Infovest21's Special Research Report: Acquisition of minority stakes is most likely M&A approach for hedge funds while mergers between smaller funds of funds is expected

The pace of hedge fund mergers and acquisitions transactions quickened in 2010, particularly those involving minority stakes. Transactions this year have generally been more strategic compared to the transactions done in 2008 which were generally done at distressed prices and for survival. Investment bankers describe the tone as cautious and careful.

Freeman & Co predicts the number of alternative manager deals will outpace those of traditional manager deals in 2010 for the first time as firms consolidate, are acquired by larger strategic firms or are spun out by banks facing regulatory issues. Smaller asset managers are being acquired by larger alternative managers and other traditional managers/financial institutions that have the benefit of distribution, brand name and/or size and scale.

Through June 30, 2010, alternative asset management deals were up 108% to 52 transactions year-to-date compared with 25 transactions for the same time a year ago. Freeman projects that alternative manager deals should exceed 100 this year with acceleration in the second half of the year due to pressure from the Volcker Rule and other international regulatory initiatives.

In comparison, traditional manager deals totaled 31 in the first half of 2010 and may only reach 70-75 for the year.

For hedge fund managers, acquisitions of minority stakes is the most likely expected approach going forward. In the fund of funds community, mergers between small funds of funds is expected, say investment bankers.

High profile transactions

This year, three high profile transactions were Man’s purchase of GLG, RBC’s acquisition of BlueBay and Credit Suisse’s minority stake of York Capital. Man’s offer price was 55% higher than GLG’s share price, Man paid 12.5x GLG’s 2010 EBITDA. RBC paid a 29.3% premium for BlueBay.

Buyers are prepared to pay up for growth opportunities. If you look at multiples, recent transactions suggest 10-12x EBITDA versus EBITDA’s long term range which has been 9-11x. Distressed deals during the crisis were at 5x EBITDA, says Manuel Arrive at Fitch Rating.

Investment bankers emphasize that each transaction needs to be examined on a case-by-case basis. EBITDA/multiples can’t be extrapolated from these large transactions to other hedge funds due to the size and scale. “None of them are the same size or scale as Man/GLG. Man gained access to all of GLG products and clients and can cross-sell their products. Many reasons exist to why that value was what it was but it doesn’t fit conventional thinking of just putting a multiple on it,” says one boutique investment banker.

Public stock prices of hedge funds are a good background reference to start with. Asset size, stickiness of assets, number of clients, performance, number of distribution channels and geographic range are some of the factors to consider in evaluating each case, says Eric Weber of Freeman & Co.

Excerpt from Infovest21 Special Research Report - M&A/Consolidation in the Hedge Fund Community