Cetera, Avantax quiet on $1.2B deal that's poised to shift industry power

With its parent securing an agreement for the largest M&A deal among independent brokerages this year, Cetera Financial Group is on track to become the fourth largest firm in the channel.

The pending all-cash acquisition of Dallas-based Avantax by Los Angeles-based Cetera Holdings announced earlier this month values the selling firm at about $1.2 billion inclusive of debt. The merger of Avantax by the end of the year into Cetera, which closed its acquisition of the retail wealth and trust business of Securian Financial Group only last month, will likely enable the combined firm to leapfrog the current No. 4 firm in Financial Planning's IBD Elite rankings of the largest independent brokerages, Raymond James Financial Services, based on the fact that the three companies together generated $3.85 billion in revenue last year.

In order for the Genstar Capital-backed firm to be successful as it leaves the memories of its parent company's 2016 bankruptcy protection case in the dust, Cetera will have to recruit and retain thousands of advisors who will be fielding calls and offers from rival brokerages and likely manage "a significant amount of debt," according to Moody's Investors Service. Only two days after the unveiling of the Avantax deal and in a potential reverse action of its upgrade after the Securian agreement, Moody's said it would be reviewing Cetera's parent firm, Aretec Group, which does business as Cetera Holdings, for a potential downgrade of its junk-level debt rating.

The case for Cetera taking on that additional debt to make the deal revolves around how it will enlarge its footprint at the intersection of tax and wealth management, according to Carolyn Armitage, a longtime independent brokerage executive formerly with Thrivent Advisor Network. Avantax's tax professional/financial advisors are joining the firm alongside fellow dual practitioners with Cetera Financial Specialists.

"To pair that tax expertise with wealth management expertise is pretty unstoppable," Armitage said in an interview. "From a strategic standpoint, I think it's brilliant. The execution of it is, I think, where the challenge comes in."

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Only constant is change
Representatives for Cetera and Avantax declined requests for interviews to answer questions about the details beyond what's available in the firms' Sept. 11 press release.

"As we explored expanding Cetera's capabilities into wealth management and tax expertise as a core component of our growth strategy, it quickly became clear that Avantax was an ideal target and a powerful fit for our business," Cetera CEO Mike Durbin said in a statement. "As we enter Cetera's next phase of evolution, our five-year growth strategy is off to a terrific start. Avantax will significantly build out Cetera's capabilities in tax and wealth management. As we have said in the past, disrupting the market with expanding capabilities means more flexibility for advisors, and developing adjacent capabilities and channels expands our addressable market. This acquisition will activate this potential and represents an important milestone in Cetera's growth trajectory."

In its review of Cetera's parent firm, Moody's will be considering the amount of debt used to finance the acquisition, the possible synergies stemming from the merger and any shifts in the combined firm's strategy, according to a ratings action note by analyst Gabriel Hack. The company could face a downgrade of its "B2" corporate family rating and "stable" outlook if its debt rises to more than 6.5 times its earnings and its interest expenses expand beyond two times the firm's earnings, Hack wrote.

"The $1.2 billion transaction value will likely require Aretec to issue a significant amount of debt to fund the purchase of Avantax, and could lead to a worsening in its debt leverage [and] interest coverage, leading to an overall weaker financial profile," Hack wrote. "Moody's also noted that the planned acquisition would add significant scale to Aretec's existing platform, since Avantax currently has over 3,000 financial professionals with almost $84 billion in client assets. Increased scale and the possible synergies that could exist from the transaction may provide credit benefits."

The deal to take Avantax private followed a similar move away from public stock listing by Focus Financial Partners last month, the spinoff of a tax software firm once owned by the same parent as Avantax for $720 million, two activist investor proxy campaigns defeated by the company's board and years of signs and reports that Avantax may be sold someday. The flux in ownership came as nothing new for many of the 3,078 financial advisors with the firm once known as HD Vest Financial Services in a nod to its founder, Herb D. Vest. Its outgoing parent firm bought HD Vest for $580 million from private equity investors in 2015. Four years later, the firm purchased one its largest competitors in tax-focused wealth management, 1st Global, for $180 million.

Avantax's annual revenue is on pace to more than double to $755 million this year from its level only five years earlier, according to its most recent quarterly earnings presentation. The firm has struggled to maintain its headcount of advisors over much of that span, though. From a peak of 4,225 advisors after the close of the 1st Global deal in the second quarter of 2019, the ranks have fallen by 1,147, or 27%. Avantax's earnings presentation points out that many of the departing advisors were low producers, with the firm's quarterly production retention rates hovering near or above 99% in the past two years.

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Recruiting and retention fights
Still, competitors will pounce on potential big recruits to peel off from Avantax before it folds into Cetera, as is the case in any major acquisition involving independent brokerages and registered investment advisory firms, according to Rita Robbins, the president of New York-based Affiliated Advisors, a branch of Cetera rival Osaic with 90 advisors and $3.5 billion in client assets. She cited a comparable recruiting test that's currently playing out with Creative Planning's acquisition of Goldman Sachs' Personal Financial Management.

"I have noticed that advisors generally feel that they want to make their own decisions. They want to make their own decisions, they don't want to have their decisions made for them," Robbins said. "Advisors are always going to be shopping for the place that best fits them and where the economics make the most sense."

The acquiring firm's history displays its own winding path to its current form. Genstar, a private equity firm whose current industry portfolio includes Ascensus, Cerity Partners, Mercer Advisors and Orion Advisor Solutions, purchased a majority of Cetera in 2018 at a reported price of $1.7 billion. Two years earlier, Aretec, or "Cetera" spelled backward, became the moniker of Cetera's parent company when it emerged from the bankruptcy protection of its prior holding company, RCS Capital. Cetera's network of brokerages has consolidated into four firms in recent years from as many as 11 under RCS.     

Cetera has pledged to retain all of Avantax's legal business entities, technology platforms, products and clearing and custody providers, including by establishing the first relationship between Cetera and Avantax's custodian, a division of Fidelity Investments, where Durbin was head of Fidelity Institutional prior to joining Cetera earlier this year. Cetera also promised that Avantax will operate as a standalone unit within its new parent upon close of the deal. However, it's not immediately clear whether their technical brokerage affiliation will change, or if the unit will tuck into Cetera Financial Specialists or another existing Cetera brand.  

The firms haven't said publicly whether Avantax advisors will receive any "stay bonuses" or other retention payments if they remain through the transition. Cetera offered them to the roughly 1,000 advisors who came over from Securian in the other deal, and the payments are "very standard in our industry for mergers and acquisitions," Armitage said. More than 91% of Securian's advisors managing almost $50 billion in client assets made the move in that deal. Retention of 90% or more of Avantax's advisors would represent a "great" outcome, she said.

"It's nice to have, but they're not the only thing that will keep an advisor around," Armitage said of the retention bonuses, noting other factors such as flexibility in setup, availability of products and vendors and fair pricing. "It should be a terrific match. … They have a pretty good support infrastructure for advisors, so I would imagine the transition would go pretty well for them."