London's Evening Standard newspaper broke the story. The latest in a long line of London-based merchant banks was to lose its independence to a large continental European commercial bank. But this one's assets didn't include anything like the butlers of Schroders or the fine art of Rothschild. In fact it was devoid of that sort of upper-crust City culture, having received its securities licence only 18 months earlier. What's more, it was best known for its activities in Russia, despite having nearly half its staff in London. So why all the fuss?
The bank in question, MC Securities, might be a newcomer, but it has a promising pedigree p; it's the brainchild of Hans-Joerg Rudloff, formerly chairman and chief executive of Credit Suisse First Boston. The news was greeted with surprise, partly because MC Securities was supposedly the vehicle for the German-born Rudloff, apparently tired of commercial banks, to go it alone.
Name change
The new ownership agreement is with Banque Bruxelles Lambert (BBL) and, under it, Rudloff will ultimately answer to BBL, just as he once reported to Credit Suisse. "Yes this is correct," says Rudloff with a laugh. "I am an employee of BBL. I am back to stage one." Rudloff has been in the limelight for years p; his first portrayal on a Euromoney cover, riding a chariot into battle, was in 1981.
The loss of independence is nowhere more evident than in the company name. The bank will no longer be called simply MC, which stands for Marcuard & Cie, Marcuard being Rudloff's mother's surname. (One of Rudloff's cousins, a Marcuard, works for the Geneva operation.) Now the BBL name will be tagged on to the main operating companies. A new logo will probably be designed too.
The obvious conclusion when the news leaked was that Rudloff's $75 million venture had failed. Much the greater part of MC's business might be in western Europe but this did not apparently attract attention. Rumour had it that the highly-publicized drive into Russia had eaten up Rudloff's capital and that MC Securities needed recapitalizing. Rudloff denies the rumour, pointing out that despite start-up costs MC's eastern European operation is already pretty well out of the red.
Charles Harman, who is in charge of eastern Europe, recalls that before he joined he asked Rudloff why he needed $75 million in equity. Rudloff told him that even if annual costs were $25 million and no revenue was forthcoming, that way the firm could operate for three years.
In fact, "losses" were limited to $15 million in 1995. "Obviously we lost $15 million," says Rudloff. "We built from zero to 220 people in a year." And, he points out, the headline $15 million loss included many one-off costs, such as legal fees for incorporating the business ($1 million) and start-up costs such as equipping trading desks, each of which Rudloff estimates costs $50,000. And the figure would have been lower had MC not missed out on first-quarter trading because of a delay in receiving its licence from the UK's Securities & Futures Authority. In addition, the corporate finance advisory work it carried out p; with an average deal-life of eight months p; mostly occurred after April, so success fees were only paid in 1996. Finally, the $15 million also included $4 million in staff bonuses.
Rudloff says that in the first six months of 1996, MC Securities will probably break even. It may end the first half $1 million up or down depending on how well the the last four days of June went. "The Russian market was up 10% today," Rudloff told Euromoney on June 24. "That could well add $1 million."
Peter Ogden, another MC partner, says: "Well, clearly we've spent a fortune. We have a 90-man office in London and we faced the business head-on. But it's a typical J-curve. You can't creep into this business." Harman, who left CSFB after 10 years, substantiates this point. When he left CSFB at the end of 1994, it had 60 staff in Moscow, 30 in Budapest, 30 in Prague and four in Warsaw p; a total of 124 in eastern Europe. MC's 132 exceeds this, with 12 in Warsaw, 65 in Moscow and 55 in Prague.
But Rudloff readily admits to a flaw in one key area of his strategy. An ideas man p; some of his best are apparently dreamed up in the bath p; he became, as a Moscow banker puts it, a "philosopher king" when he got the opportunity to start a firm from scratch. What went awry was his notion that an ideal synergy between youth and experience could be created at MC. At the top level, a board was formed which included such distinguished figures as Lord Carrington, the former UK foreign secretary. The "experience" was largely supposed to come from the partners. And at the lowest level, it was expected that hungry young people would bounce their energy and creativity off the older generation. After a late night at the office, the charismatic Rudloff would take them to expensive London nightclub Annabel's for a debriefing.
As it happened, the structure broke down in the middle. Rudloff wanted to amass $35 million of personal capital p; in cash - from the partners. This wealth requirement meant that those chosen tended to be on the wrong side of 45 and no longer inclined to be particularly aggressive in winning business. Ogden, puffing on a cigar, is under no illusions: "Partnerships confuse employment with investment. Few of the partners proved to be great employees."
Several partners came from a group of friends Rudloff assembled in the late 1980s when he dominated the capital markets at CS First Boston. A delighted financial press portrayed it as a dream team - but it was one from the last decade.
The dream team
There was Peter Ogden, a former syndicate head at Morgan Stanley who got particularly rich when the firm was floated in 1986 and even richer when he moved out of investment banking into computers, setting up the highly successful computer distributor Computacenter. He put $6 million into MC, not much less than Rudloff's $7.5 million. Ogden's best friend, Joan Beck, a former syndicate chief at Morgan Stanley, and CS First Boston, also joined. Another founding partner was Sheldon Prentice, formerly syndicate head at Salomon Brothers. He had, however, been out of the markets for five years before his arrival at the MC offices in Commercial Union Tower in London, where the company leased a whole floor.
Ogden set up the computer systems and occupied himself with the asset management business, but neither Beck nor Prentice appear to have been particularly interested in the eastern European operation. Prentice, who is extremely well known in the US, was initially keen to set up a New York office, but this never happened. Neither had "a particular role", says Rudloff. Both decided to leave by "mutual agreement". Between them their shareholding was only 3%, which the other partners bought out.
"The younger people made a big contribution and most of the other guys didn't," Rudloff concedes. "It only works if the older people prove themselves to the younger people and win their respect." The firm is now staffed by what he calls "dedicated 30 year-olds".
In all, six partners have left. New ones joined, so there are now 11, including an undisclosed number of the eight founding partners. One of the early departures was Stuart Lucas, who for five months was in charge of trading secondary Eurobonds. He left by mutual agreement when it was decided that this business area - which was not originally in the business plan - did not work out.
In addition, Unifund, a Swiss-based Saudi Arabian fund, dispensed with its 5% stake in MC Securities after two months. It wanted additional equity in the Russian operation - a request the board refused.
It is perhaps inevitable that Russia, the most flamboyant area of MC Securities' business, became its public face. It meant, however, that other areas were overshadowed. Western European corporate finance and equity capital markets are the most important parts of the business, contributing 90% of the firm's revenues in 1995. They are headed by Willy Douin, a Belgian who was formerly head of CS First Boston in France.
In the course of 1995 the western European operation won six advisory mandates, the biggest being a shareholder restructuring at Club Méditerranée, where it participated in the syndicate for the ffr880 million ($169 million) equity issue. Two deals in Belgium arrived via BBL (which was then a 29% shareholder in MC), while Rudloff managed to win a mandate in Switzerland. The 25 professionals - eight corporate financiers plus research analysts - specialize in four industrial sectors: power, financial services, automotives and pharmaceuticals. (Rudloff is deputy chairman of Swiss drugs company Novartis, formerly Sandoz and Ciba-Geigy.)
Impressive performance
A key part of equity capital markets is the sales force in Geneva, which should come as no surprise since Rudloff began his career setting up Kidder Peabody's sales force there. He spends each Friday and Monday in Geneva and brought over a five-strong team from Credit Suisse. "We are very happy here in Geneva," says one of them. It's little wonder. In the year from June 1995, MC Securities was in 75 out of 485 Swiss franc bond syndicates, including deals for Sweden, Ontario and the European Investment Bank. Outside of Swiss francs it has leveraged its connections; for example, being part of the group when Ogden's Computacentre launched a £50 million ($75.5 million) issue and when two Danish krone issues were led by BBL.
The asset management business has also done well. In one year it has accumulated $230 million under management, which is all the more impressive since it has no track record. This includes two $50 million investments from a supranational and a province. The business is managed by two London-based fund managers (not eight, as one press report suggested): John Mojdehi and Frederick Turentini, both of whom came from - guess where - CS First Boston. There are also three well-regarded analysts.
Mojdehi was head of proprietary trading at CS First Boston from 1991 and reported directly to Rudloff, partly because CS First Boston had not had a formal prop desk before this. Mojdehi expects to have $400 million under management by the year-end, and he points out MC's asset-management business is not capital-intensive. Costs in 1995 were $1.5 million. The funds managed in the London-based business are not necessarily invested in eastern Europe. (MC does manage a Russia fund in Switzerland but the London operation has no involvement in it.)
Harman's eastern European operation is the most complex part of MC's business, if only because of the shareholding structures. The newest operation, MC Concordia in Poland, run by Adrzej Mierzwa, has always been under MC's control - it has a 52% voting stake. In Russia, the operation is a joint venture, known locally as United City Bank, which until the BBL deal was only 25% owned by MC Securities. Patria, the Czech business, was only 20% owned by MC before the BBL takeover. (Rudloff, though, had a substantial personal shareholding.)
Patria is run by Zdenek Bakala, the former head of the Prague office of CSFB. There are 11 partners who own 51% of the business. It is described by everyone at MC as the "jewel" in the portfolio and has developed a profitable domestic fixed-income franchise, ranking in the top three in Czech primary market business together with Komercni Bank and Ceska Sporitelna. In 1995 its fixed-income sales and trading turnover were in excess of $1 billion. It is also ranked in the top three in equities. Its return on equity for 1995 was nearly 60%.
Jan Vlachy, a Patria partner who formerly worked for the Czech Development Bank, says of the relationship with MC: "We very much prefer to be called an associated company, not an affiliate." He continues: "I don't remember a situation where there would have been an outright veto of a Patria deal by MC."
The new arrangement with BBL should tidy up these diverse shareholdings. The net effect is that the business has been split in two. The first business, MC-BBL Securities, takes control of all western European activities - encompassing capital markets, merger advisory and research. It becomes a 100%-owned subsidiary of BBL and will be run by Douin with the objective of making it BBL's investment banking arm. Rudloff and the partners of what was MC Securities will have no direct equity. Rudloff, however, will be encouraged to bring in deals under a "shadow" equity plan.
The other business is MC-BBL Eastern Holdings, which will be run by Harman and is 51% owned by BBL. The partners of MC Securities and its outside investors (mainly Swiss) control the other 49% of the company which, as part of the BBL deal, increased its stakes in the eastern European businesses. It has a 60% controlling interest in the Russian operation (up from 25%), 49% of Patria (up from 20%) and 52% of the voting rights in the Polish business.
But two businesses remain outside BBL's control. The profitable Geneva operation - in which Rudloff retains a 25% stake alongside a group of minority interests - is one. The other is the asset-management arm which will be partly owned by BBL and partly owned by the partners, primarily Ogden.
The new structure has strategic advantages. The western European operation, a BBL subsidiary, will benefit from the BBL balance sheet. This will enable it to underwrite primary equity business and distribute it through BBL's brokerage subsidiaries: Williams De Broë (UK and Scandinavia), Vermeulen-Raemdonck (Belgium) and Ferri (France). BBL's investment banking business will be channelled via MC's London headquarters.
Equity stake
But the deal's key benefit for BBL is its majority control of a large eastern European operation. "Outside of MC, our presence in eastern Europe is one person in a representative office in Warsaw," says a delighted source at BBL in Brussels. So the danger of overlaps is minimal.
The deal, largely brokered between BBL's Jean-Pierre Wellens, an adviser to the board, and Rudloff - friends for over 15 years - will focus the minds of MC's partners. Their equity play has become almost purely eastern Europe, the business with which the MC name is most closely associated and which promises the greatest returns - though with the greatest risk.
In spite of losing his independence, Rudloff has managed to retain a structure which he always advocated at CS First Boston, but was frustrated in his attempts to create: one which gives those running the local operations an equity stake, even if the overall majority is in the hands of a commercial bank. One of the principal reasons for Boris Jordan's leaving CS First Boston in Russia to create Renaissance Capital was said to have been his annoyance that in a year when his Moscow team had made $100 million, none of its members was given any equity in the operation by CSFB. Rudloff points out that 30% of the equity in the Russian operation is owned by the locals.
The need for capital in the rapidly expanding eastern European markets was the principal motivation for ceding independence. Rudloff notes that the successful Czech brokerage Wood & Co recently entered into an agreement with Commerzbank. Russian broker Grant similarly hooked up with Creditanstalt. "I never left any doubt there would be capital increases, otherwise nobody would have joined," says Rudloff. "But the partners will benefit from the greatly increased scope of the operation. The cake will be three or four times as big."
MC previously had $4 million in equity capital in eastern Europe, says Rudloff. MC-BBL Eastern Holdings has $23 million. With other shareholders (such as the partners in Patria), the eastern European operations are capitalized at $34 million. The bulk of this is in Russia. The capital-intensive nature of trading in eastern Europe prompted the increase. In Russia, for example, it's not unusual for a broker to carry a client position for a week, funding the transaction with its own capital.
Russia is the great gamble. One interpretation of the deal with BBL is that Rudloff has given up his independence for Russia. Although he will control only 14% of MC-BBL Eastern Holdings, which he admits constitutes a dilution, the deal with BBL was driven by the potential that Russia offers. "I think Russia is the most important part of all this," says Harman, "maybe 60% of the picture."
The 65-strong operation of United City Bank (UCB), the 60%-owned MC-BBL vehicle, had been in its new premises between the Garden ring and Boulevard ring of old Moscow for only a month and a half when Euromoney visited last month. They are a marked improvement on the old offices which were flooded four times last year. UCB is spread over three floors and, according to the Rudloff principle of employing locals, has only eight expatriates. The heavy weighting in Russians is aptly reflected by a sign on the stairs saying "Cigarettes Only". Downstairs in a homely corporate kitchen the heavy smokers can enjoy nourishing food served up by babushkas.
Capital injection
The head of trading is Dmitri Evenko and the merchant banking head is Sergei Pykiev, whose task it is to find stakes in undervalued companies. On any given day UCB reckons it does between 5% and 10% of brokerage volumes. The office is run by Alex Radzienko, a Russian American. "My ancestors left Russia after the Revolution," he says. "I have Russian culture in my blood." He traded emerging-market debt for Chemical Bank for 13 years, but in the 1970s was an interpreter in the US-Soviet strategic arms limitations talks. Before he agreed to become head of MC-BBL's Russian venture, Rudloff told him: "If it doesn't work out you will have had an experience that almost no-one else in the world will have had. So you have nothing to lose."
Radzienko is happy about the BBL sale: "It adds that element of stability," he says. "I'm actually quite pleased with it." The capital injection will, says Harman, lead to a commitment of $25 million to Russia, both onshore in Moscow (where capital must be held in roubles and is prone to depreciation), and offshore in Cyprus (where it can be kept in dollars and where some clients prefer to trade). This will substantially increase the operation's ability to trade both on customers' behalf and on its own account.
Both Harman and Radzienko think a return on equity of 50% is appropriate for Russia, where the risks are high. In the second quarter, revenues were $1.9 million against expenditure of $1.3 million. It was the first quarter that the Moscow operation moved into the black.
Just as important as the capital injection, however, is the fact that the connection with BBL - which has a $3 billion balance sheet - ought to make it easier to access short-term credit lines from foreign banks at more reasonable rates. Russian commercial banks charge punitively high interest rates because they can buy high-return rouble-denominated government treasury bills (GKOs, nicknamed gekkos) yielding in the region of 150%.
The hope is that UCB, which has a commercial banking licence, can leverage its connections with BBL further. BBL is already involved in trade finance in Russia and as Harman says: "A lot of companies you want to do business with are exporters." UCB also hopes that it can point companies desperate for short-term finance in BBL's direction to borrow at reasonable rates - not the gekko-inspired ones that few companies can afford to pay Russia's commercial banks. BBL, which unlike German and Austrian banks has an almost non-existent Russian loan book, may wish to get involved in loan syndication. UCB is aware that should this happen the relationships formed will be crucial when companies later award mandates for international equity issues.
According to Rudloff, UCB has 296 counterparties trading Russian securities. One New York-based investor running a $60 million Russia fund recalls his first involvement with MC's Russian traders. He received a rather brusque call at 5.30am New York time to be informed of a market move. "I was so impressed with the service and the ideas that I gave them a series of large orders - irritated as I was to lose my sleep."
The same investor says: "You can find things out calling MC that you can't from other people." He says that Russian oil company Surgut Neftugas recently announced annual profits three times higher than the previous year's. You could have known this three weeks before the announcement, he adds, because of a cryptic result leaked onto the Reuters screen for the principal daughter company. "It needed interpretation. But some in the market were too lazy. The only people we were talking to who were equipped to come to sensible solutions were MC."
The research that UCB produces is highly regarded. Christopher Granville, a former British diplomat in Moscow and the winner of a local magazine's award for best Russian analyst, writes the Russia Weekly, a news digest whose only flaw is that it's not published as regularly as its title suggests. "As an analyst in this market you feel like you are writing for individuals," he says. His prediction on the first round of the presidential elections was spot on: 33% Yeltsin, 31% Zyuganov.
Back in London, a further team of researchers write sectoral research. One of the most highly regarded is Stephen O'Sullivan. His all-inclusive 130-page "book" on LUKoil was written as a credibility-building exercise. O'Sullivan was previously an oil consultant at Coopers & Lybrand, and before that at BP and Total. It's easier for him to make contact with Russian oil companies now that Vitaly Cherniak, Russia's former deputy fuel and energy minister, is on the MC-BBL staff. Oil stocks are the most heavily traded of all Russian equities.
The connection with Cherniak resulted from a relationship he had with MC-BBL's local partner, Sintez, a Russian trading company that began selling compact disks in 1987 and among others things now owns an oil refinery and an oil field. Sintez retains 40% of UCB.
A good time to be in Russia
Euromoney visited UCB's office the day after the first round of the presidential elections on June 16, when excitement was at fever pitch. Third-placed candidate Alexander Lebed had just declared his support for Boris Yeltsin. His quote on the Reuters screen amused Andrew Cowley, an MC Securities partner in Moscow. Cowley formerly wrote for The Economist and recalled the interview Lebed permitted him in 1993 when the fiery general was acting as a peacekeeper, and nearly walked out because Cowley was wearing a pink shirt. Things did not get much better. Lebed responded to a whole series of questions with the cryptic response: "I walk like a cat."
Nevertheless Lebed's cat-walking pledge of support for Yeltsin was interpeted in the financial markets as certain victory for the president in the second round against the communists. At the end of the day the Moscow Times index hit its highest level since September 1994. The average yield on gekkos fell 20% to 132% - the previous Thursday the yield had been 215%.
MC's Russian operation had had a good day. In the trading room, the three equity traders and two gekko traders had telephones stuck to their ears. "What can I tell you. The market's going up," one screamed. That day alone the Russian operation made $2 million in marked-to-market profits.
Rudloff is one of the many who is greatly relieved by the turn of events. If Yeltsin wins it is forecast that a flood of foreign investment will arrive. A good time to expand your trading book in Russia. (Although at the time of going to press, Yeltsin had mysteriously failed to appear in public for several days, leading some observers to assume his re-election in the second round was by no means assured.)
It is somewhat ironic that Rudloff should be putting so much faith in Russia coming right. When he was first invited there in 1992 by Guy de Selliers, a friend of Rudloff's at the European Bank for Reconstruction and Development, he arrived on a private jet with Carl Kuhne, then CSFB's Russian country head. His only meeting was with Anatoly Chubais's deputy at the State Property Committee, Dmitri Vasiliev (now head of the Russian SEC), who famously did not stay in the meeting for long. A six-month period followed in which it appeared Rudloff and Russia were destined not to be an item.
The mandate to privatize Bolshevik Biscuit, Boris Jordan's first assignment in Russia, and the subsequent sale of repurchased voucher shares to Danone, changed Rudloff's mind. Giving up his independence to BBL is the latest example of his resolve. "Would I love to have $200 million and finance it all myself?" says Rudloff. "Of course. But I know my limitations."
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