Chase can’t be too surprised about people focusing on the equities capability that its purchase of Hambrecht & Quist – to be known now as Chase Securities West – adds. This is the bank, after all, that has spent two years courting investment banks in the US, and even some abroad, in the hunt for an equity capital markets operation. And speaking to Euromoney earlier in the year Don Layton, vice-chairman in charge of global markets, said: “Stay tuned. You’ll see equity at the right time and in the right way.”
Others put it more bluntly. “Chase has been very clear that it wants to have a global equities capability,” says Catherine Murray, bank analyst for JP Morgan. “And that it has to be a merger, not an acquisition. That would mean low premiums, so making the shortlist of potential targets very very short.” Merrill Lynch has been the most recent whisper in the US, but most have been in the frame at some point or other. As for foreign houses, Chase has been linked to Warburg Dillon Read, where rumours persist that UBS is still considering selling it off. But it has apparently spent more time looking at Schroders, a strange move given the lack of direction the small UK family-owned investment bank has in the US – but it does have a formidable asset management presence, another business that Chase would like to expand into. Why then did Chase and H&Q get together? H&Q doesn’t have just equities. Merrill Lynch certainly had no need of its equities underwriting and trading operations when it was pondering a bid. There is evidence that Chase went for H&Q for reasons other than to fill its gap in equities and that a merger gets H&Q out of a cul de sac.
Narrow product range
Founded in 1968, H&Q offers investment banking services to high-growth industries, specializing in technology, life sciences, branded consumer products and service sectors.
But of late it has been suffering for two reasons: first, the larger investment banks have been building up their own technology efforts, with Goldman Sachs and Morgan Stanley Dean Witter generally recognized as the industry leaders, and CSFB charging up the ranks since luring Frank Quattrone and his team of hired guns from Deutsche Bank last year.
Second, the companies it brought to market are beginning to mature and need services H&Q is not so strong in, such as structured products and debt instruments. A recent example is Amazon.com, which H&Q took public. The on-line firm recently did a convertible and a high-yield deal, which H&Q was unable to provide.
H&Q CEO Dan Case was not blind to the effect these developments were having on his business, so he was prepared to entertain enquiries from Deutsche, Merrill Lynch and no doubt others. This led to a review of options, and to a conclusion that other boutiques and smaller investment banks were not so prepared to accept. “Hambrecht & Quist underwent an honest self-appraisal,” says Judah Kraushaar, first vice-president and bank analyst at Merrill Lynch. “Case and others realized that without becoming part of a larger entity they would have to go down market, and so away from their old strengths of doing big deals. Senior executives at Montgomery didn’t feel that, instead believing that they would have a lot more independence in the new Bank of America than was the case.” Consequently chief executive officer Tom Weisel, many of his senior executives, and several bankers have left in the last 15 months.
No silly multiples
Chase management have been reluctant to pay a premium for acquisitions so far. The mergers of Chemical with Manny Hanny, then Chemical with Chase were achieved without paying silly multiples. The H&Q deal might be a full price – $1.35 billion in cash, with another $200 million in stock set aside as a retention pool – but it is not a silly price. Using cash has brought praise from some quarters, too: “Using cash instead of stock shows that they are aware that their stock is too inexpensive at present,” says Sally Pope Davis, bank analyst at Goldman Sachs. “It proves they’re treating it as an important resource.”
Former Chase CEO Walter Shipley, who stepped down earlier this year, was of the mind that to enter the equities arena for its own sake would require a major commitment. As Euromoney wrote in April this year: “Shipley knew Chase’s own size, and its ambitions, would require a much bigger institution as a partner [than brokerage firms such as Montgomery Securities or Alex Brown].” So H&Q obviously fits into neither Shipley’s nor Layton’s definition of what Chase is looking for in an equities play.
Another sign that H&Q was not an equities play for Chase was that its newly appointed head strategist, examining how to enter the equities market, was left out of the rounds to analysts, investors and journalists to explain the H&Q deal. Neal Garonzik was hired for that role – as well as examining asset management opportunities – in August this year, after acting as an external consultant for a couple of years beforehand.
Instead, vice-chairman James Lee has been put forward as the driving force behind the deal. This is the man who has been largely responsible for building up Chase’s syndicated loan and debt capital markets businesses, and more recently the M&A division. “What attracted us most about this deal is to do with the mindset of their CEO, Dan Case,” says Lee. “He saw that remaining independent might not be the best route for H&Q, and they occupied the space we wanted to be in.”
These two factors, says Lee – mindset and business direction – were the main reasons that Chase bought H&Q. The equities capability is something of a bonus. “It is small, but very focused, and while not transformational to Chase, it is transformational for Chase’s aspirations in the new economy,” says Lee, who has spent most of the last month trying to persuade people that this is not an equity play. It also, says one insider, is a way for Chase to avoid waking up one morning to find that its rolodex of clients resembles that of Barnes & Noble – the US bookstore chain which lost out to on-line bookshop Amazon.com.
It will, of course, add that extra layer of service to Chase’s operations by allowing the bank for the first time to provide its own private equity department with an exit strategy for its investments. One recent example is Starmedia, an internet search engine for Latin America, in which Chase private equity was a major investor. The lack of an equities arm stopped Chase from doing the IPO last June; instead the mandate went to Goldman Sachs.
Chase now has the opportunity to see how well an equities capability in a couple of distinct market sectors will gel with its own investment-banking operations. H&Q has roughly 850 employees and its net income last year was $40.2 million, so Chase is hardly staking its future. But the ability to serve these start-up firms at all the stages of their corporate development could help win other mandates, and expand Chase’s reach.
Master equity plan
Where does that leave Chase’s equity ambitions? Garonzik is still investigating Chase’s options in equities, and nothing has been said to change Chase’s stated aim of being a big player in this business. Lee has heard this too many times now, and answers simply that there is enough on the record already.
There are some fears that Chase could be tempted into using H&Q as a platform to build a much larger equities platform. That would go against the stated aims first of H&Q – “H&Q achieves and maintains its specialization by limiting its client base to high-quality companies and investors that are within its industry focus areas,” reads its mission statement. But it would also go against those of Chase which says it has no intention of using H&Q as a base to build a bigger equities division. “We like its industry focus, and we’ll keep it highly focused and new economy-centric,” says Lee.
And Chase has already spent a lot examining ways to build an equities division, but that would be a long haul, and is probably too late in any case. JP Morgan started down that path in 1990, spending $1.8 billion over the next eight years with revenues over the same period totalling $2 billion. That was hard enough, but Morgan had two factors in its favour that Chase does not: the equity markets were much more fragmented than they are now, and shareholders were a lot more tolerant of such outlays. They also, says one analyst “have remained for the most part in awe of the reverential Morgan name”.
JP Morgan now stands sixth in the equity league tables in the US, but is still a long way from being a Merrill Lynch or a Goldman Sachs. Over the last three years investors have been much more critical of Morgan’s expenditure and its share price performance, but this has been met by a robust defence by CEO Sandy Warner – and better results in the last three quarters have helped somewhat.
Chase would find such a route difficult, aside from the issue of time. Shipley created a unique institution through the two-stage tripartite merger, and has created shareholder value not just by the cost savings inherent in any in-market merger but also by improving business revenues. Investors would almost certainly be very critical of anything which damages that.
“Chase now must decide the nature of its next large merger,” says Kraushaar at Merrill Lynch. “Though the company has built great value in the 1990s by pursuing large in-market mergers, the next substantial deal will more likely be to extend its product or business reach into a new area – asset management and public equities seem like the top priorities. Investors will wonder whether transactions in these areas can be concluded without incurring meaningful earnings dilution.”
That’s assuming Chase does a deal at all. To get a Merrill Lynch or Morgan Stanley to jump in with you requires a major change on their part, which would imply some kind of failure. Last year got close, but not that close. Judging by Chase’s record, any deal would also most likely result in the loss of the brokerage firm’s identity, subsumed into the Chase brand, which could pose problems of its own.
And maybe Lee is also considering the option of not going into equities beyond H&Q. After all, H&Q’s founder, Bill Hambrecht, left the firm last year after a dispute over the direction the firm should take to adapt to the effects of e-commerce; he now runs a small on-line underwriter called WR Hambrecht. So Lee must be asking himself how far he goes down a path when a new highway is being built.
And then there is the more obvious point, made by Ray Soifer, bank analyst at Brown Brothers Harriman: “I’d be happy if Jimmy never solves the equities problem. Buying a major equities firm would be very expensive. A commercial bank which earns nearly $2 billion a year from a formidable presence in loan syndication, debt, foreign exchange and derivatives looks very attractive.” *
