The appeal of Cayman’s financial service firms to private equity companies is a non-traditional driver for consolidation in the industry that is likely to continue, according to a panel examining M&A trends for fund managers and service providers at Campbells Fund Focus conference in November.
However, concerns that mergers and acquisitions or spin-offs involving Cayman’s financial services firms will ultimately lead to a reduction of the workforce don’t necessarily have to play out, panelists said.
A large number of Cayman businesses recently have been subject to management buyouts or acquisitions, often in partnership with private equity funding. In the past three years alone the Cayman Islands Monetary Authority received 16 applications for shareholder changes from local service providers.
In 2012, Walkers sold its fiduciary business, with about 100 staff in six countries and annual revenues in excess of $50 million, to Intertrust, and in May of this year the law firm announced it would relaunch its professional services business.
Appleby announced the management buyout of its fiduciary business backed by private equity firm Bridgepoint in July, following a similar management buyout at Ogier’s in 2014, which resulted in a new fiduciary company called Elian.
Since then, Elian has formed a partnership with global financial services company SEI and in September Elian agreed terms to buy corporate service provider SFM Europe.
Colin MacKay, the group director of Elian Fund Services in the Cayman Islands, said the drivers for spin-offs and mergers and acquisition often evolve around value realization – the owners simply want to cash in – in addition to other strategic motivations such as the expansion of service lines or the client-driven expansion into new regions and jurisdictions.
The easiest way to gain entry into a new market “is to buy your way in, because that buys a regulated business,” MacKay said.
“But essentially it comes back to the basic driver that one and one should make more than two.”
More recently, the drivers for M&A activity have been more investor-based, he said, spurred on by their appeal to private equity houses. As a result, the market is now seeing the typical transitions in the life of a private equity investment starting with refinancing and buyout, followed by an aggressive acquisition phase and ending with a listing.
An informal poll of delegates at the conference anticipated that private equity involvement in the consolidation of the industry will be a long-term trend.
MacKay said there are three main headline items that his firm is looking at when conducting the due diligence of potential acquisition targets. They include the likely client retention after the transaction, engagement and structure of the staff and the clean regulatory history of the target business.
All three elements have to be in place for a transaction to go ahead. Elian had looked at 30 acquisitions and concluded two, he said, with most deals falling through because one plus one would not have equaled more than two.
The realization of synergies is important to ensure that the sum is worth more than the individual parts.
Consolidating back-office functions such as finance or HR are a possibility and technology offers natural synergy savings. But simply moving two businesses that operate on different platforms on a single one may not be feasible. And cost savings from consolidating staff do not have to be automatic either, said MacKay.
“The assumption is always that when you put two businesses together there are going to be cost synergies and there may well be. Some of this may be staff but it should not be an automatic assumption that it is staff. We are all in people business. We don’t create anything other than intellectual property,” he said.
“The reality is you may need more staff and you may well need more resources.”
“There may be revenue synergies and those revenue synergies may be more attractive. For us with SFM the big attraction is not actually the cost benefits, it is the revenue side,” he said.
Accessing the respective client bases of the two companies across different markets and regions will open up revenue opportunities that are more important in making a deal successful than cost savings.
In contrast, a poll at the conference showed two thirds of delegates believe industry consolidation will nonetheless lead to a reduction in headcount.
MacKay argued this result was influenced by the decline in the number of fund administrators in Cayman, which was more about the outsourcing of a standardized delivery of services on the back of technological developments and the ability to outsource to low-cost jurisdictions.
However, Cayman has evolved over the last 10 years and “we have seen real genuine value added go up,” he said. “Our services in that period have grown markedly.”
MacKay said Cayman as a jurisdiction should follow the same strategy by aiming to develop value-added services rather than compete for low-cost, technology-driven services that do not readily fit within the local economy.