Take the Liberty Valuation Challenge

How do you value a company with both asset management and annuity businesses?
Craig SchneiderNovember 14, 2000

Someone is going to make Liberty Financial an offer it can’t refuse. That is, of course, presuming that a buyer can figure out the best way to value the asset management and annuity businesses.

It won’t be easy. Liberty, which put itself up for sale earlier this month, is an exception among the acquisition targets in the rapidly consolidating money management industry because of its hybrid business. Considered separately, both the asset management and annuity businesses are hard to evaluate — taken together, they create a maze of financial variables.

What both businesses in common is that they manage investments, but merger advisors typically use different benchmarks to value the individual companies in these markets.

“The transparency of the business is not as good, and looking at it on a comparable basis, a little more problematic,” says Mark Lane, an analyst with William Blair & Co. “So it’s a little more difficult to slap a multiple on it.”

Several analysts believe the most significant factor in the ultimate valuation of Liberty lies in its asset management business, and a common metric for valuing that side is to use a multiple of earnings before interest, taxes, depreciation and amortization, or EBITDA.

“Multiples of EBITDA bring down to a common denominator the differences in margins or asset compositions between asset managers,” says John Hall of Prudential Securities. “All assets are not created equal.”

However, Hall also uses a percentage of assets under management as a “rough gauge” for valuing this side of Liberty’s business.

For example, Hall says the recent sales of United Asset Management to Old Mutual plc and Nvest to CDC Asset Management were priced in the range of 1 percent to 1.5 percent of assets under management.

Allan Lannom, principal at Houlihan Valuation Advisor in Chicago, also recommends using either a multiple of gross revenue, which is built on the commission fees, or a percentage of assets under management.

Could the metrics work in a deal for Liberty? Perhaps, but forming a bid is not going to be an easy task, given Liberty’s mutual fund mix.

The company has $38 billion in mutual fund assets, 68 percent of which are in equity funds and 32 percent of which are devoted to fixed income securities, according to a recent report from brokerage firm, Fox Pitt, Kelton. The company also manages another $15 billion in institutional assets. The equity funds are the most profitable of the three fund management businesses, while the fixed income funds have the lowest margins.

The difference in the profitability of the three asset management products could make the use of a multiple of EBITDA – – typically 10 times to 5 times – – the preferable method for valuing the company as a whole. However, Lannom strongly disagrees.

Simply put, cash flow analysis does not account for consolidation efficiencies. “You don’t know what level of earnings, EBIT or EBITDA that the buyers will extract from the purchase,” Lannom says. “You don’t know the synergies, the economies of scale. With the other metrics, it’s more predictable.”

There are huge economies of scale for picking up volumes of customers, merging funds and eliminating redundant overhead such as research analysts. “It’s not unusual to buy a book of business and create at least 50 percent margins,” Lannom says.

Prudential’s Hall warns that a percentage of assets under management “doesn’t represent the fee or the margin off the assets owned.” The gross revenue would.

What’s more, Lannom’s argument regarding the economies of scale is primarily intended for when one asset manager buys another, a scenario that doesn’t always happen.

If a variable annuity company buys Liberty, it’s going to be a very different transaction than an asset manager that buys it and sells off the annuity block, William Blair’s Lane says. “It shouldn’t be valued the same way as another asset management company.”

Nevertheless, some analysts use other deals as a guideline.

Some of this year’s biggest asset management mergers have included the $1.2 billion buyout of Pioneer Group by Italy’s second largest bank, UniCredito Italiano, and the $2.2 billion buyout of Nicholas-Applegate Capital Management by German insurer Allianz AG.

Last May, Alliance Capital bought equity manager Sanford Bernstein for $3.5 billion in stock and cash. That price works out to a 4.2 percent of Sanford’s $82.7 billion assets under management as of the end of June, and 11 times its most recent quarterly run rate of EBITDA.

The value of Sanford Bernstein’s assets under management is slightly higher than Liberty’s total of $77 billion, but that doesn’t automatically mean that Liberty’s takeover value will be in the same range as Sanford Bernstein’s. For starters, with so many of its portfolios tied up in fixed income securities, Liberty is not likely to command a price comparable to Sanford Bernstein.

The company’s annuities business also sets it apart from other pure play money managers. An annuities business is usually valued as a multiple to book value. Lane says, “Book value is not really an issue for valuation of an asset management company, because it’s a cash business and not often a capital intensive business.”

Still, despite the complexity of valuing the several lines of business, analysts are estimating a possible takeover price. The company’s shares ran up 33 percent in early November on the day the company said it had retained Credit Suisse First Boston to help it find a buyer. Prior to that announcement, the stock had been treading water near $24 for months. Since then, the shares have been trading closer to $40.

Prudential’s Hall thinks an acquirer will be willing to pay a premium above the recent share price.

First, Hall retools his EBITDA expectations for the asset management business based on Liberty’s other announcements intended to make it more saleable and ultimately profitable. Liberty will divest the Private Capital Management (PCM) division of its Stein Roe & Farnham mutual fund subsidiary and step up the integration of Wanger Asset Management’s fund group.

Hall then takes Liberty’s current quarterly run rate of $20 million of EBITDA, which accounts for the PCM loss, to arrive at $80 million for the full year, and adds Wanger’s projected $35 million EBITDA as well as its stated $10 million pre-tax stated savings goal. The resulting $125 million equates to $2.58 per share in EBITDA, on which he applies a multiple of 10 to arrive at a takeover price of $26 per share for the asset management business.

Why is his multiple at the low end of the aforementioned range? “If it was growing at a more rapid rate or there were expectations that it will grow faster, we would be willing to pay more for it,” he says. “Liberty’s assets have been shrinking from client withdrawals.”

Hall then adds the expected worth of the annuity business to his price for the asset management business. Under GAAP guidelines, the value of the annuity business is approximately $1.1 billion or about $22 per share, he writes in his report. Given the business unit’s 12 percent return on equity, a price to book multiple of 1.6 times is a fair value. That suggests the insurance operation is worth approximately $35 per share.

The total value of the asset management business and the annuity business comes to $61 per share. But Hall then subtracts the company’s $780 million in debt, which translates to $16 per share. The final figure suggests an acquirer will have to cough up $45 per share, or $2.18 billion, to buy the company.