Big deals have returned to the investment industry, with Morgan Stanley agreeing this week to pay $7bn for rival Eaton Vance and Franklin Templeton splashing $6.7bn to buy Legg Mason earlier this year.
Building scale via M&A is seen by fund chiefs as key to counteracting the grinding competitive pressures exerted by BlackRock and Vanguard, the world’s two largest asset managers.
But not everyone is cheering the prospect of a deal uniting Invesco and Janus Henderson, two serial underperformers.
Just over a week ago it emerged that activist investor Nelson Peltz’s Trian hedge fund had established stakes of nearly 10 per cent in both companies, worth about $900m. Mr Peltz played a key role in Franklin Templeton’s acquisition of Legg Mason so the news triggered widespread speculation he wanted to engineer another deal.
Invesco’s shares have risen 15 per cent since the news on October 2, while Janus Henderson’s have surged 24.7 per cent. But despite the share price response, some have responded with scepticism.
“The competitive pressures on managers such as Invesco and Janus Henderson are a long-term structural trend and it is not clear that Trian can provide a solution to this problem by merging the two companies,” says Will Riley, who runs the Guinness Global Money Managers fund that also holds positions in both groups.
Patrick Davitt, an analyst at Autonomous Research in New York, said that while Trian was making “a strong statement” with its stakebuilding, “there are questions about whether combining these businesses would create value for shareholders”.
A deal would probably lead to additional investor withdrawals when both companies are already suffering significant outflows, according to Mr Davitt. Institutional clients often review their use of asset managers when there is a change in ownership.
Investors have pulled $106.7bn from Invesco, excluding money market funds, since the start of 2018 and outflows have reached $65.9bn at Janus Henderson over the same period.
Christopher Harris, a senior analyst at Wells Fargo, also struggles to see a strong strategic justification for a deal given the outflows risk and the overlap between the two companies.
“Janus Henderson would not really provide much in the way of products or capabilities that Invesco does not already have,” says Mr Harris.
Recent mergers and acquisitions involving both Invesco and Janus Henderson have not delivered the anticipated improvements in performance, resulting in scepticism over whether an even more ambitious deal would provide a solution to underlying problems.
Marty Flanagan, Invesco’s chief executive, is regarded as one of the investment industry’s most astute dealmakers. But its acquisitions of Guggenheim’s ETF business and Source, the London-based ETF provider in 2017, followed by OppenheimerFunds in 2018 have failed to stem investor withdrawals. Between the start of 2018 and the disclosure of Trian’s stake, Invesco’s share price fell 69 per cent.
Before Mr Peltz’s move, Janus Henderson’s share price was down 29 per cent since the May 2017 completion of the merger that created it. Chief executive Dick Weil has admitted progress has been slower than expected.
Michael Carrier, an analyst at Bank of America in New York, believes more consolidation in the sector is needed as bigger companies are more able to cut costs and deal with complex regulatory challenges.
“But M&A in the asset management industry is challenging. Publicly traded managers that have done recent larger-scale deals have generally underperformed the market and their industry peers since those transactions were announced,” he says.
Analysts also question how a deal could be financed. Invesco is already highly leveraged and unable to take on much more debt without breaching existing financial covenants.
Wells Fargo estimates that the group’s debt, including preferred equity, already stands at a multiple of four times underlying earnings. This is significantly higher than the average across the rest of the sector.
Mr Davitt says it would be “challenging” for Invesco to issue more debt to fund a deal, but issuing new shares to raise money would be dilutive for earnings and less appealing to other shareholders.
Others are also cautious about the extent of any improvement in earnings growth that might be delivered by a takeover, partly because Invesco’s shares trade on a significantly lower valuation multiple than Janus Henderson’s.
Brian Bedell at Deutsche Bank in New York reckons an all-stock offer from Invesco for Janus Henderson priced at $25 a share would cost $4.4bn but deliver a boost of less than 5 per cent to earnings for the combined group. If a quarter of a deal was financed with debt, the earnings accretion would increase to just over 10 per cent.
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“The projected earnings per share accretion would need to exceed 20 per cent to boost Invesco’s share price,” Mr Bedell cautions.
A deal might deliver a 20 per cent improvement in Invesco’s earnings if everything goes to plan, says Mr Harris, but his central forecast is for zero earnings accretion. He also warns that earnings for the enlarged group could be diluted by up to 23 per cent if it were followed by significant investor withdrawals.
The strongest argument for a deal is the possibility of cost savings that Wells Fargo estimates could amount to $500m — 8 per cent of the expense base of the enlarged group. But this could be offset by outflows from institutional clients.
Another option Mr Peltz might pursue would be a so-called merger of equals. However, this would also present difficulties, says Kenneth Lee, analyst at RBC Capital Markets.
“Mergers of equals can be challenging to execute successfully, given the need to fairly allocate responsibilities,” says Mr Lee. Such a deal would still involve significant risks, including the possibility of key staff leaving and investor outflows from overlapping funds.
Mr Peltz could try to set up Invesco as an acquisition target, mimicking the strategy followed by Trian when it invested in Legg Mason.
“Invesco is a very attractive asset trading at a very depressed valuation,” says Mr Lee. “But there are very few companies that could be potential acquirers given Invesco’s $6bn market capitalisation.”
Additional reporting by Siobhan Riding