Custom House's Hedderman: Are We Delivering EBITDA At The Expense Of Client Service?

May 31 2017 | 6:55pm ET

Editor’s note: As traditional fund administration undergoes a fairly dramatic, fintech-inspired revolution in areas like efficiency and cost, a more macro shift is also quietly taking place in the ownership model of alternative fund administrators, writes Mark Hedderman, CEO of Custom House Global Fund Services. This trend, described as “EBITDA at all costs” is more akin to a private equity firm’s approach, Hedderman contends, and is not the ideal situation for fund administrators or their clients.

Are We Delivering EBITDA at the Expense of Client Service?
By Mark Hedderman, Custom House Global Fund Services

Private equity firms are known to acquire companies with the intention to resell them at a profit. This may work very well for some mainstream sectors like healthcare and technology where deals are plentiful and companies that go public are a dime a dozen. However, can the private equity ownership model benefit the fund administration space? And what is the ultimate impact on client servicing? 

The outlook of PE firms, as we know, is dramatically different to that of an institution or an entrepreneur building their business. Their view is that their purchase or investment is simply an asset to be sold on in the future at a much inflated price than what they paid for it. Often  the outlook can be relatively short, a couple of years, and therefore the pressure being put on their acquisitions is to drive up profitability at almost any cost. This is in stark contrast to being part of a consolidated service offering, or a long term business creation plan. This plan may work for PE firms but it may not be the ideal situation for fund administration and their clients.

There is a change that is occurring at the very macro level that is not be talked about, but is having a dramatic impact on the industry – the new PE ownership model of alternative fund administrators. The traditional ownership model of the fund administration business tended to be investment banks and entrepreneurs. The former, as part of a broad financial services offering and the latter the normal occurrence of individuals spotting gaps in the market or following their dreams. This is no longer the case though. The exit by the investment banks from the fund administration business has been on-going for a number of years now, as they decided that it is too high risk and low profit and increasingly complex. The entrepreneurs have typically reached the stage of their lives where they wish to realize the value of their business and create an exit. With both of these came a degree of strategic certainty that they were being run with a long term goal in mind, either as part of an institutional offering, or the development of a business. The outlook tended to be a broader and more patient one, which allowed the service to clients to remain as the core element for long term growth. As both of these groups began their exit, in their place has typically come private equity ownership in one form or another. If it is not in entirety, then it is as part of an investment/financing solution.

The shift from leading with client service as the way to build your business to profit over time is a significant one that is having a real impact. In short, firms are becoming hell-bent on adding to the top line, while at the same time achieving cost savings within the business to deliver EBITDA. The direct result of this is that the level of pricing being offered to clients is falling significantly as the business believes it can make savings elsewhere. Usually this is done via the creation of large scale back offices in low cost locations and, in fact, the main issue is really ‘scale’ and the ability to rationalize business models.

As a result of this, we are seeing falling prices and the classic ‘race to the bottom’. In fact, a majority of the time the rates being offered are at a loss to the firm, as they believe their rationalization will deliver savings elsewhere which will make the business profitable as a whole. The focus has become the price, not the service and this is the main factor contributing to the commoditization of the industry. The irony being, of course, that this is something that all administrators lament over. You could say that the industry is almost cannibalizing itself, as it leads with price as the only way to achieve differentiation as opposed to service.

Therefore, does this new PE ownership model benefit the needs of clients? 

Let me lay it out for you. The priority of the PE firm is simply to increase EBITDA as quickly as possible, realize profit, and move on. The needs of the client are secondary to the short term maximization of profit. There is a reluctance to engage in long term investment as it will not be of benefit in the timespan of the ownership and the business is now focused on a monthly/quarterly EBITDA target attainment. If the target is not met for uncontrollable reasons, such as market performance or investor redemptions, then it must be achieved by the way of cost savings. ‘EBITDA’ becomes the focus and trade-offs are found to deliver it that would normally not be considered. This can be in the form of withdrawal of bonuses, staff cuts, the cancellation of technology spend, etc.

It is impossible to stress enough the change in culture that this focus brings. Management teams become obsessed with ‘EBITDA’, every decision is taken from an ‘EBITDA’ perspective and there is a slow relegation of the client to fall behind the needs of the business itself. The PE owner will typically have a seat on the board and the management team forced to defer to ‘valuation enhancement’ experts whose role is to monitor the decisions of the board to ensure they are in line with the objective of the PE owner.

The creation of value in a business has, of course, always been the goal of every company that has been set up. However, the shortening of the time frame for the realization of this value has created a completely different environment, where the focus to the client is price over service and the goal of the business is short term profit over long term sustainability. The value being placed on the role of the administrator is diminishing in the eyes of the client, as price becomes the main differentiator and therefore decision factor, while concurrently the responsibilities and demands increase. Whatever the outcome is, it is concerning to see such a short term outlook becoming the prevailing norm and EBITDA the overriding goal. Whether this will prove to be in the best interest of investors, remains to be seen.


In Depth

Q&A: Rotation Capital's Rothfleisch On SPAC 2.0

Aug 11 2017 | 7:43pm ET

Corporate actions have long been a staple of event-driven investors, but activity...

Lifestyle

CFA Institute To Add Computer Science To Exam Curriculum

May 24 2017 | 9:25pm ET

Starting in 2019, financial industry executives sitting for the coveted Chartered...

Guest Contributor

Star Mountain Capital: Private Lending in the Lower Middle-Market

Aug 14 2017 | 4:45pm ET

Private credit has become one of the most popular alternative asset classes in recent...

 

From the current issue of