Introducing Forte Asset Solutions
Forte has retained the database of Kenyon Prendeville and all previous registered buyers information has been maintained to provide ongoing service and communication.
Forte will continue to offer all the previous services of Kenyon Prendeville, and we will enhance these services over the coming months. We are confident that we will provide the same or greater level of service to our clients, the industry and the wider community.
Thank you for your continuing support.
Forte Asset Solutions
Tel: 1300 858 996
The GFC Hangover Continues:
The financial services industry is yet to fully recover from the global financial crisis, with most financial planning businesses operating at 20% below their 07/08 highs. Little to no new business is being written, aside from cash. Concerns about European sovereign debt, a US double-dip recession and largely unprecedented debt levels have resulted in little market confidence. If that wasn’t enough there were geo political concerns and social unrest with the removal of long term regimes in the Middle East as well as recent rioting in London.
From Forte Asset Solutions’ perspective, most financial planning businesses are still operating with the same personnel and infrastructure of 2008, yet on diminished turnover. We attribute this current financial backdrop as the single biggest contributor to the increase of supply or number of practices coming to market in recent months.
Over the financial year 2010/11, we experienced a 100% increase in the number of business currently “in Market” against any other period over the last 8 years.
The main reason (56%) is that businesses are financially stressed. This is characterized by the dissolution of partnerships, bank instructed sales, divorce and the search for a growth partner.
A growth partner is an individual or an entity that not only brings equity to the table but also has the ability to leverage earnings and profitability normally via aggregation or the adaptation of a new business model. Often this involves funds management and the ability to access all or additional parts of the value chain.
Financial stress has occurred because the average historical contribution of new business is 20% to Gross Revenue. The average profit or EBIT has also been 20% which directly corresponds to the average profit or EBIT. Therefore in the absence of new business, there is the absence of profit.
The second most common reason is leaving the industry and in contrast to expectations the average age is mid 40s. These business owners have become disillusioned and seek alternative industries or lifestyles. Whilst full retirement is still a factor for realisation many are still deferring due to reductions of revenue and therefore sale price. However as investment professionals we know market timing is a dangerous strategy as potentially when market and revenue recover there will also be organic growth and potentially diminishing demand and greater supply as those deferred sales come to market in a rising interest rate environment and against a potential new industry focus on profitability valuations and not recurring revenue.
There has also been a significant increase in the sale of “C & D” clients. The main motivation for this is that some principals are looking to reduce borrowings or to take a portion of capital off the table, to support lifestyle or reinvestment in the business. Many book sellers look to streamline their service offer, pricing and compliance and wish to focus on only the A & B type clients. There is a significant disparity in the pricing of a book of C and D clients and the sale of a full book or business. A book of C and D clients is achieving 3 times recurring revenue yet a business including A and B clients as well as vendor retention is averaging 3.3. Why this imbalance? The answer is demand. There is significant demand for small books, <$300k recurring revenue that can just be picked up and dropped into existing infrastructure, creating full utilization of the buyer’s team, no vendor or staff costs and the prospect of new business generation. Yet the acquisition of a full book or business represents better value with engaged clients. The size of the transaction is likely to be larger and for client retention to be optimised vendor and key staff retention is critical and therefore there are additional costs associated with a business buy versus a book buy.
There are buyers for both businesses, just at the moment we have significant demand at the lower end and this is creating the distortion and whilst small book multiples are not expected to fall, full business books could justifiably increase with the quality of clients and strength of revenue.
We continued to see registered buyers increase over the financial year, adding some additional 120 registered buyers to our existing 2000 buyers. We did however witness a decline in the last quarter of the financial year and into the 2011/12 financial year.
When markets started to fall in April 2011, we saw less demand for larger practises and an increase in demand for smaller books. The exception to this was a couple of the Institutional groups who completed some significant acquisitions.
However what we also witnessed is similar to the property market, that those sellers who did not have to sell simply held on and that is why the market valuations have experienced little movement.
2010/ 2011 Market Prices;
In the last 6 months of 2010 and early 2011, we witnessed media reports claiming the widespread collapse of business values in our industry. We are here to report that the reality is vastly different to these reports with one exception.
On the release of the Bowen Report, over the Anzac weekend 2010, we saw the immediate collapse of values for Corporate Super business. Normally these businesses / books achieved around 3 times, however higher prices were sometimes achieved depending on the relationship, member demographics, service offer and value of the group life contribution to total revenue.
Our reality is that there are no buyers and fewer lenders for this type of business now. If there are buyers, they are applying a discount factor for the legislative risk of up to 50% or, in other words, buying at 1.5 times Recurring Revenue. However, sellers remain confident the income stream will continue beyond the 18 months (1.5 times = 18 months revenue stream). So many are now holding the asset and treating it like an annuity or plan to come back to market when the legislative environment and impact to revenue stream is known or vendor’s have transitioned the revenue stream to fee for service. The groups that specialise in Corporate Super are paradoxically experiencing exponential growth as they move to fee-for-service models and enhance member services. Due to this organic growth they have no need or desire to acquire.
Whilst we have experienced a substantial increase in supply, we have correspondingly seen similar growth in demand. This is another reason why the price equilibrium is being maintained.
Businesses that have been sold have traded within a tight range, as evidenced by the historical performance and continue to do so –
***Please note, that the above excludes businesses in administration or receivership.
Economics 101 states price is primarily determined by supply and demand, as evidenced above. The release of the AFA adviser research The Tides of Change, sponsored by NAB Financial Planner Banking and prepared by CoreData/Brandmanagement, provides great insights as to future market conditions with:
· 61.4% are concerned that regulatory change will endanger adviser profits.
· 56.9 % of respondent anticipate that future legislation will have a negative impact on them.
· 22% of Practice Principles see a strong negative impact on them
· 47.1% of Practice Principles see a negative impact on them
· 8.9% very likely to sell within the next 2 years
· 12.2% likely to sell within the next 2 years
· 8.5% very likely to leave the industry within the next 2 years
· 8.5% likely to leave the industry within the next 2 years
Whilst there is some pessimism regarding future legislation and the likely impact on future profitability, this has not led to, and remains unlikely to lead to, a mass exodus from the market.
The anecdotal evidence over the previous 7 years, indicates a normal market has about 10% of total practices selling within any given 12 month period. So the above “likely” and “very likely” to sell within 2 years is within normal market trading range. Therefore we do not believe the current demand and supply equilibrium will alter despite the opinion of some media commentators who have reported a crash of valuations below the 3 times level currently enjoyed. The same alarmist comments were made with the introduction of FSR and they never came to fruition. As an industry we have always been able to adapt to change, however begrudgingly, and there is no reason to suggest this will not be the case again. Some say it is the sunset on the industry and others the dawning of a new age. From our perspective we envision a positive future.
On the demand side “77.8% they are likely to grow the business within the next 2 years and more than one third 37% are very likely to do so” (AFA White Paper, The Tides Of Change). Organic growth is preferred 75.7%, while finding the right client base is perceived as the biggest challenge to achieving growth.
This suggests to us that demand will remain constant, or even increase, if the current market conditions continue to stay relatively static and there is very little organic growth. It is worth restating – In the absence of organic growth inorganic strategies come to the fore.
About 50% of practice principals believe Earnings before Interest and Tax and after Principle Remuneration (EBITAPR) is the best valuation methodology to use. Historically, however, our experience is that only 6% of transactions have been on a profitability measurement and if this methodology was to be more common, then many businesses would be challenged to maintain their current enterprise value. However 50% also said they preferred recurring revenue as the valuation methodology and if there were to be 2 buyers and each adopt different methodologies and there is a material price gap, but no qualitative or cultural preference, then the highest commercial price will always win. There has always been a close relationship between the two methodologies with more profitable businesses being afforded higher recurring revenue multiplies. It is often not about the targets business profitability, the issue is the total combined entities profitability after loan repayments that purchasers should focus on.
Financiers look to debt serviceability. Whilst access to finance has become more difficult with the retraction of one significant lender and tighter lending criteria shown by all (1.75 times your recurring revenue and 1.75 times your target businesses recurring revenue or 60% LVR) it is still accessible. The increased conservatism shown by lenders is a good thing for purchasers as their acquisitions are more prudent and viable than perhaps when it was easier to access funds.
Whilst future legislation remains a risk to valuations, it should be remembered the proposed legislation is also creating greater barriers to entry to the industry, which is always price affirming. While on the consumer side, increased education, awareness and confidence will also promote growth in participation rates, from 2 in 10 Australians receiving advice to maybe 3 or 4. All of this indicates significant growth for our industry and individual practices.
In summary, Forte Asset Solutions continue to see no fundamental shifts in the supply/demand equation. There will be some consolidation, with large businesses getting larger. All participants in the industry recognise the need for scale to remain competitive, but we are confident that practices will adapt and increase their enterprise value as they focus their management on better policy, procedures, people, pricing and profitability.