Forte Asset Solutions
The expertise of Forte is forged from the personal experience of Steve Prendeville selling his own national Dealer Group and Financial Planning Business Deloitte Financial Services in 2001 when he was a partner of Deloitte Touche Tohmatsu. Steve was the founding partner of Kenyon Prendeville in 2003 and in May 2011 Steve sought to evolve the business model to the next level and created Forte Asset Solutions.
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Forte Asset Solutions
Tel: 1300 858 996
Market Commentary for the Calender Year 2013 and Trend Identification for 2014 and beyond:
Market Freeze due to Political Inhibitors
The year for merger and acquisition activity came to a crashing end before it had really begun. When Prime Minister Julia Gillard called the election on the 30th January to be held September the 14th, the market for financial services businesses went into an immediate hold pattern.
We had the looming delivery date of 1st July for the Future Of Financial Advice ( FOFA) reforms, which dominated business focus and investment internally, coupled with the additional uncertainty of who would be in political power by the end of the year and what legislation would remain or be repelled.
The Labour leadership created even more uncertainty until June the 27th when Kevin Rudd returned as Prime Minister and on the 4th of August called the election date of 7th September 2013.
The country was in an involuntary investment freeze during this period of uncertainty, but we, as an industry, struggled with the additional uncertainty of FOFA.
This period saw few buyers and even fewer sellers. The reason was directly due to FOFA – there was the inability for the industry as a whole to be able to comply with the annual fee disclosure requirements as Customer Relationship Management (CRM) systems did not, and many still do not, actively integrate with revenue systems. For the first time ever, most practices found themselves potentially non-compliant.
The underlying theme was that If your house is not in order, you do not go and buy another – so this substantially diminished demand.
On the sell side, there was the unknown of how much revenue was at risk due to annual fee disclosure and what the impact would be on the actual price received for the practice, if they were to come to market and sell.
This freeze also impacted the movement from Dealer to Dealer post the 30th of June due to the nebulous interpretation of “new arrangement”. The industry was split in relation to legal advice received to the interpretation of the regulations, with 70% thinking this did refer to the relationship between Dealer and Authorised representative and 30% believing it did not.
What this did was engender the thinking of – if you didn’t have to move or sell you didn’t. The truism of “if in doubt, stay out” absolutely describes the prevalent sentiment witnessed.
There were a couple of significant exceptions with Westpac’s acquisition of Lloyds $8.4 billion loan book for $1.45B as Lloyds departed Australia after repeated annual losses. The other transaction was the three way bidding war entered into for Trust Co with Perpetual being the eventual winner at $250m and IOOF acquiring Trusts Co’s stake in Equity Trustees. Financial Index acquired Finovia and ILH acquired Capricorn and Pentad.
Dealer valuations, especially for mid -sized dealer groups, collapsed. This was due to many reasons – certainly due to the unknown ability to generate future revenue post July 1, the inability to recruit existing practices, higher professional indemnity and compliance costs leading to margin compression and with a backdrop of collapses and ASIC actions heightening risk assessment. There was also significant focus by the majors on integration of previous acquisitions and some anticipation of acquired asset write downs from the original purchase price.
We saw the collapse of AFS, AAA and Chambers and Enforceable Undertakings given to Commonwealth, Macquarie, Wealthsure, Lionsgate and the folding of Whittaker McNaught into Financial Wisdom.
Additionally, the indefinite suspension of the planned merger between SFG and WHK did nothing to lift the cloud cast over the industry. SFG share price appreciated over the year whilst WHK/Crowe Horwath declined dramatically.
There were significant management changes in bank-owned wealth management channels and this saw the cessation of the war between the Institutions in relation to adviser retention and attraction. The cheque books were put away.
A predatory view was taken. Why buy a Dealer Group when you could wait for a collapse and cherry pick the practices you wanted?
The exception to the above was the sale to SFG of Lachlan Partners in February and the continued share price appreciation of SFG, which has inspired many to potentially follow the business model and seek similar success.
There are about 160 dealer groups currently operating in Australia, according to a Senate report on the sector. There are just over 18,000 financial advisers in Australia working for 749 advisory groups, operating more than 8,000 practices.
The largest 20 dealer groups are responsible for about 50% of the financial planning market.
Around 85% of financial advisers are associated with a product manufacturer, either as self-employed advisers operating a dealer group’s licence or as salaried representatives of a dealer group.
Many commentators spoke of the end of “independents” or boutiques. However, Forte believes that we will see a significant return to the equilibrium we have previously known with break-away groups from institutions expected in coming months.
The move to non-institutional distribution will be fuelled by the actual or perceived breach of culture of previous management, with new management taking a position that principals of practices are not clients of the Dealer but employees of the institution. Directives are being given and perceived as not respectful nor in clients’ best interests.
Additionally, many practices will find themselves in 2014 out of their retention periods from previous acquisitions and with stronger equity markets and growing revenue streams buoying revenue and profitability.
There has been a significant lack of investment or delivery in the area of technology by many. This means that primary platforms are now not delivering to expected service standards. Their cost and service are seen to be uncompetitive and perceived as no longer in clients’ best interests.
Principals are very aware of their fiduciary responsibilities and the need to be competitive to grow.
Institutions enjoy scale benefits to be cost competitive, but many mid-sized Dealer groups are likely to form collectives, pool their resources and outsource certain functions and intellectual property to each other with a view to staging a fight back against margin compression which has threatened their very survival.
This fight will be assisted by technology to lower the cost of delivery and maintenance, as well as allow retention of profit with the adoption of vertically integrated business models.
Technology and Platforms.
We have seen substantial price revaluation in the area of listed technology players such as Praemium (share price 6 cents to 16 cents) and Hub 24 (30 cents to $1.40) as well as the successful capital raising of One Vue and the continued growth of Powerwrap and Linear.
Worksorted cemented its value proposition with its ability to meet Annual Fee Disclosure requirements.
The most active M&A area of financial services was in the area of technology with Ironbridge’s acquisition of Bravera Solutions, IRESS’s acquisition in the UK of Avelo financial Services for A$361m, Rubik Financial acquisition of Coin desktop for $26.75m and also the acquisition of Provisio technologies. AMP acquired Tranzact as well as other SMSF aligned businesses of Super Concepts and Supercorp. AWI acquired 49.6 % of Van Eyke research in April 2013 for $13.3m and Fairfax Media acquired online broker InvestSmart for $7m.
The concern Forte has for the advice industry is that few practices seem to be actually attracting new business as equity markets continue to gather momentum. Practices are beneficiaries of existing asset growth but not new Funds Under Management (FUM).
The lead indicator for Forte is the employment market. There appears to be no wage push concerns and no shortage of talent. This is a reflection of the little organic growth we are witnessing.
The dominant flow of funds seems to be in the area of SMSFs which may or may not have the benefit of planner advice as well as many new entrants also competing in the same space.
Mortgage brokers like Yellow Brick Road and Mortgage Choice appear to be beneficiaries of new business with Mortgage Choice having to defer their planned 2013 launch of their financial planning services simply because they cannot meet the demand already being experienced and cannot employ quick enough to meet the demand.
Other Mortgage participants will follow the example, buoyed by significant new mortgage business being written and having the ability and desire to invest and expand their service offer and capital value.
Accountants need to and will move to protect their participation in the growing SMSF sector. The pricing of SMSF audits (average $3,000) is under threat by technology or product provider subsidised offers. For client and revenue retention they will be pushed into acquisition or merger activity. There were significant joint ventures entered into in 2013, but there are also many who are unsatisfied by the outsourcing solution and will seek to bring the advice service in-house.
Industry Funds continue to grow membership but are losing FUM at the back end; this is estimated to be in the vicinity of $8 billion last year, primarily to the SMSF industry. Industry Funds have been attracting experienced management over the years and they recognize that there is a significant need and opportunity to have a meaningfully presence in the advice market.
We are seeing groups like Coles Myers and others with expansive client bases and brand recognition enter the financial services industry with home, car and pet insurances, credit cards and, at some stage, products with limited or full advice. Other branded businesses will enter the market and leverage their client coverage.
The direct market will also continue to grow with disintermediators like Aqua 2, now renamed ASX Managed Fund Service (AMFS), becoming available in the 1st quarter of 2014, and the continued growth and understanding of Exchange Traded Funds being great enablers for self-directed investors.
With more choice is the need for more advice. However, it may be scaled or limited advice pertaining to portfolio creation and not maintenance, with only irregular reviews required as circumstances change. Business models need to adapt to the changing consumer.
Valuations of Practices.
For primarily the FOFA reasons nominated above, we saw a fall in demand and, correspondingly, prices offered. The fall was approximately 30% or from 3 times to 2.5 times for full business sales. The market for C and D client bases which has been in high demand for the preceding 2 to 3 years reduced to 2 from 2.5 times, as revenue maintenance was deemed at risk.
Sellers took a view that if they didn’t have to sell, they wouldn’t. So Forte witnessed the greatest divide in the 11 years of deal facilitation between offer and acceptance – with few acceptances and, therefore, diminished transactional activity. What transactions did occur experienced significant time delays as negotiations faltered or greater due diligence was entered into. For transactions that Forte did facilitate, the average Recurring Revenue multiple for metropolitan practices were at 3 times and 2.75 times for regional practices, but there was greater flexibility shown in deal structure or contractual agreements.
Deal structure flexibility was expressed by the amount paid up front (70% instead of 80%), with longer periods to full payment (2 years instead of 1 year).
Narin De Saini of Xavier Drake Lawyers, who almost exclusively represents all of Forte’s clients reported –
For transactions where sellers were not operating under a dominant fee-only model, we saw greater scrutiny of the definition of recurring revenue used in contracts.
This was coupled with caution in ensuring that the benefits of conflicted remuneration were addressed in contracts, properly grandfathered and brought into earn-out calculations whenever intended. Where the parties needed to liaise with dealers and product manufacturers, this tended to add to completion lag times.
This caution also resulted in greater due diligence of revenue-arrangements, buyers’ servicing strategies after completion and the transferability of grandfathered conflicted remuneration – sometimes adding to transaction costs and usually stretching the time from the signing of a term sheet to closing.
The use of normalisation in transactions (which aims to address a seller’s earn-out risk associated with a buyer’s inability to service acquired clients) featured less often in 2013 deals.
This may have been the symptom of greater and longer principal retention in larger transactions, making normalisation inappropriate, and more acquisitions of passive client books, where pre-completion servicing by a seller is minimal.
Normalisation clauses were still seen in purchases of actively serviced client books and in acquisitions of going concern businesses with shorter principal retention periods.
We also saw greater use of transition plans and integration committees by sophisticated buyers and sellers, even in smaller transactions, who were keen to preserve client retention and transaction value.
Contractual flexibility was evidenced in stronger warranties and indemnities being provided and reduced principle retention remuneration.
However the supply and demand equilibrium quickly reversed post-election. Demand was quickly restored and further strengthened after Arthur Sinodinos’ December FOFA reform statements providing greater clarity and confidence.
Demand has been restored, however supply has not yet followed suit. The reason for this is that most businesses have not complied with annual fee disclosure requirements and there is still broad uncertainty associated with revenue maintenance.
Also, Institutions were very effective in their acquisition programmes and some business-owners accelerated their exit strategies in 2011 and 2012 given the prices and terms offered. This impacted normal accepted market flow of 5% to 10% of practices seeking to sell annually.
2013 was a buyers’ market for the first time ever. However, this was short-lived and we expect that 2014 will revert back to a sellers’ market given the current scarcity factor.
2014 and beyond.
The market was artificially suppressed in 2013 and Forte expects there are many sellers who have been timing their exit and holding back for the opportune time. The current market is optimum as there is significant scarcity in the market and this will impact pricing and bring it back in line with historical precedence. Additionally, most market commentators are predicting continued share market growth and the environment seems conducive to revenue consistency or growth for the next 12 months and beyond.
Buyers are coming back to the market, including listed financial services groups and the emergence of new buyers, such as accountants, seeking to protect and grow their SMSF offering. We also expect to see Industry backed boutiques, private equity, mortgage brokers and Dealer groups emerge as buyers.
The majority of buyers we are seeing at the moment are Independents with their own funds management and administrative platforms seeking to acquire $100m FUM practices with principal retention offering premium prices on transitioned FUM, as well as practices seeking tuck-ins of $20 to $50 million.
We expect institutions to assist existing practices and will be back in the market, but not to the levels seen in 2010 to 2012.
The technology sector is expected to be very active in the coming year and beyond as there are few leading technology providers and the growing recognition by all parties that new technology is the great enabler.
The new generation of administrative platforms are well positioned for future growth and the Institutions, with the exception of BT, do not seem to have the courage or ability to evolve as they seek to maintain their existing margins for as long as possible. However they will not be able to stem the tide and, at some stage, will need to build, acquire or partner with the next generation platforms.
The new platform providers represents a disruption to the status quo and will fuel Institutional break-away groups, the growth and resurgence of mid-sized Dealers due to lower cost, margin participation and higher acceptance by consumers.
The launch of Domacom in 2014 represents, for the first time locally and globally, the potential for advisors and investors to personally choose direct fractional property. This is an evolutionary response to the failure of large diversified property trusts with Domacom providing investors the ability to personally select property and create their own portfolio of multiple properties. The structure also provides liquidity and the removal of the risk that the dominance of holding single individually owned property has in a client’s portfolio. For Financial Planning practices, this will enable the ability to grow the client value proposition and correspondingly revenue.
As an industry, have we ever really been truly independent if we haven’t been able to advise on direct property. This represents a new asset class and a new opportunity.
Forte is participating in a national roadshow with Domacom in March to all capital cities where we will be speaking in greater depth about the year of 2013 and the opportunities and trends identified that will impact practice valuations in the future. For more information go to http://www.cvent.com/events/fractional-property-investment-conference/custom-40-5879f4b7bf684a93a8aac5e91d3ab48b.aspx
Forte is the industry’s litmus test for M&A market activity and the above supply comments are best illustrated by Forte current reality that we need businessesto take to market and represent with hundreds of unsatisfied buyers across the country and all of Forte’s current listed businesses under offers or in advanced discussions. To reflect the imbalance of supply, Forte is for the first time offering a discount of 20% on our success fees for those businesses that register for sale in February (a minimum fee condition applies which can be discussed on enquiry).
The Year of 2014 holds great promise to unshackle ourselves from the multiple burdens faced and met over the past 6 years. Businesses have emerged after the hardest and longest period of stagnation and attack ever seen in our 30 year young industry. The saying of ‘what doesn’t kill us makes us stronger’ is evident. There will be more competitive challenges than ever before but, as an industry, there is new courage, conviction and innovation. Better business models have been built and designed to capture the next wave of a consumer-lead revival. 2014 holds great promise.