On Second Thought, Warburg Looks Tasty

Back in January, Marcel Ospel, head of international banking at Swiss Bank Corp., was asked if his bank would consider bidding for S.G. Warburg Group PLC, whose attempted merger with Morgan Stanley & Co. had just collapsed. Ospel's answer was clear: "I would not want to expose shareholders, and more important, my staff, to a takeover of this magnitude."

Really, Marcel? On May 2, SBC admitted it is talking with Warburg about buying out the blue-chip British firm's securities and investment banking business for an estimated $1.3 billion. That would be SBC's third big acquisition in four years, following the purchase of options trader O'Connor Partnerships and asset manager Brinson Partners Inc. Buying Warburg would certainly weigh down SBC profits in the short term. And absorbing another culture would be one more headache for the Swiss, who are only now learning how to live with the brash Chicago options traders from O'Connor.

DASHED HOPES. SBC isn't talking, but it's clear three crucial factors account for the change of heart. First, in one swoop, SBC could claim the title of Europe's preeminent investment bank and the world's largest underwriter of equities. Second, the price is right--roughly book value, as opposed to Deutsche Bank's 1987 purchase of Morgan Grenfell, which went for 2.5 times book. Third, if SBC lands Warburg, it avoids being outflanked by rivals who might want the British firm for themselves. Even now, a bidding war could pull in U.S. competitors such as Smith Barney Inc. or Merrill Lynch & Co., both said to be interested bystanders.

For its part, Warburg, whose global aspirations are dashed without a merger, must halt an internal crisis. Key executives have been leaving in droves: On May 2, in the latest defection, the four execs who led Warburg's European equities business decamped to Morgan Grenfell. Warburg has had to cut back operations in the U.S. and shutter most of its Eurobond operations. So Chief Executive Sir David Scholey's vow to remain independent now looks hollow. "It was difficult for Warburg after the Morgan Stanley fiasco," says a competing investment banker. "It's tough to carry on like nothing happened." Warburg now sees full-year profits due out at the end of May sharply below market forecasts.

SBC's challenge is to grab Warburg fast enough to prevent any more decline in the franchise's value. SBC does not want Warburg's Mercury Asset Management division, which would duplicate its own in-house business. Instead, it wants Warburg's blue-chip investment banking clients, including chemical giant ICI, Britain's General Electric, and pharmaceutical maker Glaxo/Wellcome PLC.

Capturing Warburg relatively intact would give SBC a leading role in European mergers and acquisitions and a strong London base for placing equity and debt globally. Those are critical elements that have eluded SBC in its efforts to become a full-service provider to corporate clients worldwide. Despite leading some high-profile corporate finance deals in London in recent years, SBC "still ranks as a second-rate operation there," says a former SBC exec. "Compared to Warburg, they had neither the merchandise nor the customers at the other end." Besides being the top equities issuer, an SBC/Warburg combine would be a force in foreign exchange and Eurobonds. And SBC's $190 billion in assets would certainly provide the capital Warburg has needed for so long.

It's not an ideal fit, though. Even with Warburg, SBC still lacks the distribution network it needs to tap the big U.S. market for privatizations and corporate debt issues. And though it will expand its foothold in Asia, SBC will remain a second-tier player there, too.

TOO FAR. Explaining the bid back home might not be so easy, either. SBC's original strategy was to build investment banking clout by relying on O'Connor's options trading expertise. Instead, trading losses drove SBC profits down 41% last year, to 1989 levels. As a result, says Bank Julius Baer & Co. analyst Hans Kaufmann, SBC is "going to be very concerned about earnings dilution" caused by a prospective Warburg purchase.

But SBC has pursued its dream of investment banking dominance too far to back down now. If it loses the Warburg deal, it will have to watch Continental rivals like Deutsche Bank and the Netherlands' ING consolidate their positions in London's investment banking world. Given SBC's penchant for innovation and aggressive behavior in recent years, it's likely that Wall Street and the City will be hearing a lot more from the Swiss.

— With assistance by Paula Dwyer

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