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Wealth managers are hot assets as PE seeks to reap benefits of good cash flow

Registered investment adviser businesses, or RIAs, are increasingly sought after by private equity investors. Just three months after it was itself acquired by Reverence Capital Partners LP, Advisor Group Inc. bought peer Ladenburg Thalmann Financial Services Inc.. in a bolt-on deal worth around $1.3 billion.

Combined, the firms will create an organization of nearly 11,500 financial advisers with over $450 billion in client assets. The investment is "necessary" to build out competitive technology, for practice management, and because products and services "require a greater level of scale than either of our companies can achieve on a stand-alone basis," Advisor Group President and CEO Jamie Price said in a statement.

The deal, under which each firm will retain its branding, will enable the combined business to build size and scale, benefiting both margins and resources, and could create strategic opportunities for each to leverage specific services or offerings that the other has brought to the new business, said John Eubanks, vice president at Park Sutton Advisors LLC.

Ripe pickings

Private equity activity in the wealth management industry has been hot for a number of years, said Jim Abbott, Co-Head of the Business Transactions Group at Seward & Kissel. "Bottom line, private equity likes good cash-flowing businesses," he said, adding that a good economy means more people are getting wealthy, translating into more customers.

The wealth management space, made up of both larger managers and smaller brokers, is also ripe for consolidation. "For private equity [firms] that want to build a portfolio company into something bigger so they can sell it and turn a profit, there's plenty of opportunity for [growth]," Abbott added.

And because they are sought-after businesses, exit opportunities are abundant and wealth management businesses make attractive secondaries acquisitions. Once a buyout firm has built up its portfolio company, it can sell it on to another private equity fund that can add its own resources, expertise and capital, Eubanks said. His firm has recently seen more patient capital move into wealth management businesses where investors are more interested in the cash flow opportunities.

Room to grow

Some in the wealth management space focus on smaller, more retail-type clients, while others focus on ultra-wealthy clients. Advisor Group and Ladenburg fall into the former category, in which consolidation "makes an awful lot of sense," Abbot said, adding: "There just can't be that many who are chasing those kinds of clients."

A handful of specialized private equity firms have traditionally invested in RIAs, but now other investors such as a broader base of private equity funds, family offices, sovereign wealth funds, insurance companies and pension funds are also starting to invest in these businesses, according to Houlihan Lokey Inc.'s Fall 2019 RIA Industry Update. Most buyers, both strategic and financial, aim to mitigate revenue lost to fee compression, broaden products and services, capitalize on synergies and work on succession planning, the report said.

Eubanks expects large regional RIAs will continue to grow, and more smaller RIAs will expand with the help of outside capital. Even those remaining small will gain the scale needed to compete with their larger peers through more deals. "You do see consolidation at the higher-end and mid-level-sized firms, but there's still new RIAs being launched every day. And even with consolidation, there's still growth in that space for sure," Eubanks said.

Private equity interest in wealth managers shows no signs of abating, and an increasing number of firms are scoping out opportunities in the industry. "Every time we turn around, we run into another group that says they're going to do the same thing as far as setting up a fund to make investments in the wealth management or financial investment management industry," Abbott said.