J.P. Morgan: Dressed for a Deal?
In a radical change of strategy, CEO Sandy Warner has taken J.P. Morgan downmarket
J.P. Morgan & Co. Chairman and CEO Douglas A. "Sandy" Warner III is surrounded by reminders of one of America's greatest financiers. Leatherbound books belonging to John Pierpont Morgan line one side of his office on the 20th floor of 60 Wall St. Across from them, a portrait of Morgan, with his thick moustache and stern stare, looks over Warner's mahogany rolltop desk. The trophies are rewards for reaching the top of a bank once synonymous with American capitalism. But Warner views the legacy differently. "It's a curse," he says.
It certainly is in a stock market that lusts after the likes of J.P. Morgan and its prestige. In the past decade, J.P. Morgan has rebuffed potential deals with a dozen marquee firms, from Goldman Sachs to Dean Witter, which later merged with Morgan Stanley. But as other midsize players from Donaldson, Lufkin & Jenrette Inc. to PaineWebber Inc. are wolfed down by predators, Warner may not have the luxury of saying no much longer. There's a risk that J.P. Morgan could be forced into a shotgun marriage with a foreign suitor. On Sept. 6 Morgan stock jumped 6% to $172 at one point after a German magazine said Deutsche Bank was talking with Morgan about a deal. Neither bank would comment, but Deutsche insiders say that the bank--despite earlier official denials--would like to buy Morgan. The very idea that his creation might become just another division of a foreign bank would make old Pierpont turn over in his grave.
Warner, however, is hardly operating in Pierpont's world. For most of its existence, the House of Morgan could count on customers beating their way to its famous front door. But starting in the early 1990s, J.P. Morgan began to fall behind competitors. As late as 1991, it was by far the most valuable bank in America. These days, though, its capitalization is just $27 billion, way behind onetime peers such as Citigroup, worth $247 billion. Obsessed for a decade with transforming itself into an investment bank, J.P. Morgan made little effort to recruit vibrant New Economy upstarts, while sticking with its staid Old
Economy corporate clients. Warner is changing all that. He is betting he can revive the bank by taking J.P. Morgan's class downmarket. His proposition is simple: With the Internet, J.P. Morgan, a trusted adviser to blue chips and blue bloods for more than a century, can profitably attract midsize companies, newly minted millionaires, and high-tech startups as clients. He's also wagering that by concentrating on higher-growth businesses, such as asset management and investment banking, and implementing rigorous cost-cutting, J.P. Morgan can escape the consolidation wave engulfing the financial industry.
To do so, Warner must turn the market's current logic, which rewards financial mergers and size, on its head. To him, technology, not a merger, is the answer. He argues that the Internet has fundamentally changed the game to favor nimbler and more focused players such as J.P. Morgan. He may be right: A Federal Reserve Bank of New York study shows that smaller, not larger, banks have gathered assets more rapidly in the 1990s. "Everybody is talking about consolidation. The world is consolidating. Fact of life," Warner says. "[But] the bigger you are, the harder it is to move."
At every turn, however, Wall Street shows it doesn't believe that Morgan can evade capture. On Aug. 31, the day after Credit Suisse Group made an agreed bid for DLJ, Morgan stock leaped more than 11% on hopes that it might become a takeover target. Asked whether he would consider an offer for Morgan of four times the firm's book value, or more than $200 a share--vs. the already rich 3.4 times book that Switzerland's UBS paid for PaineWebber--Warner gave a boilerplate answer. He told BUSINESS WEEK: "If somebody has a better idea [for managing the bank] and can deliver the kinds of returns that would make an offer like that possible, I'd like to hear about it." All the same, Warner clearly wouldn't welcome a bid. "The threshold for us [to consider a bid] is very high. We think we can deliver growth and shareholder value executing our plans."
Lately, J.P. Morgan has been out beating the drum hard to boost its stock price from a low of about $105 in early March. With financial companies trading as fast as baseball cards in a schoolyard, the bank was exposed to an unwelcome lowball bid. The stock's weakness was also undermining morale among staff, who now own 23% of the equity, up from 2% a decade ago. Top talent was starting to walk out the door. In April, for instance, Vice-Chairman Roberto G. Mendoza defected to Goldman. Over the summer, Chief Financial Officer Peter D. Hancock delivered pep talks, preaching the attractions of the stock to investors, fund managers, and Morgan's 500 managing directors. The title of his presentation: "Why J.P. Morgan is a buy."
To redeem that bullish promise, Warner must morph J.P. Morgan into a reliable earnings engine. Ironically, the closer he comes to success, the more alluring the bank becomes as a takeover prospect. And there are signs that his new strategy is working. For the first time in years, J.P. Morgan beat the Street's estimates last year and earned $1.2 billion net in the first half this year. It also beat rival Chase with a 22% return on equity. "Three years ago, you would not find one analyst who would have predicted that we would be earning 20% on equity," gloats Warner. "And we are."UNLIKELY CONTRARIAN. J.P. Morgan's equities, investment banking, and asset-management businesses have gone from minimal profits to 39% of pretax income in just three years. And it has climbed from No. 10 to No. 6 as an issuer of equity in the U.S. by raising $7.8 billion for clients so far this year, according to Thomson Financial Securities' Data Corp.
That's not all. By advising on 131 deals worth $385 billion this year, it became No. 6 in completed mergers and acquisitions worldwide. And though Morgan is 11th in underwriting U.S. initial public offerings, it's No. 6 in the bigger market for additional equity issues. "Even if they dig their heels in and stay independent, there's a reasonably attractive value if you view J.P. Morgan as a going concern," says Judah Kraushaar, securities industry analyst at Merrill. He figures it may now be worth as much as $250 per share. At the least, he says, "they have improved their ability to control their own destiny."
Normally, Warner shuns the limelight and is reluctant to discuss strategy. But BUSINESS WEEK gained exclusive access to dozens of Morgan's top executives and managers. In one interview after another, it was clear that while Warner's strategy is a work in progress, he has mobilized the bank far more than is generally recognized by the Street.
Warner, 54, is one of Wall Street's least likely contrarians. The son of a Cincinnati insurance executive, he has often opted for the safe route. A pre-med student at Yale, he ended up working for J.P. Morgan by following his father's advice to try something different the summer before his senior year. He has been a devoted Morgan man since. Warner started by soliciting business from rubber companies in Ohio. He got onto the fast track serving in high-profile posts, from assistant to Chairman Thomas Gates in 1970 to running the London office in 1986, before becoming chairman.
Once in charge, Warner immediately junked the bank's long chain of command. He replaced it with the House Arrest Group--a dozen executives who meet monthly to galvanize the company into doing better. In 1998, he ditched Morgan's clubby jobs-for-life system that set it apart from the rest of Wall Street. With the bank suffering from sharp declines in trading in Asia, Latin America, and Russia, he cut more than 500 employees, or 3% of its staff.
No other chairman since J.Pierpont Morgan has led the bank on such an aggressive campaign to win customers. New clients have long seemed anathema to J.P. Morgan--the Street's most hidebound financial firm, ruled by the elite to bankroll the privileged. But Warner ordered his troops to court, hat in hand, clients the bank once shunned. And he is recruiting new talent from rivals for key positions and promoting women and African Americans within. Outsiders welcome the crumbling of the WASPish walls. "This isn't the J.P. Morgan of years ago that is wedded to a legacy," says George A. Bicher, financial services analyst at Deutsche Banc Alex. Brown. "That promises some chance for salvation."
Still, Warner has a way to go. J.P. Morgan is not alone in the global rush for millionaires' assets, crossborder acquisitions, and public offerings. And as an investment banking newbie, it still doesn't have the resources of its toughest competitors. For example, it has only 17 top-ranked equity analysts--a key to winning business--in the U.S., vs. 43 at Goldman. Abroad, J.P. Morgan must defend its global franchise that began when it persuaded European investors to finance America's railroads in the 1800s. Today, foreign operations produce about half of its earnings. But that position is under threat as Morgan Stanley, Merrill, and Goldman all come on strong in Asia, Latin America, and Europe.
Never has the bank waged war on such a broad front before, but Warner is determined that J.P. Morgan will make it on its own. "We've got five yards to go to the goal line," he says. "You don't give the ball to somebody else and say, `Help us punch it in."'GOSPEL ACCORDING TO GE. To those who know him, Warner's resolve is no surprise. "I don't think he sees a combination out there that will materially change their positioning," says Lawrence A. Bossidy, former chairman of Honeywell International Inc. and a member of J.P. Morgan's board. Warner is a driven man. He talks fast, jumping from thought to thought, as though he doesn't have time to finish his sentences. He is constantly in a hurry to seize not just "big" opportunities, but "big, big, big" ones, such as the "equification" of the world. "Is that a word?" he asks. Then, he decides he does not have time to get hung up on the issue. "You know what I mean. The whole world is now thinking about privatizations. Thinking about individual ownership of equities. Every waiting room anywhere in the world I go has CNBC on the screen. This is a big, big, big change."
Dogged determination and hard work are the underpinnings of Warner's ethos. As a medical student, he worked through his vacations at hospitals. Now, he spends his free time either charging around golf courses with General Electric Co. Chairman Jack Welch or serving as chairman of the Memorial Sloan-Kettering Cancer Center. Why Warner participates in the center's work is especially telling: "This is an organization that is the best in the world at what they do," says Warner. "And they are intent on staying there."
To bolster J.P. Morgan's performance, Warner instilled the religion espoused by GE, where he has been a board member since 1992. Under a program called Six Sigma, 300 projects are squeezing costs out of everything from distributing research to selling derivatives. Thousands of managers have attended "black-belt" and "green-belt" sessions to learn how to slash costs while simultaneously boosting sales by, in Six Sigma lingo, "delighting" clients. Bizarre as they may seem, Warner says the sessions helped to save $1.1 billion last year--enabling him to spend $700 million to build up an online financial service and equity teams in Germany and Japan.
Taking another leaf from Welch's GE playbook, Warner ordered 70 executives to cancel their holidays to participate in a month of "e-SWAT team" meetings last December. The aim: to pull together a catch-up strategy for the Net. Signs were posted on a board in a hallway to spark discussions. They read: "Build Morgan. Enable Morgan. Kill Morgan."
Using ideas generated in the sessions, Warner reorganized his top ranks in February. He consolidated nine divisions into four groups, one devoted entirely to harnessing the Internet. J.P. Morgan's strength has never been to spot technology trends early and then to amplify them to reshape entire industries. But Warner is counting on one of Morgan's stars, Nicolas S. Rohatyn, 40, who built the firm's emerging-market business from scratch, to change that. Rohatyn, whose father, Felix, is the U.S. Ambassador to France and a former rainmaker at Lazard Freres & Co., is widely viewed as a leading contender to succeed Warner. "When they put me in this job," he says, "it was making a statement about change."
LabMorgan, as Rohatyn's unit is dubbed, will spend up to $1 billion on new e-finance initiatives in 2000, while simultaneously attempting to improve the performance of the firm, for example, by developing a site that permits corporate treasurers to access all of J.P. Morgan's services from investment banking to asset management. Since March, it has received more than 1,500 e-finance business plans, a fifth from inside Morgan. It has also launched 34 e-finance ventures, including one that allows clients to trade derivatives and foreign currencies electronically.PLANS, PLEASE. Online, J.P. Morgan is waging war by making alliances with competitors to launch electronic trading systems. In one such pact, it has joined Bear Stearns & Co., Chase, and others in a fixed-income trading system called Market Axess. The system competes head-on with BondBook, an exchange in which the likes of Morgan Stanley, Merrill, and Goldman are grouped. The stakes are huge for Morgan: Rohatyn wants the bank to double the number of institutional clients it has. Because it's much cheaper to acquire clients online, he can cut the former high minimum of $100 billion in assets per account.
LabMorgan's most unusual mission, however, is to rip apart J.P. Morgan by encouraging employees to submit plans for their own businesses. The bank's technologists and a newly hired patent lawyer from IBM regularly scour the company for ideas. It wants to turn up to 60 employees into CEOs of J.P. Morgan affiliates. And it has sweetened its managing directors' compensation packages by creating an in-house private equity fund that has holdings in the new e-finance ventures. The strategy shows promise: RiskMetrics--one of the earlier startups, now 22% owned by J.P. Morgan--sells the bank's own risk-management software for tracking exposure to market volatility. Buyers include more than 20,000 individuals, 5,000 institutions, and some of the world's leading central banks.
Next, J.P. Morgan wants to spin off a company called TransactPlus that will sell tools the firm has used for as much as $800 billion in secure Internet transactions daily. "Think about it as a digitized FedEx," says Peter Miller, a managing director at LabMorgan. "We think this company can be worth as much as a couple of billion dollars over a few years."COLD CALLING. J.P. Morgan's asset-management unit is undergoing radical change, too. After serving a select few for years, its private bankers are now scrambling after African Americans, Internet millionaires, and corporations' defined-benefits plans. "Cold calling for Morgan is something new," says Ramon de Oliveira, the unit's head. To attract these new clients, the private bank has revamped its plain-vanilla products. It is pushing private equity, real estate, and even hedge funds. And it has gone to the Net with its Morgan Online financial advisory service, developed by a subsidiary located on the edge of Massachusetts Institute of Technology campus in Cambridge. There's no outward sign the firm is part of J.P. Morgan: It's named for Arrakis, a planet in the science-fiction novel Dune, and is run nothing like a prestigious 150-year-old firm (page 134).
The approach seems to be working. The asset- management group earned $213 million in pretax income in the first half of this year, compared with $230 million in all of 1999. At this rate, says de Oliveira, asset management will soon contribute 25% of J.P. Morgan's earnings, up from 10% now.
To keep up that momentum, Morgan's investment bankers, led by Clayton Rose, have to generate IPOs and share offerings, which its clients can buy ahead of the crowd. So Morgan needs to become a lead adviser on more deals, instead of the perpetual co-manager that it has been. And that means elbowing the behemoths aside as it did in February when it led a $1.9 billion offering for Network Solutions Inc. "J.P. Morgan's senior management went out of its way to build relations with us and to understand our business," says Michael Daniels, former chairman of Network Solutions."
Warner's troops are trying to win new clients by offering advice on everything from their strategic deals to estate planning to information-technology strategies. "On any given day, we can beat Morgan Stanley," says Warner. "That's what we need to do." Private bankers, derivative traders, and engineers have all recently been moved to J.P. Morgan's investment banking team. And Warner has ordered everyone to drum up new ideas that "scream value" to new clients. The global trading group, led by William T. Winters, boosted revenues from equity derivatives 60% in the first half. "We feel we've just started to get clients focused on equity problems," he says.
Thanks to the push, the names on J.P. Morgan's client roster are changing from industrial giants to technological leaders, which should help the future flow of deals. In August, 1999, it led biotech company Genentech Inc.'s $2.8 billion IPO. More recently it has led IPOs for the likes of Japanese online broker Monex Inc. and European e-travel agency eBookers.com.
Still, the chase for new business is not without its snafus. For example, the bank took shares in return for acting as a placing agent for London online retailer Boo.com on its IPO, only to see its stake go up in smoke when the company collapsed earlier this year. And its defense of Britain's National Westminster Bank flopped, too. NatWest, advised by Morgan, tried to buy insurer Legal & General last year but then found itself on the receiving end of a hostile bid from the Royal Bank of Scotland.
To prepare for a bigger flow of deals, J.P. Morgan is beefing up staffing. In the past year, it has added 350 investment banking staff, luring cash equities teams from Dresdner Bank both in Tokyo and Frankfurt. Since January, it has pulled together a new technology, media, and telecommunications investment banking team by raiding Merrill, Bear Stearns, Chase, and Salomon.
However, the troops Warner desperately needs right now are backers on Wall Street. He has remade the House of Morgan into an investment bank and focused the old-line bank on seeking clients with big profit potential rather than a long pedigree. The effort is paying off in record revenues and profits. If Warner had not done all that, J.P. Morgan would surely have been easy meat in a takeover battle. Yet even now, the bank's revival may not protect it from an offer that its shareholders can't refuse.
Warner points to a 100-year bond in a gilt frame that was signed by Pierpont Morgan. He treasures the bond because it was issued in 1896 and the firm was still around in 1996 to pay it off. "I like this for the statement it makes about the need to constantly adapt, change, adjust--if in over 100 years you're still going to be around," says Warner. Ironically, Warner's efforts to soup up the bank could reduce the chance that J.P. Morgan can stay independent.By Emily Thornton; With Stanley Reed in London, Pamela L. Moore in Connecticut, and Bureau ReportsReturn to top