M and A

The Winners & Losers in Recent US Wealth Management M&A Activity

Chris Owen 9 July 2007

The Winners & Losers in Recent US Wealth Management M&A Activity

The completion, on 2 July, of both Bank of America’s $3.3 billion acquisition of US Trust Corporation and Bank of New York’s $16.5 billion takeover of Pittsburgh-based Mellon Financial, was a red letter day for the US financial services industry.

The completion, on 2 July, of both Bank of America’s $3.3 billion acquisition of US Trust Corporation and Bank of New York’s $16.5 billion takeover of Pittsburgh-based Mellon Financial, was a red letter day for the US financial services industry. But was it just random coincidence or do these twin deals and other recent transactions reveal any underlying movements in the wealth management sector? WealthBriefing spoke to Robert Ellis, senior analyst at Celent, the global financial services research and consulting firm. “I don’t detect any common themes in terms of the purchasers, but rather a series of different themes. Perhaps the only real thread is that we seem to be hitting the top of the cycle and some of these firms may not be worth as much again for a five to seven years period. So there is clearly an incentive for sellers to realise their current value,” said Mr Ellis. BoA’s all cash deal for US Trust, the wealth management subsidiary of Charles Schwab, will create the largest manager of private wealth in the US. Based on assets under management by private banks, Bank of America is currently the second largest manager of private wealth in the US, while US Trust is the fourth. The combined entity will be first, according to Bank of America, with a total of $265 billion in assets under management. Schwab first bought US Trust for about $2.8 billion in 2000, but the purchase never worked out well for the mass discount brokerage and the segment has the worst pre-tax margins of any of Schwab’s three business segments. “I see this essentially as an opportunistic deal,” said Mr Ellis. “US Trust never really fitted well with Schwab. Schwab wanted out and knew it could deploy its capital better somewhere else. At the same time the BoA brand is seen as down market and does not sit well with the high net worth segment. So it made sense to acquire penetration and a brand to leverage into this market. “What makes less sense is BoA’s decision to rebrand the new operation as US Trust, Bank of America Private Wealth Management. This could wipe out all the advantage of the US Trust brand and destroy the value in the deal. Clients liked the history and cachet of US Trust but the brand is now at risk of being damaged twice – firstly by Schwab and secondly by BoA,” he added. The Bank of New York Mellon Corporation, the new, combined entity created by the $16.5 billion stock merger of Bank of New York and Pittsburgh-based Mellon Financial, will be the world's largest securities-servicing company and have greater assets under custody and administration than any other bank, with over $18 trillion of administered assets. The acquisition combines Mellon's wealth management business with Bank of New York's corporate services and government bond clearing services, giving the combined company an extremely diverse business mix and leading positions in most of the sectors it competes in. The new entity will rank as a top ten US wealth manager with more than $160 billion in client assets and as a leading US cash management and global payments provider. In addition to asset management and securities servicing, the company is the largest provider of corporate trust, depositary receipts, clearing and shareowner services. “This deal is simply a scale play,” said Mr Ellis. “The custody and securities businesses have very low margins. They needed to scale up to be able to set the prices for the industry. The combined business is now so much bigger than State Street. They have paid fully for Mellon but they will now have pricing power and may be able to reverse the 20 to 30-year decline in margins.” Wachovia Corporation announced on 31 May that it was to acquire St. Louis-based brokerage firm A. G. Edwards in a $6.8 billion cash and stock deal to form the second largest retail broker in the US after Merrill Lynch. The combined brokerage unit will operate as Wachovia Securities, headquartered in St. Louis, and will have more than 3,300 brokerage locations nationwide, more than $1.1 trillion in client assets and nearly 15,000 financial advisors, according to Wachovia. A.G. Edwards was founded 120 years ago and was regarded as the quintessential regional US broker. “The Wachovia deal was sold as all about scale, but it is all about ego,” Mr Ellis commented. “Wachovia wants to be taken more seriously. It was the number four wirehouse and this deal will make it number two. If Wachovia didn’t have sufficient scale before to do what they want, why should the AG Edwards acquisition make a difference? Wachovia will have to close about 120 offices and staff numbers are almost certain to slip due to some expected attrition. Wachovia is already having to pay very heavily to retain advisors. When Wachovia announced the deal, it said it would create the second-largest retail brokerage firm in the US, and that is what it is all about." Chicago-based wealth manager Nuveen Investments is to be acquired for $6.3 billion in cash by a private equity consortium majority-led by Madison Dearborn Partners and including Merrill Lynch and Merrill Lynch Global Private Equity, Wachovia and Wachovia Capital Partners, Citi, Deutsche Bank and Deutsche Bank Investment Partners and Morgan Stanley. The price, including existing debt of $550 million, is a premium of 20 per cent over the last closing price of Nuveen's shares. The firm had $166 billion under management at 31 March 2007. “This strikes me as a typical private equity overpayment deal,” said Mr Ellis. “They have paid a 20 per cent premium at the top of the market. Added to this, Nuveen is heavily weighted towards the municipal bond market and may be in for a rude shock if the US Supreme Court rules against the current exemption from state income tax for bondholders buying an issue from their state of his residence. This may put in jeopardy one of the main selling points of municipal bonds and could blow up the Nuveen business model.” Less obvious perhaps is Citigroup’s $680 million acquisition of US-based Automated Trading Desk (ATD) to boost its automatic trading technology offering to brokers. ATD, which will operate as a unit of Citi’s Global Equities business, adds a network of broker-dealer customers to Citi’s base of institutional, broker-dealer and retail customers. Citi said it intends to use its global capabilities and expand ATD’s technology and trading expertise to markets around the world. It is the latest in a series of acquisitions and investments Citi has made in recent years to strengthen its electronic and alternative execution business. These acquisitions include Lava Trading, Knight’s options market making business, TD Waterhouse Capital Markets and the OnTrade ECN. “This is a ‘jump start’ deal. Citi has little organic growth in any of its main businesses and the stock price is flat,” Mr Ellis said. “I see these technology moves as an attempt to goose the stock price because technologies carry higher multiples. Citi can’t buy anything big in US retail banking or brokerage, and has retreated from insurance. In fact, they’re still selling retail banking branches, so it now wants to transform itself into a technology company. I think this could have a negative impact on the trading organisation as a whole. When you buy a platform you are tied in, but don’t you want to be best of breed?” Asset manager BlackRock last month acquired the fund of funds business of the Quellos Group, a Seattle-based boutique investment firm in a $1.7 billion deal. The acquisition will give BlackRock a fund of funds operation of more than $25.4 billion. Under the terms of the agreement, the Quellos Group will receive $562 million in cash and $188 million in BlackRock stock. The acquired company could receive as much as $970 million in cash and stock over the next three years, based on performance targets. According to Mr Ellis: “This deal makes sense because it fills a product gap. BlackRock was lacking a complete fund of funds offering. The acquisition was properly priced. They didn’t overpay and it has filled a gap. It makes good strategic sense.” Another transaction that gains Mr Ellis’ approval is Merrill Lynch’s decision to make a non-controlling investment in Sterling Stamos Capital Management, a private investment firm that manages more than $4 billion in assets on behalf of HNW individuals and institutional investors globally. Founded in 2002, Sterling Stamos invests in alternative and traditional assets – absolute return, fixed income, public equity, real assets and private equity. Sterling Stamos, which has offices in New York, California and Tokyo, will remain independent. “This is a smart deal,” said Mr Ellis. “Merrill has taken a minority stake and it has paid a fair price. They will be able to access each other’s clients and products and it should bring mutual advantages from which both will benefit down the road. ”

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