The Pendal-Perpetual Acquisition: Risks vs Rewards

After months of negotiations, two of Australia’s fund management firms have agreed to combine forces to form what is anticipated to be Australia’s pre-eminent global asset manager. On 25 August 2022, Pendal Group accepted rival firm Perpetual Limited’s acquisition offer, which values Pendal at $2.5 billion. Whether or not this takeover deal will work in favour of these companies is a topic of debate.

Details of the deal

Perpetual is set to acquire 100% of Pendal in a scrip and cash deal, creating a $201.0 billion investment firm. Pendal had turned down Perpetual’s earlier proposal in April, which offered one Perpetual share for every 7.5 Pendal shares and a cash component of $1.67 per Pendal share. The new deal, which Pendal has agreed to, involves an 18.3% increase in the cash component, from $1.67 to $1.976. Pendal’s executives affirmed that their engagement with Perpetual since April, and the increase in the cash component, boosted their confidence to accept the new deal.

Perpetual will now own 53.0% of shares and board seats in the combined business. CEO and Managing Director of Perpetual, Rob Adams, will hold the leadership of the combined firm. However, the acquisition agreement is still subject to shareholder, court and regulatory approval from authorities in Australia, the UK, Ireland, Singapore and the US. The companies are expected to complete the acquisition in late 2022, or early 2023.

Reasons behind the takeover

The aim of most company consolidations is to cut back on costs assigned to duplicated service functions, such as marketing, HR or risk and compliance. Another motivation behind this particular deal is to reap the benefits of boutique funds management. The consolidated firm is anticipated to continue running boutiques, providing specialised services to specific market segments, while benefiting from cost savings accrued from its large scale. In essence, the aim of the deal is to keep Pendal and Perpetual’s brands separate and allow the investment teams to maintain their autonomy and individuality.

Some advantages of the takeover are:

• The boutique manager will get the financial stability it was lacking from being part of a larger firm.
• Retaining boutique functionalities will likely moderate the key drawback of a larger firm, that it is often driven by product over personality.
• The deal is expected to result in $60.0 million of annual pre-tax cost synergies within the first two years, which amounts to 8.0% of the cost base of the combined business.
• Pendal, which has three boutiques at present, obtains a stronger distribution platform to leverage the investments it has already made.
• The combined sales and distribution team can offer clients a broader spectrum of products with over 100 strategies across Pendal and Perpetual – another scale benefit.
• The multi-boutique model will allow fund management teams to operate with autonomy while benefitting from the operation scale and increased sales support to win new business and deliver robust returns.

Additionally, both companies have had a solid history of ESG (environmental, social and governance) investing. Perpetual CEO Rob Adams said, “I really do see us as being a powerhouse in global ESG investing as a combined firm”. All in all, this deal is expected to deliver an increase in scale, an improved global distribution team, superior product capabilities, expertise and diversity, and global ESG leadership.

Potential hindrances associated with the deal

It is no secret that this acquisition deal is occurring during challenging economic conditions for fund managers, as persistent inflation and geopolitical tensions are leading to falling markets and reduced confidence. In the June quarter, investors withdrew over $8 billion worth of funds from Pendal and Perpetual combined. The question remains, how will two undersized fund managers that have recorded declines in assets under management in 2021-22 combine to form a stronger business?

The finance and investment services sector is entirely reliant on its talent, where power struggles can be a genuine factor in considering strategy. Furthermore, retaining that talent during a takeover can be a significantly challenge. Integrating cultures and staff retention are therefore crucial in merging professional services firms.

Shareholders have also had mixed reactions to the acquisition. Soon after the announcement, Pendal shares rose 9.6% while Perpetual shares fell by more than 10%. Some financial analysts opine that fund managers that handle between $100 billion and $1 trillion of funds usually experience diseconomies of scale in their operating margins due to increased complexity. This deal, which is creating a $201.0 billion investment business, therefore involves significant risks.

In the past, asset manager mergers and acquisitions (M&A) activity that banked on scale alone have lost revenue. Even after Perpetual and Pendal acquired US fund managers Barrow Hanley and Thompson, Siegel & Walmsley (TSW) respectively, clients withdrew approximately 15% and 8% of funds. Some other risks associated with the deal include:

• Loss of key staff;
• Increased debt as Perpetual is financing Pendal’s cash component with a new debt facility;
• Declining valuation if the business mix shifts to lower margin offshore asset management;
• Additional risks in cultural merging as the recently acquired firm TSW will experience its second ownership switch in 12 months; and
• While Pendal and Perpetual may mitigate the risks of Australian clients attrition by handling their funds autonomously, global clients might move their investments.

Although executives from both companies have full confidence in the deal, the effects of the takeover could go north or south depending on external economic factors and how the acquisition is handled.

Effects of the deal on the finance sector

M&A activity in the Australian finance sector is hardly unheard of. Consolidation is a popular concept among businesses looking to grow their market share. Australian funds managers are known to charge lower fees than their global counterparts. However, because the fixed costs required to function in this sector are high, industry consolidation is prolific so that firms can reduce duplicate costs to maintain profitability and these low fees. Crispin Murray, Pendal’s head of equities said, “The industry is fundamentally changing. Consolidation is occurring at all levels – super funds, platforms, and fund managers.” Recently, ANZ also announced its offer to acquire Suncorp’s banking arm, further emphasising the consolidation trend in the Australian financial sector.

The Australian finance and investment services sector is in the mature phase of its economic life cycle. The market for funds is reaching saturation, driving up competition. To tackle this problem, the sector’s more established firms are resorting to mergers and acquisitions to cut the competition, achieve economies of scale and increase profit margins. Rising M&A activity is expected to further increase market share concentration in the sector. Increased consolidation among financial services businesses is also anticipated to discourage new players from entering the sector as fewer independent firms will be available to market new players’ funds.

Mergers and acquisitions between professional services businesses go far beyond costs and scale. Particularly in the finance and investment services sector, matching the cultures of the integrating firms and retaining talent are equally as important as the numbers. As the executives from both Pendal and Perpetual have discussed the leadership, ownership, autonomy and functioning of the combined firm, if executed diligently, the benefits associated with this deal may well outweigh the drawbacks.