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Acquisition Premium Basis Could Shift

Asset management buyers beware. The high premiums that acquirers have been willing to pay for growth-style or publicly-traded firms may soon prove to be too high, as these two brands of asset management firms may soon be out of favor.

This is the conclusion of a recent analysis of merger and acquisition valuations by Putnam Lovell Securities of San Francisco. The report, "Asset Manager Style and M&A Valuation: Transaction Pricing Rotates in Synch with Market Styles," was published in August. It was written by Neil Epstein, vice president and director of research at Putnam Lovell.

Growth and value styles of asset management have been falling in and out of favor with investors in three-year cycles, the report said. Fixed-income investments might also join the cycle, Epstein said in an interview. In addition, publicly-traded versus privately-held ownership models have traded places as the preferred, and more profitable, method of ownership, Epstein said.

The overall market is also affecting prices, the report said. When the market is doing well, buyers are willing to pay higher prices for asset management companies, Epstein said.

The pricing premium for growth managers may not last, the report said.

"Acquirers of value managers should be opportunistic to take advantage of discounts," the report said. Value managers have been forced to sell at low prices because the style has been so long out of favor, the report said. The report urged acquirers to take advantage of the fact that such companies have been weakened by the prolonged poor performance of value funds.

Acquirers consider the long-term when they make a multi-million-, or multi-billion-dollar purchase, Epstein said. This long-term investment view would render these short-term cycles moot, he said.

Nonetheless, current or recent performance figures cannot help but have an impact on negotiations and prices, Epstein said. Sellers can use performance to their advantage and buyers should be aware of the impact of performance so that they do not overpay, he said.

"Because an acquirer is taking a big bet, they can't help but view strong recent performance as an asset," Epstein said. "It's part of the confirming process that lets people open up and bid up." However, because the investment management industry is so cyclical, acquirers should not be blind-sided by the numbers, Epstein said.

On the sell side, a firm that is currently doing well because it is in a growth cycle, could take advantage of its position, Epstein said.

"Somebody in the business of selling their firm might want to be aware that some of this oscillating, cyclical influence can operate in the background, and that they can use it opportunistically," Epstein said.

On the other hand, poor performance or concentration in an investment area that has fallen out of favor might prompt a fund company to sell, the report said. If the fund company was not prepared for its cycle to return to favor, this might be the best route of action, the report said.

"A manager might sell in an unfavorable market if it projected that the long-term benefits of strategic or economic partnership outweigh the penalty of a current multiple discount," said the report. "Otherwise, it might wait for style rotation to occur."

"If a company is under-performing today, it might be hard for it to get recognition for style," Epstein said. "But, if they are wise enough to trade on issues that would mitigate style - to go into a negotiation prepared for that and emphasizing other issues instead - they would be able to keep the negotiation on track."

"In summary, our observation that style-based transaction multiples move in tandem with the style performance, is consistent with buyers' and sellers' decisions on when to transact and at what price," the report said. "Over the past ten years, the average pricing of managers with a growth or value style rose and fell inversely. Currently, growth manager pricing is dominant."

Prices of asset management firms, in general, are rising, the report said.