Fitch/Algorithmics deal analysis

New York-based global ratings and risk management specialist Fitch Group has acquired Toronto-based enterprise risk management software supplier Algorithmics for $175 million.

New York-based global ratings and risk management specialist Fitch Group has acquired Toronto-based enterprise risk management software supplier Algorithmics for $175 million. Under the agreement, Fitch’s risk software and advisory elements will be amalgamated with Algorithmics, which will also receive funding and support to further develop its product suite and risk management services.

Founded in 1989, Algorithmics has been a pioneer in the application of technology to enterprise risk management (ERM). Last month, it emerged as the clear leader in ERM in the inaugural Risk technology rankings, while in 2001 it won Risk’s technological development of the year for its Mark-to-Future valuation methodology. The company has more than 150 clients globally, including some of the biggest risk installations at some of the world’s biggest banks, such as HSBC and SG.

But developing and supporting such complex large-scale software needs deep resources, and the company struggled to generate the necessary funding from revenues. Over the years, Algorithmics obtained several rounds of funding from a group of investors, including Morgan Stanley and Commerzbank, most recently in March last year. In 2001, the company filed a preliminary prospectus for an initial public offering (IPO), only to withdraw it later that year when the market cooled on technology stocks. However, with the emerging requirements of Basel II, which demands new functionality of risk systems while also presenting substantial market opportunities, and key investor Morgan Stanley acquiring rival ERM software vendor Barra last year, Algorithmics was in need of a strong partner.

“Risk management is an exciting and growing market with a lot of opportunity, but it is a global market, where global vendors are required to support global clients, and you need a certain scale to do that effectively,” says Michael Zerbs, president and chief operating officer of Algorithmics. “Also, the effort in developing industrial-strength software at the level and scale that Basel II requires is easier to do in a large company.”

For Fitch’s part, it has seen its ratings competitors extend their operations into risk advisory and software over the past few years, with New York-based Standard & Poor’s (S&P) creating its Risk Solutions division, and California-based Moody’s acquiring credit analytics specialist KMV.

“We started investigating whether we should take a stronger position in the risk analysis and portfolio area about three years ago,” says Stephen Joynt, president and chief executive officer of Fitch. “The reason S&P, Moody’s and Fitch are all interested in doing this is because it is a natural extension from doing just credit risk analysis and individual bond ratings to doing portfolio analysis, first on credit and then on any kind of risk.”

Fitch had made some forays into extending its reach with the creation of its Fitch Risk advisory and software division, and the acquisition of operational risk management data and software specialist NetRisk in 2002. “So we had several key products, but to move forward we would have had to make significant internal investment if we wanted to be able to compete fully, or we had to make an outside acquisition,” says Joynt.

Although as the leading ERM vendor, Algorithmics is something of a prize for Fitch, it also didn’t have a lot of choice. Most of the other major ERM systems on the market are part of the product suites of companies that are among the largest software vendors in the world, such as SunGard with its Panorama system, Germany’s SAP with its Bank Analyzer and SAS with its Risk Dimensions.

Algorithmics’ competitors claim to be not unduly surprised or worried about the deal. “The fact that Algorithmics has been acquired is not a surprise, but that it is Fitch that has done the acquiring is,” says Peyman Mestchian, head of SAS’s UK risk practice. Had a major technology company, such as Oracle or IBM, taken over Algorithmics, it would have potentially posed more of a threat because of those companies’ ability to strengthen the technology base of Algorithmics’ products, and in particular its data handling capabilities, he says.

Like Mestchian, Don Mumma, managing director of New York-based rival ERM systems vendor Axiom Software Laboratories, is only surprised by the identity of the acquirer. Although there had been some talk in the market of Algorithmics attempting an IPO again this year, Mumma was sceptical that it would have succeeded because of the narrow nature of Algorithmics’ business. “I think Fitch is a natural buyer for Algorithmics, particularly in light of Moody’s and KMV,” says Mumma.

Algorithmics users contacted by Risk were positive about the deal, seeing it laying to rest concerns about funding that have at times plagued the company. “Algorithmics is very good at what it does, and getting involved with a partner like Fitch should help them fund their projects, give them stability, and for both companies to leverage off each other’s strengths,” says Mark Engel, managing director, financial engineering at Scotia Capital, the global corporate and investment banking division of Toronto-based The Scotiabank Group, which uses Algorithmics’ market risk management software.

For the most part, the product lines of the two companies complement each other, although there is an overlap in the area of operational risk management software. But Zerbs says it is still early days in op risk, and the software products are still relatively immature, so it is the bringing together of the two op risk teams that is the key benefit of the deal.

Joynt says Fitch’s ratings business will be more or less unaffected by the deal. Fitch Group is a wholly owned subsidiary of Fimalac, a global business support services group based in Paris.

Risk