Hungry ING looks for its next meal
When investment bankers at San Francisco-based high-tech boutique Robertson Stephens began to receive regular e-mail messages about business developments at their new parent, BankAmerica, they feared the worst: “It was an indication that big brother had come,” says a Robertson Stephens source. It wasn’t that the e-mails were directives on anything substantial, he says: “The news was just irrelevant. It didn’t add any value.”
Downstairs, in the corridors of the much larger financial institution, the commercial bankers at BankAmerica were likewise annoyed by their new colleagues. “It’s typical for them to underestimate the value that a commercial banker can bring to the business; the assumption is that he’s not as sophisticated,” says a former commercial banker at BankAmerica. This banker left soon after the merger, when a series of meetings between the commercial and investment bankers convinced him the integration of these two disparate cultures would be difficult to achieve.
Unlikely marriages
Out of a dozen mergers between US banks and securities firms last year that were prompted by the relaxation of Glass-Steagall rules separating the two businesses, none illustrates the clash of cultures more sharply than the $540 million all-cash BankAmerica-Robertson Stephens deal. It was the third largest of last year’s mergers, behind the $1.2 billion in cash and stock that NationsBank paid for Montgomery Securities and the $1.7 billion stock swap by Bankers Trust for Alex Brown.
Each deal is the marriage of a bank with the least bank-like of securities firms, the boutiques: typically a small firm which has made its name financing high-growth industries such as technology and health care, mostly through initial public offerings (IPOs).
Boutiques though they are, these three are important Silicon Valley investment bankers, part of a group known as the Four Horsemen: Hambrecht & Quist (H&Q), Alex Brown (though based in Baltimore), Robertson Stephens and Montgomery Securities, also collectively referred to by their acronym, Harm. Only H&Q remains independent, and has reportedly been in merger negotiations with Merrill Lynch. H&Q and Alex Brown had transformed themselves into publicly-held corporations, but the early attraction of these boutiques was the partnership structure which has now disappeared from all of them.
All three were sold for sums unthinkable only months earlier, at prices between five and nine times book, driven up by dreams of synergy-propelled growth. But will the new superboutiques, as they are being called in Silicon Valley, fulfill their parents’ dreams? Most analysts say it’s too early to tell. Big mergers like this often take a decade to unravel, judging by the recent break-ups in London of NatWest Markets and Barclays’ BZW.
But at BankAmerica and Robertson Stephens, the elusiveness of the integration is troublesome, and illustrates some of the difficulties all such combinations face. The constant e-mails notwithstanding, the two are still running separately, although the merger was completed on October 1. The group has yet to announce a new management structure, and sources close to the bank say it is wrestling with whether or not to put former Robertson Stephens president Michael McCaffery in charge of a soon-to-be created global capital markets unit. “They have gotten out of the box more slowly than others,” says a former executive.
Blonde wood and bay views
The hesitation suits some just fine. “Nothing has really changed here,” says Misha Petkevich, who heads investment banking at Roby Stephens, as it is known locally. Just a year and a half ago, Petkevich insisted the firm wanted to retain its independence. “That’s the way people like it,” he says.
To understand Roby’s reluctance to be swallowed the equivalent of a minnow going into a whale one need only consider the physical distinctions. True, the two businesses are housed in the same building, BankAmerica’s tower on San Francisco’s California Street. And their chairmen, BankAmerica’s Dave Coulter, and Robertson Stephens’ Sanford Robertson, are close friends. But, as many local bankers note, the commonalities end there.
The wealth effect of the hi-tech start-ups that have thrust the tiny partnership into the spotlight are evident in Roby’s posh home on the bank’s 26th floor. It’s a spacious modern suite full of blonde wood and stunning bay views. “You have a feeling these guys are doing well,” says a competitor. Above it and below it, BankAmerica, a sprawling bureaucratic institution that remains one of the biggest retail banks in the US, by contrast, “is drab. It has a different look and feel,” he says.
Ironically, Robertson Stephens sold out after its performance may have peaked. It had gained a reputation for simply churning out deals and the after-market performance of its IPOs sank below average last year. “We heard rumours the bankers were being asked to do whatever business they could, despite a lack of quality, to build up a backlog to show the buying community they were worth something,” says a competitor.
Petkevich won’t confirm whether the firm’s earnings suffered last year, since as part of BankAmerica the boutique no longer breaks out earnings. But sources close to the firm say the end of the year “was very light. They had to get a credit facility from BankAmerica to pay bonuses”. The firm “hadn’t met the operating profit objectives of BankAmerica”, says another source. “It didn’t perform to their expectations.”
BankAmerica may be unhappy, but it had committed itself to paying bonuses at the boutique, including hefty guarantees that accompanied the sale last year. The promised payout was a big shift from the entrepreneurial spirit that drove Robertson to the top of the technology underwriting league tables as recently as 1995. “The guys at Roby Stephens are the prototypical technology gunslingers,” says another competitor. “It’s a Darwinian environment. You eat what you kill.” Historically, he says, the firm paid out almost all its retained earnings in bonuses.
Unhappy vice-presidents
The BankAmerica Robertson Stephens problems may just be a hiccup. Indeed, even some who recently departed believe “eventually they will get it right”. Few question the imperative that has driven the two to merge.
Petkevich, who insists that BankAmerica offers “a cultural and a personality fit”, says the “increasingly complex demands” of the young companies the firm has traditionally serviced force it to provide a much wider array of financial services, “and the bank brings that to us”.
That’s clearly becoming more important. These three formerly independent firms have now been dubbed “superboutiques” not quite in the big league. Some bulge brackets firms, Morgan Stanley and Goldman Sachs, have invaded their turf recently and stolen some of their best customers. The mergers allow the boutiques to expand their financing capabilities, as well as their client-base. For example, with the high-yield debt capability BankAmerica offers, Robertson Stephens is now hoping to service the telecommunications industry and the gaming industry, for which it has recently hired analysts. Already it can offer high-yield financing for its existing consumer and health care clients.
For two decades, US banks and securities firms have been edging closer to each other, in culture and product, as the legal barriers crumbled and client demands increased. So many bankers as well as analysts play down potential integration problems in these new combinations.
When Brown Brothers Harriman analyst Raphael Soifer asked former Alex Brown chairman Buzzy Krongard why the firm chose Bankers Trust, Krongard told him: ” We picked them because they’re not a bank. We had no interest in merging with a bank.” Bankers Trust was the first commercial bank to venture into the territory of the securities industry, back in 1978, when it began underwriting commercial paper. Despite the derivatives scandal of 1994, Bankers Trust has so effectively transformed itself into an investment bank that many competitors view this merger as the most likely to succeed.
Krongard was named a vice chairman of the new merged institution, but last month he was the first senior executive to quit. He left to join the Central Intelligence Agency as a counsellor. Bankers Trust chairman Frank Newman acknowledged that Krongard was crucial to making the merger succeed. Krongard was near retirement age, and had become less active in the day-to-day affairs of Alex Brown. But Newman and other industry executives claimed his contributions would be missed.
Few senior executives are expected to follow Krongard for several years, because of the payouts that have accompanied the deals. However, bulge bracket firms report receiving inquiries from bankers at the boutiques, and expect a flurry of lower- to mid-level hires once bonus season has ended. So far, only a few moves have occurred. Morgan Stanley’s recent hire of Robertson Stephens’ internet banker André de Baubigny created something of a stir in hi-tech banking circles, although Petkevich says “he was only a vice president.”
It’s the vice presidents, however, who “make it all happen,” says a senior banker at a competing firm. In all three firms such individuals “weren’t as well taken care of as they would have liked”, says the banker, who has interviewed individuals at all three. With the exception of Alex Brown, which was already publicly-held, “the partnership was the pot of gold at the end of the rainbow. Now these guys are inside a commercial bank, with no equity stake, and suddenly there’s a feeling that the rewards aren’t going to be that great”.
Whose customers are they?
Compensation in investment banking is about motivation and providing performance incentives. It is simple. If you want people to work together, cross-selling products, you have to pay them to do so. One former BankAmerica executive says the struggle between BankAmerica and Robertson Stephens is going to be “what role the commercial banker plays in bringing the business in and how much it is worth. That’s where the rub is going to be.”
He believes that is why the institution is proceeding so slowly with its integration. “They are being very careful on relationship management issues,” he says. Because BankAmerica has strong lending relationships in the high-tech area, while Robertson Stephens has serviced the same clients for their equity needs, it’s been difficult to decide who would have primary client responsibility. “That’s where the rubber meets the road, who’s got the client relationship. Today they have two separate teams, and two sets of calling officers.” As a result, he says, “they haven’t decided how the marketing side is going to work. There are situations where we gave conflicting advice”.
“Robertson Stephens going into Bank of America has got to be the worst cultural clash of all,” says a competitor. “The commercial and investment bankers are vying for who’s going to control an account and how the product is going to be portrayed.” He explains that the Robertson Stephens bankers “aren’t going to be paid on whether they do corporate loans, but on equity. They want to drive home their own products”.
The two other institutions say they are working to avoid such problems. NationsBank vice chairman and CFO James Hance says the bank is integrating its client managers with Montgomery Securities investment bankers when they followed the same company. “No one is replacing one with each other, but we are going with strength in terms of calling on customers. Which team should be the lead on a relationship? If it’s a Montgomery person who has the lead relationship, they are charged with bringing the full resources of the firm to bear on that customer and to expand their horizons in terms of what products we have.”
BT Alex Brown’s co-chairman and co-chief executive Yves de Balmann focuses on the results of industry groups, not product areas. One measure of how well an industry group does is to look at the entire amount of money available on Wall Street to that industry. The totals are approximated by adding up closed transactions on mergers and acquisitions, debt, IPOs, loan syndications, and such. “We look at that industry, and there’s x million available, and ask the group ‘How much did you capture?’ It gives an incentive to do as much as possible,” he says. If the group is weak on in one area in any year, it adds that product on as a goal to increase the totals.
That perspective on the business is what led de Balmann to Alex Brown in the first place. He first met former Alex Brown president Mayo Shattuck, now his co-chairman and co-chief executive, in 1993, when Bankers Trust was starting to build its equity business under Section 20 Glass Steagall limitations. “We both shared the same kind of concern about how we could make up for some of the gaps in our own product base.” Since the two “shared many of the same views on the business,” he says, “we knew that Alex Brown was the ideal candidate for us if this were to happen.”
A tail called exposure
As long as banks use their capital to grant credit, they are unlikely to pay totally on performance. “In corporate banking, you’re dealing with a firm’s capital in underwriting. You have a tail called exposure,” says one commercial banker. “It’s unlike what investment banks have to worry about. You can’t compensate completely on the business brought in and not take into consideration that tail.”
That could present more of a problem in the future since new superboutiques are trying to use the muscle of that credit-granting authority to build their business. But for the moment, it’s not the credit exposure, but the competition that is ruffling feathers. Competitors at bulge bracket firms say they are seeing the new firms using aggressive pricing on credit facilities to try and win the business. “They shouldn’t think that offering aggressive pricing on commodity products will lead them to more market share in non-commodity products like IPOs,” says one indignantly. “Our clients are smart, and if they can get some below market credit facility, they’ll do that all day long.”
NationsBank Montgomery has quickly earned a reputation for pushing a below-market so-called “bundled” credit line. “It’s a ‘We’re your banker’ kind of thing,'” says one rival. He names one company, a hot high-tech start-up called Vixel, which was offered this credit line if it would award Montgomery the lead mandate on its upcoming IPO. “The company said ‘We’ll give you strong consideration’, but they are leading them down the primrose path.” He cautions: “When it comes time for the IPO bakeoff, they may give Montgomery a fair hearing, but will go for the firm with the best research and the most experience.”
Hance at NationsBank Montgomery chuckles at the accusations of undercutting. “I don’t think it’s happening, but it’s good if it is,” he says. Before the mergers, he says all the boutiques had a difficult time competing with institutions that could also provide financing. Those that are left, he says, “have got to step up and be competitive. That’s just the way it is”.
Flagship confusion
Indeed, cross-selling is what the new era is all about. “The only way to make the model work is to cross sell products,” notes another competitor. Investment bankers may complain, but so far cross-selling has been far more successful than many expected. At least that is the case at BT Alex Brown and NationsBank Montgomery Securities, both of which provided impressive numbers.
“In the short term, the strategy is working very well,” says Hal Schroeder, a banking analyst at Keefe Bruyette & Woods who initially expressed concerns over the NationsBank Montgomery Securities deal, because it was costlier on just about any measure than the other two deals. During the first three months of the new institution’s existence, NationsBank reported 185 cross referrals from Montgomery Securities to NationsBank and vice versa. “It generated $40 million in 29 closed deals, and after three months, that’s a pretty good hit rate,” he says. Their deal closed on October 1.
Similarly BT Alex Brown reports that cross selling products including domestic high-yield, convertible and investment-grade bonds and common and preferred equity transactions, accounted for 33% of its fourth quarter 1997 deals, up from 10% in the third quarter. The merger was effective September 1. Corporate finance fees hit a record $324 million in the fourth quarter, which Newman attributed to the “continued strong momentum of our merger with Alex Brown.” The combined firm also had the highest after-market performance of IPOs, and maintained a strong position in the high yield underwriting rankings, where it has the lowest default rate.
At BankAmerica Robertson Stephens, the two have continued independent marketing, with simple cross referral bridging the gap. “If a Roby banker runs across a lending opportunity, he refers it to the corporate bank and vice versa,” says a former banker with the firm. “If it works from a bottom line, that’s fine. But it’s not maximizing the investment the firm is making in the relationship. It causes confusion among the clients as to who is the flagship carrier.”
Clearly BT Alex Brown has chosen the fast route towards integration, a strategy that was used successfully at such institutions as SBC Warburg. In part, that was necessary because Alex Brown was much bigger: it accounts for 20% of the combined firm a much higher percentage than at either of the other two. “This was a marriage of two willing parties,” says de Balmann. “Very quickly, it was very clear to both of us that there were common interests to integrate fast.”
“Because there was little overlap, there was little arguing about what would become redundant,” he says. “In fairly quick order, what we did is recognize that debt underwriting, sales and trading was superior at Bankers Trust and keep those, and equity underwriting, sales and trading was superior at Alex Brown and keep those. What we needed to integrate was the banking and research side. We decided to go with industry groups and meld the groups we both had.”
However, in San Francisco, where Alex Brown focuses much of its hi-tech banking, there was some grumbling in the ranks. “People are reluctant participants in the merger,” says an individual close to BT Alex Brown there. “They joke about the BT on their business cards. They see themselves as Alex Brown and not BT Alex Brown.”
Adds another executive who has interviewed several disgruntled employees: “There is some level of unhappiness with how the firm is being managed and how decisions are being made.”
Some of the discomfort comes from those who think that the traditional West Coast strongholds such as technology will become less important to the new institution. A recent advertisement in The Wall Street Journal in which BT Alex Brown thanked its participants in its first annual global forest products event was just the kind of thing to draw attention. “It doesn’t have anything to do with software, telecommunications and the internet. They are changing the mix of the client base,” says one banker.
Defunct Glass Steagall
Montgomery Securities had already begun to expand its limited industry coverage to more emerging growth companies, which seemed a perfect fit for NationsBank’s vast middle-market clientele. That makes the merger seem amiable, despite the fact that top bank executives only met the Montgomery partners for the first time last May. The deal was struck June 30. “It was a pretty quick courtship,” says Hance. “We just liked the people.” And while he points to the bank’s previous purchase of CRT (Chicago Research and Trading) as experience in merging the two cultures, others say that marriage wasn’t much to brag about. “The history of NationsBank and CRT never worked out very well,” says Soifer. “Most of those people at CRT have left.”
With the Depression era legislation of Glass Steagall practically defunct, banks and securities firms may have to learn to get along in the future. After all, the two weren’t always separate. “They were merged long before 1933. We just have some archaic rules,” says Schroeder. “It’s kind of like the Berlin Wall.” But, however similar the Germans might have been before the Wall went up, few would disagree that they had drifted apart culturally, and that unification is a fractious process. “That’s what happened to investment and commercial banks. Is it going to be smooth? No. But 15 to 20 years from now we’ll look back and say ‘what was all the fuss about?'” says Schroeder.
That doesn’t mean there’s no room for a new crop of boutiques. Many bankers view the recent sales as nothing more than selling out at the top of the market. “There was a greed and fear metre at work here,” says a competitor. “Capital was becoming more important and they didn’t have it. And if financial institutions were willing to pay huge prices, they were thinking ‘let’s mark this puppy to market, and take our cash off the table. If we can get a capital gain at the height of the market, we’d be stupid not to do so’.”
The prediction of DMG Technology’s chief executive officer Frank Quattrone may yet come true: “What we’re going to start to see in late 1998 and 1999 are new boutiques,” he says. At that time, the guarantees will be up, and the payouts completed. Quattrone, who left Morgan Stanley a year and a half ago to work for Deutsche Bank, opines: “These new boutiques will be created by some of the people in the old boutiques who are frustrated by being in big banks.”
