Eerie Calm On The Street...a perspective on the US I-Banking Business...
Monday March 12, 12:01 pm Eastern Time
Forbes.com
By Tara Murphy
<<U.S. investment banking business has fallen off a cliff. That's clearly bad news for Wall Street, which made a pretty penny underwriting stock and advising companies on mergers and acquisitions until a year ago.
Though the biggest investment banks are already feeling the pinch, some will likely suffer more than others in a protracted economic downturn, including those firms that rely heavily on fees from stock underwriting and M&A advisory, such as Goldman Sachs (NYSE: GS - news) and Morgan Stanley Dean Witter (NYSE: MWD - news), both downgraded by Merrill Lynch on Feb. 28.
It shouldn't have been this way. Brokerage stocks rallied ahead of this winter's much-anticipated interest rate cuts by the Federal Reserve Board. ``By the time the rate cuts happened, the brokers were priced to perfection. And it's hardly in a perfect environment for the brokers,'' says Ken Worthington, brokerage analyst at CIBC World Markets.
U.S. companies have raised just $3.8 billion so far this year in 21 initial public stock offerings, compared with $11.3 billion in 82 deals through March 9, 2000, according to Thomson Financial Securities Data. Investment bankers are still generating substantial M&A fees, but nothing like this time a year ago. So far this year, they have advised companies on 192 mergers worth $101 billion, compared with advisory work through the same period last year on 553 deals valued at $425 billion.
Last week, Bear Stearns (NYSE: BSC - news) kicked of the latest round of layoffs on Wall Street, cutting 3,000 jobs from its workforce. If current trends continue, more firms are sure to follow.
``It had been the case that firms were afraid to fire because they were afraid to lose market share,'' says Worthington, referring to fears that departing employees will take business with them to other firms. ``But if the market continues to be weak for the next two quarters, I expect that we'll see more layoffs.''
Diversification is the best defense that a firm can have in a period of slack corporate finance business. Merrill Lynch's (NYSE: MER - news) brokerage arm has been strengthened by a transition to an asset-based fee structure, for instance. The brokerage unit has also improved margins by reducing headcount and reallocating capital. On the corporate finance side, Merrill's IPO calendar was always more diverse than at shops that focused on hot technology issues.
Other diversified financial services companies have a cushion against this rough patch in investment banking. Best example: Citigroup (NYSE: C - news) and, to a lesser extent, J.P. Morgan Chase (NYSE: JPM - news).
Roughly half of Citigroup's 2001 profits are expected to stem from its consumer banking branches this year, says Andrew Collins, banking analyst at ING Barings, while its investment banking arm, Salomon Smith Barney, and its global corporate bank combined are expected to contribute 23% of total earnings.
Another advantage that both Citigroup and J.P. Morgan Chase enjoy is a strong fixed-income underwriting business, which should counterbalance the drought in stock underwriting.
Despite the recent downgrades by Merrill Lynch's influential analyst Judah Kraushaar, Goldman Sachs and Morgan Stanley can hardly be written off. Both flourished in the heyday of tech underwriting and M&A and, if the IPO market kicks into life in the second half of the year, the bulk of deals headed down the pipeline are tech-related. ``It's still 70% or more tech, media, telecom and the new economy,'' says Guy Moszkowski, brokerage analyst at Salomon Smith Barney.
Morgan Stanley is better diversified, thanks to its 1997 merger with retail broker Dean Witter. The firm's credit card unit generates about 20% of earnings, and another 15% or so comes from asset management, according to Moszkowski. So roughly 65% of profits stem from investment banking.
That didn't stop Moszkowski from reducing earnings estimates for Morgan Stanley's first quarter, fiscal 2001 and fiscal 2002 last month, saying that the firm's recent track record had fueled aggressive estimates that would be tough to hit in the current environment.
Goldman, of course, was closely identified with underwriting the tech stock boom of the late 1990s. It is now honing in on other hot sectors to make up the slack, says Henry McVey, brokerage analyst at Morgan Stanley Dean Witter.
``They have a very strong energy practice and very strong financial services,'' says McVey. ``So I think the key message is that we won't get the same zip on the upside, but I still think that if the industry is growing their earnings, Goldman Sachs will be growing their earnings.''
He says he also thinks Goldman is primed to take advantage of its strength in international markets, with 35% to 40% of the firm's business outside the U.S. ``In the latest data that we put out, Europe is actually outperforming the U.S. in terms of underwriting and M&A, so that will help them out over the long haul.''>> |
