" "There is no consolidation, there is just combination and fragmentation."
financial times....2 december 98.
ft.com
Shrinking middle ground
Now that Deutsche Bank has taken over Bankers Trust, Tracy Corrigan considers where that leaves other medium-sized Wall Street firms
<Picture: Deutsch Bank graphic>In selling out to Deutsche Bank, Bankers Trust has finally abandoned its attempt to build an independent medium-sized investment banking business on Wall Street. This is the largest, but only the latest development in a two-year round of consolidation on Wall Street, which has seen the likes of Oppenheimer and Dillon Read gobbled up by bigger parents. What does it mean for those left behind in the now sparsely populated middle ground of investment banking - for companies such as Paine Webber, J.P Morgan and Lehman Brothers?
"There are two views," says Sallie Krawcheck, financial services analyst at Sanford C. Bernstein, the US brokerage. "One is that Bankers Trust presumably couldn't make it work, therefore it can't work. The other is that there is business to be gained." To judge from the opinions of those involved, the latter view seems likely to prevail. "Most brokerage firms are viewing this combo not as a threat but as an opportunity," says Ms Krawcheck, "[because there are likely to be] unhappy clients and unhappy employees."
But are they right to do so? After all, the recent spate of mergers and acquisitions is itself a testament to the widespread desire for critical mass. At the outset of the latest phase of consolidation, the driving force was ambition. Investment and commercial banks were jockeying to join an emerging elite of businesses able to span the world's financial markets (the so-called "bulge bracket").
But recently, partly because stock markets have been falling after more than a decade of gains, consolidation has started to look more defensive. The middle ground, it is widely held, has become too small in a world of global contagion and financial-services super-markets.
One reason for thinking that is that investment banking is a capital-intensive business. When Sandy Weill approached Citicorp about a merger this year, it was partly because his financial services giant Travelers Group, the parent of Salomon Smith Barney, "needed a much stronger equity capital base so that next time [a market dislocation happens] it would be an opportunity not a catastrophe", as he put it recently. The merger created Citigroup, one of the world's largest financial services groups. Concentrating on a few segments of the market can leave firms highly vulnerable to market turmoil in those areas, as Bankers Trust, with its specialities in emerging markets and high yield, found in the third quarter, when it recorded a loss of nearly $500m. As in the oil business, the advantage of sheer size is that it enables risk to be spread over a wider range of markets and assets.
Risk increased as a result of the globalisation of financial markets. Globalisation once appealed to investment banks partly as a means of flattening the cycle of earnings. The trouble is that markets can now all swing at once - as they did this summer after Russia's default on its domestic bonds in August.
The other problem with the middle ground is that medium-sized firms are often chasing the same deals as bigger competitors, but may not be able to offer the same range of financing options. "You have to have a core set of services that covers 70 per cent of what the client needs," says Michael McCaffery, chief executive officer of BancBoston Robertson Stephens. Otherwise, it is impossible to "help the client achieve the lowest cost of capital". Robertson Stephens, the San Francisco-based investment bank specialising in technology, is now owned by BancBoston which has a lending and high yield bond capability to complement Robertson's expertise in advising and raising equity for growth companies.
So who might be the next to go? Lehman Brothers is a leading candidate after its rocky ride during the recent market downturn. "They haven't made a lot of money but they have made a little money, which is better than a lot of firms," concedes Ms Krawcheck. Still, analysts worry about how the firm would fare in a prolonged and painful bear market.
Paine Webber is another possibility. It recently had talks with Dresdner Bank. It has a large retail distribution network - an obvious prize - but it has little to offer in advancing investment banking ambitions.
Of course, every seller needs a buyer, and Deutsche's acquisition takes the most aggressive buyer out of the market. Dresdner and Chase still appear interested, and others, such as the new UBS are seen as potential bidders.
But the emergence of the big commercial banks as players - and buyers - in the securities business has transformed perceptions of what "big" really is in investment banking. Once, Merrill Lynch and J.P. Morgan were the giants of the business. But they are small in comparison with commercial banks. Chase, for example, views them both as potential targets. The appearance of banks such as Deutsche on Wall Street means that even Merrill Lynch and Goldman Sachs (which still says it plans to go public next year) can now be considered medium-sized. And they, of course, are announcing healthy profits. That suggests the middle ground might not be quite such a bad place after all.
Still, in order to survive, you have to have a strong balance sheet, plenty of capital - and probably a spread of businesses. Pure investment banks suffer disproportionately in a market downturn. Morgan Stanley Dean Witter, for example, did much better than its peers in recently because its earnings come from brokerage and credit cards as well as investment banking.
In short, while almost everyone believes that big has advantages in financial services there are doubts both about what "big" actually is and about how to create it. Concerns are growing about some of the giant mergers produced by bolting together very different sorts of company. The jury is still out on the new Citigroup, for example.
So has Wall Street been transformed fundamentally? Perhaps not. Consolidation is as old as finance itself, and while some firms disappear, new boutiques and specialist firms continue to emerge. "The unchanging history of this business is that more capital comes in," says Ms Krawcheck. "There is no consolidation, there is just combination and fragmentation." |
