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Opinion

Abigail with attitude: Accentuate the positive

M&A investment

Abigail's biography

Last September, we were all puffed up that the worst was behind us. This September, we are fearful that the worst might be yet to come. Phrases such as "double-dip", "depression" and "pushing on a string" constitute the humdrum backdrop that grinds our spirits lower.

There has rarely been such confusion even among the knowledgeable. "Big daddy" hedge fund manager Stan Druckenmiller announced in August that he would close his hedge fund after 30 years because he was dissatisfied with the fund’s recent performance. So I thought I would share with you, later in this article, the views of some market participants whose expertise I respect. Perhaps one of them will make sense of the jigsaw.

When the big picture is so cloudy, the best thing to do is to accentuate the positive, as they say in investment banking circles. I will therefore focus on one area of the business that has experienced an unexpected resurgence of activity, the M&A market.

Most investment bank chiefs tell me they want to achieve dominance in the M&A field because this gives them access to the chief executive, which in turn means they will have a better chance of selling other products to this client. I’m not convinced this is true and I wonder if building the CEO relationship is worth the money you have to invest. Companies don’t do many big M&A transactions, so it may be a case of a lot of expensive dinners that translate into zero revenue. Also investment bankers tend to be pricey prima donnas who bluster but fail to deliver. In other words: all mouth and no trousers. They talk a lot about their close personal relationships with this or that corporate titan but always have a good excuse when a key piece of business goes to a competitor. "We have a conflict of interest," tends to be one of the most frequent. Of course, there are some genuinely talented corporate financiers who have excellent and productive relationships with their clients. But in general the species is overrated and overrates itself. I am shocked that the shares of online UK grocery chain Ocado fell by 20% in the six weeks after the company was floated. Ocado had hired three investment banks to advise on the deal. Where’s the added value in that?

In the current competitive financial landscape does it make sense for universal banks to invest heavily in the M&A business? Can your firm offer a sufficiently differentiated product to justify the build-out costs? I am genuinely not sure of the answer. HSBC tried to build a global M&A platform when it hired John Studzinski from Morgan Stanley. This experiment cost HSBC a lot of money but achieved no long-term legacy. Barclays has aspirations to expand its M&A business, as do Nomura, UBS and even Société Générale. Meanwhile, when I hear the term M&A, a few select names come to mind: Goldman Sachs, Morgan Stanley, JPMorgan and Lazard. Other firms might be able to pick their spots but will they ever penetrate the inner sanctum?

This summer, Deutsche Bank was named Euromoney’s global investment bank of the year. However market participants were surprised that in June Deutsche’s co-head of corporate and investment banking, Michael Cohrs, abruptly downed tools and headed out the door. Cohrs had been responsible for Deutsche’s M&A business since 2001. During that period, Deutsche rose from the number eight house (according to the Dealogic global M&A net revenue league table) to number four (as of June 30).

It is not clear to me why 53-year-old Cohrs decided to wander off. Normally the alpha males who run divisions of investment banks have to be prised out of the C-suite by a Caterpillar crane and even then they have a tendency to cling on by their fingernails. A Deutsche spokesperson provides a somewhat convoluted explanation based on the fact that Cohrs wanted to resign at the same time as chief executive Josef Ackermann was meant to step down in 2010. Ackermann’s plans changed and he is still at the helm; Cohrs left anyway. Of course, this has caused loose tongues to search for other reasons for his retirement.

Clearly the challenge for Anshu Jain is to make the division more profitable while retaining key staff and integrating the investment banking business more closely with the markets business. Jain is a talented and tenacious banker. I will watch with interest what he does
I’m assured such talk is misplaced. Cohrs and his former co-head, Anshu Jain, were much closer than people realized. I hear the friendship extended far beyond Deutsche’s offices, and Cohrs even coached one of Jain’s children on an application to go to one of the leading universities in the US. In his last interview as a Deutsche executive, in the July issue of Euromoney, Cohrs said he and Jain "were a bit like kindred souls". That may be a bit touchy-feely for investment bankers, but as one mole points out, the two worked together as co-heads for more than six years. Most bankers in a similar situation tolerate each other for a couple of years at most.

Cohrs’ resignation means Jain is promoted to run the whole investment bank. Cohrs had built a strong M&A franchise for Deutsche although competitors quibble that the business is more balance-sheet than advisory led. Others say some of the weaknesses of Cohrs’ part of the Deutsche empire were masked by the successful global transaction banking business that also fell under his remit.

Clearly the challenge for Jain is to make the division more profitable while retaining key staff and integrating the investment banking business more closely with the markets business. Jain is a talented and tenacious banker. I will watch with interest what he does with the firm’s M&A business.

On Ondra

Ondra is starting to differentiate itself in the advisory business. The firm was launched in October 2008 by Michael Tory, the former head of Lehman’s UK investment banking business. Michael started Ondra in a temporary office with an assistant and two analysts. He was joined in late 2008 by senior bankers Michael Baldock (in the US) and Benoit d’Angelin, who divides his time between Paris and London. Ondra’s proposition is that it can provide strategic and financial solutions without the necessity for an immediate transaction. Big investment banking divisions have high fixed overheads. Deal flow is the only way to cover these overheads. Ondra, with 40 employees and one main London hub, is able to interact with clients differently as its retainer model and low cost base free it from dependence on transactions. Tory started his career at Warburg and he talks about "having a lifetime horizon for client relationships". Benoit d’Angelin explains: "Since the formation of the firm, we have made capital market capabilities as central to our client work as M&A." I have believed in Ondra from the beginning. I was therefore gratified to see the firm acting as an adviser to Prudential when the insurer bid for AIA and advising GDF Suez on its successful combination of assets with International Power. Gérard Lamarche, the chief financial officer of GDF Suez, told me: "The International Power transaction was our first time working with Ondra. We greatly appreciated their in-depth knowledge of the UK market and their ability to deliver high, value-added advisory services."

Michael Klein was paid $10 million for his advice on the purchase over a period of 11 days. A commentator opined: “Wow! So nearly a million dollars a day. Even if he worked completely round the clock, at $10 million for 264 hours, he earned $37,878 per hour!” I’m sure Barclays’ management consider that Klein was worth every cent
Indeed my contention that the winners in the M&A business might not be the universal banks with their burgeoning cost base is perfectly illustrated by a story that surfaced during late summer. In case you missed it, the Lehman Brothers’ trustee and its creditors are suing Barclays. They claim that the UK bank purchased the US broker/dealer operation in September 2008 at an unfairly low price. During the trial in the New York bankruptcy court, we learnt that Barclays’ closest corporate adviser was not a grandiose Wall Street firm but the mighty one-man band, Michael Klein, formerly co-head of Citi’s investment bank. Klein was paid $10 million for his advice on the purchase over a period of 11 days. A commentator opined: "Wow! So nearly a million dollars a day. Even if he worked completely round the clock, at $10 million for 264 hours, he earned $37,878 per hour!" I’m sure Barclays’ management consider that Klein was worth every cent. We are constantly being told that the Lehman acquisition was transformational for the Barclays group. However, shareholders might disagree: the Barclays share price was about £3.50 as of September 12 2008. On September 1 2010, it closed at £3.16 – hardly a transformational or terrific outcome for shareholders.

More on Nomura

While I am on the subject of Lehman Brothers and suffering shareholders, I have to comment once more about Nomura. Regular readers will know that I think Nomura’s Japanese management, who purchased most of Lehman’s European and Asian operations, squandered money by agreeing to pay peak-price bonuses to former Lehman employees. I was therefore depressed, but not surprised, to learn that Sadeq Sayeed, the former chief executive of Nomura’s European business, was paid £22 million for "loss of office". Sayeed, who some credit with being the architect of the Lehman acquisition, resigned when Jesse Bhattal was promoted to run Nomura’s wholesale business. A spokesperson said: "Sadeq was with the firm for over a decade. He was our troubleshooter and saved us billions of dollars by selling our RMBS positions early in the cycle. The payment reflects his work during the whole period."

Nomura’s first-quarter wholesale results (as of June 30) were disappointing: net revenues were down 36% quarter on quarter and 49% year on year. The wholesale business made a pre-tax loss of ¥41.1 billion ($490 million) and investment banking made a first-quarter loss of ¥14.8 billion. These months were tough for the whole industry. But I contend that Nomura’s fixed overheads are too high and this is a hindrance. An insider insisted: "Our aspiration is to build a global investment bank. This will take time. One disappointing quarter will not change our strategy."

I have been ruminating about Jesse Bhattal. The former head of Lehman Brothers in Europe and Asia, Jeremy Isaacs, did not join Nomura. Instead, he set up a firm called JRJ Group with his former colleague Roger Nagioff in early 2009. Jeremy, Roger – presumably these are the "J" and the "R" in the name JRJ. But what does the other "J" stand for? Might it be the initial of another senior Lehman colleague who never quite made it out the door? Jesse Bhattal was a direct report of Isaacs at Lehman Brothers and I believe the two men are good friends.

As the magazine was going to press, we learnt that one British chief was stepping down and another was stepping up. HSBC’s executive chairman, Stephen Green, will become the UK trade minister in January 2011. Green moving on is no surprise but the abruptness of his departure is odd, as is the fact that there is no successor in place. The well-oiled HSBC machine seems to have sprung a leak. I talked about the "moving pieces in the HSBC senior management jigsaw" in my August 2009 column and I tipped board members Sir Simon Robertson or John Thornton as possible replacements for Green.

I believe I was the first commentator to whisper, in my December 2009 column, that Barclays’ president, Bob Diamond, and its chief executive, John Varley, had reached a Granita-type accord. "Diamond is 58," I wrote. "He probably has one more big job left in him... Perhaps as an incentive to stay with the British bank, Diamond was promised that Varley would stand down (maybe as early as 2010) and he would become chief executive."

I will delve deeper into both these stories in my October column, where I ask: "Has the great recession changed anything on Wall Street?"

Expert predictions

So how do the experts see the next six months? Ken Moelis, chief executive of advisory firm Moelis & Company, is in the deflation camp. "We are involved in a global deleveraging process: the private sector and certain governments are taking appropriate actions to cut debt," he says. "Companies’ pricing power will be under pressure for several years. In this environment, it is rational for corporates to hold more cash. I see a pick-up in M&A activity but not a boom. Ironically, the economics of many acquisition opportunities are more favourable than internal growth strategies. Given the current uncertainty, long-term expansion carries the risk of a higher cost of capital. We will see more companies making acquisitions to fill in product lines. There is growing confidence among CEOs about the state of their businesses. They feel good about their balance sheets, operating costs and the position of their businesses in the world today. However, they are worried about the world itself."

Franck Petitgas, co-head of global investment banking at Morgan Stanley, summarized his view as: "The macro-environment is cool but the micro-climate is in good shape. Today, markets are concerned about the US and relatively positive about Europe. The inverse of how it felt in the spring. The point is that conditions are unsettled and we need to be patient. A lot of progress has been made. This period of deleveraging is putting a damper on the recovery. But my read is that the M&A momentum can be sustained: corporate balance sheets are healthy, private equity has money as do emerging market clients. Also the financing market is supportive: there is liquidity and rates are low. And of course, holding cash gives you no return. The intriguing question is what will happen in FIG? In Europe, even after the stress tests, we haven’t seen a lot of recapitalizations and certainly not much cross-border M&A. As regards the investment banking landscape, I see three categories: the universal banks, the boutiques and the broker dealers like Morgan Stanley in the middle. If anything, since the 2008 crisis we’ve seen our market share increase. Clients need truly global intelligence and execution and there are only a few firms they can turn to for this."

Bronwyn Curtis, chairman of HSBC global research, mentioned a "Japan-lite situation" to me. "The sharp economic rebound fuelled by inventory restocking has petered out and there has been no follow-through. Developed markets look very soft or ‘Japan-lite’: not quite Japan in the 1990s but close, with falling inflation and insipid recovery. Coming out of previous recessions, the US economy always had great bounce-back ability. Not this time. The US consumer is saving not spending. Hardly surprising, given the weak job market and housing data. We will see lacklustre US growth although there is only a 25% chance of a double-dip recession. Emerging markets growth has also slowed but will not slump. Even though export demand has dropped, we envisage a slowdown not a meltdown, particularly in China. With low levels of household and government debt and strong wage and employment growth, the prospects for domestic demand in Asia (ex Japan) are much better than the west. By year-end 2010, we forecast that the 10-year US treasury will yield 2%, the S&P500 will be around 1200, the yen/dollar rate will be at 90 and the dollar/euro rate will be 1.35."

Jim O’Neill, chief economist of Goldman Sachs, is tepid on the US but believes the emerging markets will sustain global growth: "We are the most extreme of the consensus in that we think the US economy will struggle and that there is maybe a 25% chance of another US recession. But because of the Bric phenomenon, the world can live with this. We are no longer in an environment where the US catches a cold and the world gets pneumonia. The world economy will grow by 4.8% in 2011. As regards the Treasury bond market, we don’t expect much change in yields during the next six months despite chatter about a bond bubble. The Fed will keep short-term rates where they are for 2011 and might even buy Treasury bonds. In six months’ time, we see the S&P500 around 1200, the yen/dollar rate will be at 88 and the dollar/euro rate will be 1.35. The key strategic issue of our time is that the world is no longer being driven by the countries where the most opinionated people live. Many of us in the developed world frequently feel semi-suicidal but those countries that adjust are fine – think of Germany. The future is about the Bric economies doing it for themselves and developing domestic demand. The US needs to think about exporting to the emerging markets rather than consuming cheap goods from China."

David Rosenberg, the chief economist of Gluskin Sheff, was one of the few economists to have predicted the astounding rally in government bonds this year. He told me: "The US economy is on the precipice of contracting again. You have to wonder what bullets are left in the chamber to help reverse the situation. The bulls have to answer: how could we have had such unprecedented monetary stimulus – which would have made Franklin Roosevelt blush – and yet real final sales (GDP less inventories) have not expanded at more than 1% a year? Never before have we managed to emerge from recession with real final sales so tepid. The consensus view is that the deeper the decline, the bigger the bounce. However, 33 months after the onset of the great recession, every important US data point from home sales to real GDP to employment is lower than it was then. Depending on the level of inventories, I see a microscopic or negative US GDP number for the third quarter and the 10-year US Treasury yield will reach 1.75% to 2.25% in the next six months. Everything is in the process of mean-reverting. In a post-bubble credit collapse, you do not quickly embark on the old paradigm. I believe you will be able to buy the S&P a lot cheaper – say, nearer to 850/900. I will become more positive on the equity asset class when I see light at the end of the economic tunnel. We are only one-third of the way through the requisite deleveraging process – $6 trillion of debt has to be extinguished. Most people are still delusional. The transition to the next sustainable economic expansion will be measured in years not quarters."

How was your month? Please send news and views to abigail@euromoney.com.

 
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