Valuations in a pandemic: Full Report Below
What a difference a week, a month and a year can make.
Early March I was on the speaking circuit with the IFA Strategy Days and another conference and spoke in front of more than 600 advisers in a two-week period.
Then mid-March I was contemplating the future of our industry and my business within it. The phones had died and the deals in play had lost momentum. I was already working from home due to a self-imposed quarantine given my previous two weeks of ten flights and a cough.
We are now back in full swing with all transactions in progress and moving at an accelerated rate.
This one week from doom to boom experience can be solely credited to the Governments stimulus initiatives. The subsequent return of confidence was significant and at that time expressed immediately via the ASX bounce.
Valuations had already been impacted by last year’s revelations (see Dec 2019 Commentary). On the handing down of the Hayne Report on February 4th, 2019 the fear factor for the industry was at an unprecedented level and did trigger a rush to the exit. However that rush became a trickle on the assessment they many businesses were not ready to go to market and the subsequent reduction of fear due to the return of the Coalition government, the 80% plus pass marks for FASEA Code of Ethics examination and the potential movement of the FASEA degree qualification requirement timeline from 2024 to 2026.
However, a word of caution on the extension to the 2026 date , it has not been approved by the Senate and as to whether they can re sit in May and then if this issue is going to be treated as a priority item are all problematic. Any expectation of an extension to the FASEA Code of Ethics exam timetable also needs consideration. The best risk management strategy is to not assume an extension, how-ever reasonable it is to expect one.
In 2019 Maintainable Recurring Revenue was being segmented. Fee for no service having zero value. Grandfathered revenue fell from two times to zero but with contractual upside with a rise in the deferred consideration if this revenue was migrated to annual renewal. Risk recurring revenue, due to the ASIC LIF review was being priced around 2.5 times, down from the historical 3.5 times.
Most valuations considered or where solely appraised on a profitability/EBIT methodology depending on the size of the business. The average EBIT valuation was and is 6 times. Buyers seek free cashflow after debt servicing unless it is a lifestyle asset (provides a job and revenue for an individual)
The industry’s 2019 downward pressure was also due to some part AMP’s revision of four times Recurring Revenue under their Buyer of Last Resort to pricing up to 2.5 times Recurring Revenue.
2019 saw the banks move from being historical buyers to sellers with billions to be paid in remediation. Distribution channels inverted from circa 70 % Institutional owned or aligned to approximately 70% “Independent” or nonaligned. This was a seismic change that created the mass migration of advisers in 2018/19 and continuing into 2020.
Many Dealer Groups reassessed their business models given their high reliance on platform/product rebates and other deemed conflicted revenue. The assessment for many Dealers was that practices below $400k in gross revenue did not equate to an appropriate risk and return ratio and these practices were deemed no longer viable given the infrastructure required to service these practices appropriately. We saw significant increases in Dealer fees and in some cases the weaponising of compliance to force removals. For many practices they found the economics no longer worked with PI increases (30% in 18 months) and likely further increases in the year/s to come, Dealer Fee increase (25% plus), loss of historical revenue and the need to invest in education, compliance and new client value propositions. Many decided the only option was to leave the industry.
Approximately 5,000 advisers left our industry in 2019 but from Forte’s perspective we did not see a lift in business sales. This is largely because those that left or were forced to leave were salaried bank advisers, or advisers with revenue streams that were small and treated in many cases like annuity streams. These advisers either walked away and handed their clients to associated advisers or for a few that did transact these were handled internally.
These practices did not come to the open market.
It has been reported that an additional 2,000 advisers have left year to date in 2020. But again, I believe most of these departures are of the same cohort as the departures of 2019. Thus, we have not seen an increase in supply of businesses for sale – in fact, the opposite.
Many business that were considering selling in 2019 deferred their sales on advice and began re-engineering their businesses to annual re-engagement, fixed fees, outsourced asset management, introduction of MDA/IMA/SMA platforms for back office efficiency. New client value propositions were introduced with the adoption of new technology.
We saw this happen during and post FOFA where again the common belief was there would be a huge exodus, but the reality was better businesses emerged after adaptive structural change.
Supply has decreased over the last two years – I believe the best analogy is our market is much like the property market when it experiences devaluation of asset value – from a sellers’ perspective – if you don’t have to sell you don’t.
We have checked with the leading financiers to our industry and all reported they were below their target levels and substantially below 2017/2018 transactional history. The lack of supply is counter intuitive to the industry belief that supply would be at an all-time high.
Buyers believed there would be significant buying opportunity at reduced price levels creating the widest gap seen between price offered and price expected. Serious, not opportunistic buyers very quickly discovered the reality that good profitable businesses were in fact in very short supply. Buyers were and are still waiting with the expectation of a future increase in supply however I think that wait maybe very much a medium- to long-term reality. Most likely as we draw closer to 2024/2026, supply will increase but it should be remembered that many business owners who do not seek to satisfy educational requirement will look to elevate themselves from face to face advise and take more of a CEO or Chairperson role and sell down equity to the internal or new advisers. So again, bargain shoppers are likely to be disappointed.
What does this mean for the market now in the middle of another and very real health and financial crisis.
We need to look at demand and why it is constant. The cost of business is going up and the need for scale for profitability is more essential than ever. We have the lowest interest rates in our living memories and finance and capital are very accessible. Banks are still lending but timelines are going to be impacted as personnel are seconded to assist with the governments small business stimulus loans – hundreds of thousands of applications were received in the first two week of the stimulus package release. Additionally, banks seek to understand what the COVID 19 pandemic has meant for the underlying clients regarding employment and income. CRM systems need to capture client occupations. Offshore capital will be inhibited by the FIRB requirement for a 6-month review of all foreign acquisitions irrespective of size.
Deal flow will be slower due to the bottle necks and at reduced levels.
We have yet to see distressed sales and it will be unlikely that we see any great increase due to over geared businesses with declining revenue. There is likely to be more partnership and matrimonial sales as evidenced in every previous stressed environment and especially as we work remotely and live in closer proximity.
We will see more Superfund M&A activity as they face increased redemptions with exposure to illiquid assets with written down valuations. Some will also look to diversify risk by mixing underlying member industry occupation.
The previous recession of the early 90’s was a boom time for our industry as superannuation funds were released and the need for advice on a mass scale was never greater.
Previously self-directed investors will seek advice in a low interest rate environment, product proliferation and with property and equity market valuations oscillating. It is very easy to think you do not need advice when markets are lifting your portfolio values – “a rising tide lifts all boats”.
Trust, confidence and growth in the advice profession was already returning at the end of 2019 and the beginning of 2020 and this will be further exacerbated by the current need for advice. MLC commissioned a report conducted by Business Health that showed more than 2.1m Australians sought advice in 2018 a growth of 31% and I suspect this trend continued into 2019 and further exacerbated in 2020. ASIC did a survey of Australian consumers that was released in August 2019 that showed 41% of respondents intended to get advice and of those 25% intended to get advice in the next 12 months. This growth was well underway before our current crisis.
Financial services went through our annus horribilis in 2019 and we are now seeing green sprouts of organic growth emerging. These are not our darkest days; we have already experienced the worst and are now better positioned to deliver value.
Most practices have transitioned to fixed fees over the last few years and have not been financially impacted by the market devaluation. An excellent report by Adviser Rating titled Australian Financial Advice Landscape published in December 2019 and commissioned by Vanguard found in 2019 69% of advice practices had fixed fees, 24% Hybrid pricing of asset based and fixed and only 7% fully asset-based fees. Most businesses had already substantially reduced risk to economic and market movement and the flow on effect to revenue and profit and this is affirming for enterprise value.
Clients have over years been well educated as to why they have diversified portfolios and that they were built for a market shock, we just didn’t know what the trigger event would be, we just knew there would be one. Most of us thought it would be a Trump tweet.
All the advisers we have spoken to in the last month have reported extreme levels of proactive client communication. For some this is the first time they have gone on mass to their clients via webinars, podcasts, emailed video, Zoom/Skype meetings, and the like.
This proactive service delivery is affirming for client retention and attraction and as an industry you have stood tall in a time of great need.
EY released a report entitled 2019 Global Wealth research which found the preference for in person or phone interactions down from 35% in 2016 to 22% in 2018. Further it found 47% of Australian respondents prefer mobile apps up from 12% also Australians use of Fintech to increase 53% in the next three years.
Businesses and clients are embracing technology, the workplace will change, rents will likely be lower, less floor space less with less personnel. The medium for client communication has forever changed and efficiency and profitability gains will be made as we respond to this crisis and beyond.
Digital video meetings are not only great for efficiency but also when recorded enhance compliance. Additionally, when a practice comes to sell, they can literally show their clients, their advice and the relationship they enjoy with the client.
I expect new capital to appear in the search for industries that are some-what COVID 19 and recession proof. Financial Services and specifically advise has changed for-ever, we are emerging from monumental disruption and are investment worthy whilst at the same time serving a growing market and a greater good.
Our immediate futures maybe unknown on a day to day or month to month basis but in the medium term we will come out of this with better businesses, closer client relationships, known and respected service offers, greater barriers to entry, less participants, businesses demonstrating growth, greater governance and all this is affirming to current and future valuations.
There is no oversupply, valuations have not collapsed and if anything, there is upward pressure.
Good profitable businesses will always be in demand.
Forte wishes you, your family, and your businesses good health.
Steve Prendeville | Founder and Director