Sectors: 1065

Growth in consolidation

21 February 2015

Written by Tom Carey

The last three years has seen a consolidation in the trust administration and private wealth management sectors in the Channel Islands, with private equity backed businesses accounting for the majority of the recent deals in Guernsey and Jersey. Carey Olsen partner, Tom Carey, and Wyvern Partners’ Jonathan Smith look at why private equity is backing consolidation in the market and what the future holds for the sector.

There are a number of reasons why businesses in the sector have chosen to sell over the last three years. Partners in professional services firms have sought to realise the equity in their businesses, banks have made strategic changes of direction with regard to offshore businesses and owner managed businesses have had to deal with the retirement of the principal or generational change.

These sellers have been matched by a wave of variously motivated buyers; private equity firms looking to invest in the sector, banks gathering assets and financial groups who are expanding their operations.

However almost all the current wave of corporate activity is being driven, ultimately, by private equity investors. The current wave of consolidation can be traced back to the onset of regulation from 1999 onwards. This had two effects on the sector. It introduced a compliance burden which made it more difficult for smaller businesses to operate profitably and allowed third-party investors visibility on the underlying client base, which had not previously been the case.

Prior to the early 2000s private equity investors were deterred from the sector because of a lack of clarity on the ultimate beneficial owners. With 100 percent retrospective KYC imposed on businesses the last barrier for private equity to invest in the sector was removed. Private equity investors like the private wealth sector because it has strong client retention characteristics, high margins, low capital expenditure, strong cash flows and the potential to "buy and build" in a consolidating sector which is still highly fragmented.

Private equity funds tend to have a ten-year lifetime holding each of these investments for three to five years. They will normally target returns of 25-30 percent IRR (internal rate of return) or look to double their investment in three years or triple it in five. The fiduciary industry is seeing revenue growth of five to 10 percent each year so, in order to achieve their target fund returns, a variety of techniques are being used to promote faster growth including gearing, profit increases and multiple improvement and arbitrage.

By consolidating locally they can strip out duplicated back office functions and increase margins. International acquisitions also permit economies of scale but, in addition, can introduce new products and markets and enhance the attractiveness of the group with greater scale in a business itself increasing the potential for a high exit multiple.

These attractive economic drivers are matched by the increase in the global reach of HNW clients who are more mobile than ever and who demand service providers who can provide complex trust, corporate and investment solutions internationally and not just in a specific offshore financial centre. This dynamic will give rise to greater consolidation in the market as businesses seek to meet this demand for a global service.

Interestingly, as private equity firms are driven to sell their investments after five years, we will see this growth achieved through an increasing number of secondary buyouts in the sector; a trend which has already begun to demonstrate itself with the recent deal by Silverfleet to acquire IPES. There is no shortage of larger private equity firms to whom the smaller ones can sell their investments. Additionally, private equity-owned companies will buy other private equity-owned companies accelerating sector consolidation at the larger end.

Ultimately all private equity-owned businesses are themselves potential targets. Some major fiduciary groups have explored the possibility of an initial public offering (IPO) although in the near term the state of the markets may be closing that window - for now. Fiduciary businesses should, in theory, make very good listed companies with strong cash flows for dividend yield, good margins and steady revenue growth.

To list effectively it is believed groups need to be of an enterprise value of $500 million to $1 billion and some private equity-owned fiduciary businesses are now of that size. Once the first listing takes place it will be much easier for a number of others to follow and current indications suggest that listing values will be high.

As can be seen, the sector is attractive to private equity investors and that does not look like it will change in the near future. This should mean that continued consolidation will occur at all levels. At the larger end major groups may emerge with 10-20,000 staff and this, in turn, may eventually lead to a dominant grouping, such as is seen in the accountancy sector.

An original version of this article was published by Private Client Practitioner’s 2015 Guernsey Special Review, January 2015.

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