generally, smaller M&A deals take less time to negotiate, and this is exactly what has emerged in Schwab’s YTD data.
In Q1, 58% of the sellers had less than $250 million in AUM versus the historical average of 34% of transactions. In Q2, this segment was 48% of the transactions and in Q3 the number dropped to 44%. Smaller deals have been moving through the pipeline faster, but what Schwab calls the Large Seller segment ($1B+ in AUM) are now returning to their historic averages as well.
So will this upward trend of RIA M&A continue? This hyper-fragmented industry appears to be going through a natural, long-term evolution on consolidation driven by many of the factors highlighted above. Although we may see a cooling period after this influx of ‘delayed transactions’ works its way through the pipeline, the industry is likely to continue to experience accelerating consolidation for years to come.
(See Mr. DeVoe's recent blog focusing on advisor succession planning.)