It has been nearly a decade since London's Big Bang, when the government at one fell swoop lifted regulations that kept the investment banking industry a patchwork of specialty brokers, market-makers, and merchant bankers. A handful of mergers later, there's still an informal division of labor between banks that underwrite equity and debt issues and those that sell them. And the securities business remains fragmented, with three dozen major investment banks tripping all over one another for business.
But the crowded field may soon thin out. Investment bankers predict that the City of London could soon resound with an echo of the Big Bang. Rumor after rumor of merger talks between banks and brokers, or between the big Continental and London investment banks, swirl about the City's square-mile financial district. "There are going to be mergers and takeovers, and I think some may actually happen soon," predicts Peter Letley, deputy chairman of HSBC Investment Banking Ltd. "A number of players in the London market are not sufficiently global."
POND JUMPERS. A fear of being insufficiently global is precisely what propelled Britain's premier investment bank, S.G. Warburg Group, toward Morgan Stanley & Co. in mid-December. And on Jan. 25, London's Govett & Co. announced plans to merge with Chicago-based Duff & Phelps Corp. in a $250 million deal that creates a global asset management and equity research house with $50 billion under management.
While the marriage of convenience between Warburg and Morgan Stanley fell apart a week later, the logic behind it remains: To be successful, investment banks are finding that they need to offer corporations a wide range of products in numerous markets outside their home base. London banks are increasingly losing juicy business to players with a longer international reach (table). The reason: Today's most lucrative action is in cross-border deals, from an equity issue that a British company wants distributed among American pension funds to European privatizations, up to 30% of whose shares wind up in the U.S.
Even strictly domestic deals are going to U.S. banks because they have a reputation as more resourceful and innovative financiers. A case in point: In Glaxo Group's surprise $14 billion bid for fellow British drugmaker Wellcome PLC on Jan. 23, Wellcome is being advised by both Barings PLC, a second-tier London merchant bank, and Morgan Stanley. Previously, Warburg had been Wellcome's adviser, but now "Wellcome needs Morgan to beat the bushes around the world for white knights and alternative solutions," says a top investment banker.
Another change buffeting local investment banks is the low margins they get on formerly cash-spinning businesses. Take Eurobonds. The $400 billion market is now served by more than 100 investment and commercial banks. Overcapacity is driving down fees and commissions: Typical fees are a mere 0.25% of the amount raised, down from 2.5% a decade ago. Warburg, in fact, got out of all but sterling Eurobonds in mid-January, even though its founder, Siegmund Warburg, created the market in 1963 as an alternative to bank lending.
HIGHER STAKES. The biggest squeeze is coming from the U.S. heavyweights, especially Goldman Sachs, Merrill Lynch, and Morgan Stanley, whose capital, trading technology, and global presence have pushed the second-tier London banks into niches. All three are contracting because of overexpansion in Europe last year, but their rivalry isn't likely to lessen. Merrill Lynch, for example, is now widely recognized as the powerhouse in debt securities of all kinds. Goldman Sachs is the global leader in mergers. Morgan Stanley ranks No.3 in worldwide equity issues. Meanwhile, Continental players--Germany's Deutsche Bank and Dresdner Bank, plus the Dutch powerhouse ARN-AMRO--are beefing up their London operations.
The stakes are getting higher all the time. With corporate profits recovering in Europe and the U.S., record levels of equity deals, debt issues, and mergers are expected for 1995. Cross-border mergers and acquisitions will be especially active. But the problem for London's banks is that more deals are congregating in fewer hands. Of $76 billion in M&A deals in Europe in 1994, for example, five banks acted as advisers for 65% of them, when ranked by dollar value. Of the five, three were American.
No wonder the consolidation rumors are flying. Warburg officials deny that they are looking for another suitor, but with the company's share price rising 15%, to $12, in the past two weeks, the market clearly thinks otherwise. Independent London brokers Smith New Court and Panmure Gordon, owned by NationsBank, also are "obvious takeover targets," says HSBC's Letley. The two banks would not comment. Other prominent British houses are considered bait, but any overtures would have to be friendly, since each is family owned or controlled. They include Robert Fleming, Hambros, and Lazard Brothers--all undercapitalized compared with U.S. integrated banks but profitable in their niches.
At the same time, Europe's big banks are plotting to acquire the critical mass and trading expertise to compete with the U.S. powerhouses. Deutsche Bank just moved much of its investment banking operation to London, where it previously had scooped up merchant banker Morgan Grenfell Group. Banking sources say that Deutsche is considering making an offer for Cazenove & Co., a highly secretive broker with a blue-chip client list. Deutsche and Cazenove both declined to comment.
Deutsche's German archrival, Dresdner Bank, is seen as anxious to match its competitor's expansion moves and has been named as a possible suitor for Warburg. A Dresdner spokesman declines to comment, but CEO Jurgen Sarrazin recently said he hopes to strengthen his bank's London presence. And Union Bank of Switzerland, which acquired the Phillips & Drew brokerage in the first Big Bang but in recent years has slipped behind rival Swiss Bank Corp. in corporate finance and derivatives, has also been prominently mentioned in connection with Warburg. UBS denies any interest.
Instead of merging with Continental rivals to beat back the U.S. onslaught, some London merchant banks are trying to stay independent by aiming for a niche. Privately owned Barings, for example, no longer sells shares of British companies. Instead, it has a powerful franchise in emerging markets--although its specialty could be threatened if the Mexico scare drives investors away from such markets for long. Barings is also targeting smaller institutional investors and private, wealthy clients rather than the giant pension funds and insurance firms. "We don't consider the global label as particularly relevant to us," says Peter Norris, CEO of Barings' investment banking group.
Likewise, Kleinwort Benson Ltd. is known for its work in the utilities area, privatizing oil and gas companies and electricity generators around the globe--including advising Russia's giant Gazprom. But the publicly traded bank retains a full-service equities operation and has tried to be all things to all people. The market seems to think Kleinwort is prime takeover bait, bidding up its shares 10% so far this year. Bank officials won't comment.
ANOTHER PATH. By contrast, Schroders PLC, second to Warburg in Britain, may have a firm grip on its independence. With low exposure to volatile trading income, the bank also eschews the big deals that bring lots of publicity but also high costs. Instead, it's going after project finance work in emerging markets and helping companies establish their first pension funds, in the hope of later winning the job of managing them. At a time when fund management is red hot, Schroders has patiently built a successful investment arm, with $94 billion under management. Based on results, Schroders may have the better strategy: In the six months ended June 30, profits came to $161 million, vs. Warburg's 58% earnings drop, to $98 million, for the half-year ended Sept. 30.
Nevertheless, in August, Schroders quietly bought the remaining half of its U.S. partner and equity distribution arm, Wertheim Schroder & Co., in a $94 million deal, and plans to use Wertheim to expand into Latin American equities. Clearly, even for London's successes, the siren they hear is far offshore.
Who's Doing the Plum Deals
PRIVATIZATION Goldman Sachs is Europe's top manager for the nondomestic portion of deals, with $3 billion in 1994 issues.
MONEY MANAGEMENT Three Swiss banks dominate this red-hot business. Union Bank of Switzerland manages $273 billion, Credit Suisse $205 billion, and Swiss Bank Corp. $185 billion.
EUROBOND UNDERWRITING Merrill Lynch takes the top position, with $34 billion in 1994 issues.
EQUITY Goldman Sachs is Europe's biggest house for underwriting and distribution, with $4.6 billion in 1994 deals.
MERGERS & ACQUISITIONS S.G. Warburg was tops in European M&A advising on 64 deals worth $17 billion in 1994.