Investment Strategy

Friday 1st June 2001

Consolidators use high risk to tempt professionals By David van Schaardenburg

A new phenomenon is sweeping the Australasian accounting and financial planning industries. It's nothing as ordinary as a new financial accounting standard or the latest approach to portfolio management. BRW accounting writer Tony Thomas is calling it the "invasion of the practice snatchers."

Companies generically termed "consolidators" are buying up small to mid-size accounting and financial planning practices through the issue of new shares. The natural questions for industry participants to ask are:

Why is this occurring?
Will the consolidators succeed?
What are the risks to the sellers?

In short, are the consolidators offering sizzle or substance?

Outside the big five accounting firms and national investment adviser networks, accounting and financial planning are cottage industries, highly personal, owned by senior staff and tailored to individual client needs. Industries such as retailing and manufacturing, which early on had similar features, have substantially consolidated to create economies of scale and lower prices for consumers.

Will smaller accounting and financial planning firms be swallowed up and potentially create similar broad economic benefits?

Professional practitioners in smaller accounting and financial planning firms are increasingly struggling to keep up with the rate of technical change and compete with the sophistication found in large firms. The small operators, normally partners, are also concerned about maximising the sale value of the business or just finding a buyer.

Their businesses have good cashflow and loyal trusting client bases. Their needs and business characteristics are understandably what attracts the attentions of consolidators. To targeted accountants, the sudden appearance of a new sale option that also appears to dilute competitive concerns plus help to manage increasing business complexity may look like a vision from above. But can the consolidators deliver?

Consolidating tangible and less rapidly changing industries, such as shoe retailing or car manufacturing, has proven successful. However, in professional services the people are the business. Take them out of the equation or reduce their motivation (post-practice sale) and a question mark must hover over the ability of computers to replace them.

Sure, as the consolidators desire, the professional practitioners could increasingly specialise plus become superior salesmen. However, these changes are a big ask for a 50-something small-town accountant. And history is not tilted toward consolidators proving successful in their business re-engineering efforts.

There has already been a high failure rate among such consolidation firms in the US, the UK and recently in Australia with the fall from grace of Harts Group. This has important financial implications for professionals caught in the consolidators' web.

On the business sale, their financial investment typically moves from being substantial ownership of a cashflow-positive business with an entrenched client base to a locked-in minority holding in a listed share where the company is often cashflow negative. Financial risks become substantially higher so it is no wonder the vendors seek the prospect of higher returns over time.

But, as risks rise, the ability of the vendors to influence their ultimate financial outcome collapses. So it is somewhat surprising to see seasoned accounting professionals swap cashflow for share scrip.

In response to the consolidator's strategies, options for the smaller professional firms have appeared. One has been the expansion of accounting firm networks or alliances where participating firms pool or outsource their professional training, new business services development and sometimes computer-systems needs. While this does not have the excitement of a consolidator-driven sell-out, it does address key practice issues without the downside of losing business control.

Although the promises of professional service consolidators are highly seductive, their business model is yet to be proved. They offer high rewards but also high risks for those who join their bandwagon.

At this point it is probably more prudent for accounting and financial planning professionals to focus on improving the sustainable profitability of their businesses, through the efficient delivery of existing and new services - the "substance" rather than the short-term sizzle and possibly fizzle offered by the consolidators.

David van Schaardenburg is executive chairman of FundSource (formerly Ipac), an investment strategy and funds management research company

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