At Deloitte Luxembourg’s financial sector professionals (PSF) conference on 5 December 2023, during which its was presented, Nicolas Schoukens, managing director in the firm’s financial advisory team discussed a few observations on the evolution of the sector and factors driving the M&A trends seen in the industry.
The number of PSF entities in Luxembourg--consisting of investment firms, support PSF and specialised PSF--has grown from 197 to 2006 to a peak of 322 in 2011, noted Schoukens. For the last few years, however, there has been a decrease in the number of PSF, declining to 260 at the end of last year.
Between January 2018 and December 2022, 60 new PSF firms were registered, while 89 “disappeared,” leading to a net reduction of 29 PSF over that five-year period. So what happened to them?
About one-quarter (24) of these 89 PSF entities disappeared as a result of transactions, explained Schoukens. “Eleven were due to external mergers and 13 disappeared due to internal reorganisations,” which are often initiated due to M&A deals. Specialised PSFs represented the “largest portion of those movements, representing more than 50% of the total.”
Moreover, about 10% (23) of the 260 PSFs active in Luxembourg in 2022 have been involved in merger and acquisition activities since 2018. “So although I would say that the relinquishment of the PSF licence has been the main factor explaining the decrease, we see that M&A activity remains a substantial contributor to that decrease as well.”
External factors driving M&A trends
The globalisation of financial services, which require an increasing amount of multi-jurisdictional capabilities and presence, is one of the major drivers of M&A activity, said Schoukens. Clients operating on an international scale are asking providers to assist them in more jurisdictions, and “as a response to that demand, we have many PSF who embark on an M&A journey and start to make acquisitions in other jurisdictions where they want to be present to assist existing clients or to try to gain new clients.”
A second factor is the involvement of the private equity industry. There’s strong interest from PE investors thanks to consolidation opportunities and recurring revenues, said Schoukens.
“Founder transitions” is a third factor contributing to M&A in the industry. “PSF remains a relatively young industry,” said Schoukens. Companies were created five, 10, 15 years ago, and at some point, business founders need to think about “transitioning.” This could mean selling a company, transferring it to the next generation or merging to get bigger. “The fact that we had attractive multiples for the past few years has obviously helped” with transactions and the volume of activity.
The fourth factor fuelling M&A activity has been funding costs. “We’ve seen that the recent shift in interest rates has been quite significant for the last 18 months, but for a long period--so, for the last decade prior to 2022--the interest rates were relatively low, which means that funding for acquisitions was less expensive, or relatively cheap, compared to what it is today.”
Less organic growth, diversification, regulation, technology
But there have also been internal factors responsible for the increase in mergers and acquisitions in the PSF industry, one of which is lower organic growth. “Seven or 10 years ago, it was not uncommon or unusual to have double-digit growth,” said Schoukens. “Nowadays, it’s less the case.” As a result of that, there are players who “compensate” for this lower internal growth by carrying out acquisitions on an external level.
Diversification is the second factor, particularly with regards to vertical integration strategies on the alternative investment side.
The third factor--regulation--is a “recurring theme for the industry.” “It has always been the case and it’s still the case today.” Regulations are multiplying and there’s high scrutiny for compliance, which “creates a favourable environment for M&A activity because now the cost of not being compliant is so high… you also need to expand your cost base to make sure you have the means to absorb that cost.”
“Last but not least, we have the technology,” said Schoukens. As a relatively young industry, PSFs have been less technology-driven. But that is now changing. “Clients are more demanding for secure, customised and uninterrupted access to data, which now requires some solid and robust capabilities--and also technology-driven capabilities.” One way to do that is to develop that internally, but other players will do so through acquisitions in order to accelerate the process.
Factors for success
M&A transactions are a “complex process” and don’t always provide expected results, said Schoukens, concluding with a few elements of successful M&A deals. These are:
-A well-defined M&A strategy (mergers should not be carried just because competitors are doing so, for instance, they need to serve a “broader strategy,” like developing new products or establishing a presence in a new jurisdiction.
-Thorough preparation, which includes an analysis of risk and due diligence.
-Expert advice on topics like risk allocation, value assessments or deal structure.
-Alignment of interests, which involves being transparent with stakeholders.
-Post-merger integration planning. Mergers don’t end with signatures on a contract, noted Schoukens. Real success is measured a few years later: are clients still with you, are staff members happy with the integration? “It’s really critical to prepare this post-signing phase.”