The 1994 acquisition of Hazelhurst & Associates by Northern Trust ushered in a retirement services trend: To increase their assets, financial institutions are buying employee benefits consulting and record-keeping firms, or third-party administrators, at an unprecedented rate.

Wachovia's recent purchase of two affiliated companies - Hunt, DuPree, Rhine & Associates Inc. and Retirement Plan Securities Inc. - is another example of this trend.

The two companies neatly provided Wachovia's defined-contribution business with enhanced record keeping and administration capabilities, a retirement plan asset-allocation product, and section 125 processing. These capabilities, combined with Wachovia's widespread distribution, create a potential win-win situation.

Acquisitions of third-party administrators let retirement plan service providers add or expand the service delivery capabilities critical to their long-term success.

As providers continue to move toward a "funds distributor" business model-offering both proprietary and nonproprietary investment products-the importance of service delivery as the best means of product differentiation will continue to grow.

An understanding of the strategic value of third-party administrators is driving their acquisition by visionary banks, insurance companies, brokerages, and investment management firms.

And owners of third-party administrators increasingly are viewing a sale as the ideal way to cash in the "sweat equity" of their companies, while gaining access to the investment capital and wider distribution needed to remain competitive.

Because of their strategic nature, these transactions require that both sides carefully study the potential synergies and the cultural issues involved. In particular, performing an effective valuation analysis requires an in-depth understanding of the dynamics and economic drivers of the retirement services industry.

Most of these deals are driven by the desire to develop a fully bundled 401(k) product with a high-quality service platform.

Sophisticated customers require everything from daily valuation record keeping to toll-free call centers, Internet access, and, increasingly, investment advice for their employees.

Institutions that invest in the improvement of their capabilities are best positioned for success in this ultra-competitive market.

It is also essential to recognize the relationship between the importance of service delivery and the shift throughout the asset management industry from manufacturing to distribution. This trend - perhaps best illustrated by the success of Charles Schwab & Co.'s OneSource program and Fidelity Investment's Funds Network - is in part a function of the increasing availability of information and growing customer sophistication about mutual funds.

Just as retail clients demand access to multiple mutual fund families from a single distributor, 401(k) participants and sponsors increasingly require that plan investment options include the best funds available, not just those of the plan provider.

In last year's Spectrem Group/Access Research 401(k) market needs study, 63% of plan sponsors said they offered investment options from multiple providers. As a result, the competitive advantage of plan providers with high-performing proprietary investment products has diminished significantly.

Most buyers look for third-party administrators with sound back-office operations, record-keeping processes, and experienced plan consultants.

Proprietary technology is rare, and most fully bundled providers will continue to depend on outside vendors for systems and software.

However, third-party administrator professionals experienced in record- keeping technology can provide a valuable perspective for a large institution ready to invest significant capital in retirement plan systems. Familiarity with a platform that provides participants with self-directed brokerage accounts and Internet access is also a distinct advantage.

A third-party administrator's book of business can provide an immediate revenue stream, though pretax margins on fee-for-service business rarely exceed 10% to 15%.

There is some potential to convert a third-party administrator's assets under administration to the buyer's investment products. However, this excludes assets under administration through referrals from investment managers and is often constrained by a third-party administrator's long- standing customer relationships.

Over the long term, the acquiring institution gains access to a client list that includes prime candidates for, among other things, future IRA rollovers. After all, who better to serve workers in retirement than the institution that helped them prepare for it?

Firms that have established an affiliated registered investment adviser usually provide prospective buyers with a high-margin revenue stream. More important, they may provide the basis for an institution to offer asset allocation and investment advice to plan participants.

Finally, though defined-contribution plans are typically the focal point of these transactions, third-party administrators often possess expertise in other areas, including defined-benefit actuarial services, section 125 plan processing, and health and welfare products.

Third-party administrators fill in key service gaps by enhancing the buyer's retirement product offerings. The acquisitions also let the financial institution leverage two of its core strengths-an extensive distribution network and investment product capabilities.

As a result, valuation multiples vary widely depending on the capabilities of both the buyer and the seller.

Though deal values typically fall in the range of 1.5 times to 2.5 times revenues, to establish an appropriate valuation for a specific deal requires a discounted cash flow analysis based on detailed projections of expected synergies.

Issues of cultural "fit' are inevitable in the acquisition of a privately held, entrepreneurial firm by a large, publicly traded institution.

Buyers must be sure to assimilate the principal owner and employees of the third-party administrator into their management structure without compromising the flexibility of the acquired firm. In doing so, the buyer must clearly communicate a detailed strategic vision for the proposed partnership.

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