Deutsche Bank's Big Gamble
Wind River Systems Inc. couldn't have picked a worse week for a stock offering. The Alameda (Calif.) software company was scheduled to issue 3.3 million new shares on July 11--right in the middle of a market correction in which tech stocks took their hardest hit in years. Nearly two dozen technology deals expected during the week were delayed or killed. Yet on that tense Thursday, Wind River's bank called every American insitutional investor it knew and was able to place every share. The bank made money on the deal, too.
A miracle pulled off by one of Wall Street's wizards? No, this was Germany's Deutsche Bank, sweating out its first job as lead manager for a new technology issue in the U.S. The deal was a watershed for Frank P. Quattrone, the tech guru Deutsche had lured from Morgan Stanley & Co. just three months earlier with a multimillion-dollar pay package that raised eyebrows throughout the financial community.
Deutsche Bank will need many more such victories. After resisting change for most of its 126-year history, the $471 billion-asset bank is remaking itself from top to bottom. Under the leadership of Chairman Hilmar Kopper, Deutsche is trying to forge a new identity as a global contender in the cutthroat field of investment banking.
It's a strategy that Kopper and his colleagues call inevitable. It's also the riskiest one the bank has pursued since its postwar reconstruction. Conservative to a fault, Deutsche built its franchise in the cozy world of relationship banking, lending to German companies in which it also often held shares.
Now, Deutsche Bank, along with its Continental rivals, knows that the old banking culture is doomed. Heavyweights from Wall Street and the City of London are muscling in on European privatizations and mergers. And the European banks can no longer rely on collecting fat fees from thousands of midsize companies by acting as their personal lender.
So Kopper, who had masterminded his bank's acquisition of London's Morgan Grenfell PLC back in 1989, 15 months ago pulled Deutsche's worldwide investment activities under the Deutsche Morgan Grenfell (DMG) umbrella. More acquisitions may be ahead. Recurrent industry gossip has it that Deutsche could target a major U.S. house, such as Lehman Brothers Inc. or Salomon Brothers Inc. Says Kopper: "I would not exclude it, but it's not for this century. It'll take three years to get DMG up and running fully."
LOUSY ODDS. Deutsche is fighting on many fronts. At home, Kopper is slashing costs of domestic operations while taking on giant, Munich-based insurer Allianz for domination of the German financial-services industry. In Asia, the bank is pitting new talent against old-line British banks with former colonial connections, as well as burgeoning Chinese banks, the Japanese, and the Americans. In the U.S., Kopper is trying to break the run of bad luck that other European banks have had in cracking the "bulge bracket," or top rank of Wall Street firms.
The odds seem stacked against Deutsche. A Japanese assault on the U.S. banking market in the 1980s cost the newcomers billions as they tried to win new business by accepting paper-thin margins. The Japanese never made a dent, and no European bank has ever fared better on its own.
Controlling a global investment bank is a lot harder than keeping tabs on a staid commercial bank. Last month, Deutsche had to cough up $280 million to make good on losses in two mutual funds run by DMG's Morgan Grenfell Asset Management unit in London. And on Sept. 25, Moody's Investors Services put Deutsche's AAA rating under review, citing "business and balance-sheet risks resulting from the group's aggressive global expansion strategy."
Such scrutiny makes cutting costs in domestic retail banking even more urgent. Deutsche is the least efficient of Germany's Big Three banks, with costs that run about 70% of net income. Its return on capital is around 9%, compared with an average of more than 20% for U.S. banks.
So the bank is undergoing a thorough domestic restructuring. By the end of this year, Kopper will have shed 20% of the 52,600 domestic staff it employed at the end of 1992. About half its 18 regional superbranches, classic baronies in the old Deutsche, will soon close. Back-office work for all branches has already been concentrated in just four regional technology centers.
LOGICAL FIT. To signal his seriousness about maintaining Deutsche's position at home, Kopper on July 10 announced that the bank has taken a 5.2% stake in Munich-based Bayerische Vereinsbank, Germany's fifth-largest. The ploy gives Deutsche a decisive voice in how the widely anticipated consolidation of Germany's banking industry will unfold. Vereinsbank and Deutsche are a logical fit. BV's branches are concentrated in southern Germany, where Deutsche is weaker, and it has business strengths that Deutsche lacks. For example, it is a European market leader in real estate finance. The relationship "makes a lot of sense," says Manfred Piontke, banking analyst at Bank Julius Baer in Frankfurt.
But Kopper's problem is that the huge hiring costs at the investment bank are swallowing up the savings from domestic cutbacks. Indeed, Deutsche's high compensation has rivals howling that Deutsche is driving up costs for the entire industry. Competitors also claim Deutsche is "buying" deals, Japanese-style, by severely underpricing its services. DMG Chairman Michael Dobson admits that, like competitors, the bank will sacrifice margins to clinch a landmark privatization, for example. But he says Deutsche is also often undercut.
Indeed, the bank in 1995 ranked No.11 in European initial public offerings, after Morgan Stanley and Merrill Lynch & Co. Meanwhile, as the bank spends billions on its transformation, its shareholders have watched Deutsche Bank stock bump along sideways even during a blazing bull market (charts).
Yet the 61-year-old Kopper claims the bank has no alternative to taking drastic steps, no matter how expensive or controversial. Like the other Continental "universal" banks, which unlike their Anglo-Saxon counterparts do merchant, investment, and commercial banking, Deutsche Bank risks becoming dangerously unprofitable if it continues to rely mainly on its commercial business.
That's why, in the two years through the end of 1996, Kopper will have spent an estimated $730 million--about half of last year's $1.4 billion consolidated net profit--to hire staff and install high-priced technology around the world. Making this costly bet pay off will be a Herculean task. In the U.S., says Carter McClelland, chairman of Deutsche Bank North America Holding Corp. (DBNA), investment banking revenues will be up substantially this year from a "very modest" base in 1995. Yet a former New York-based DBNA executive claims that North America is losing $100 million per year, before adding back earnings from pre-existing businesses and the commercial finance unit acquired from ITT Corp.
Kopper and his lieutenants stand squarely behind their strategy. He insists DMG is paying compensation only 3% above market averages. Says North America's McClelland, who has pumped up the U.S. head count by 600 this year, to 1,800: "It's far cheaper to build than buy." That may be true in the long run. But banking scuttlebutt has it that some of DMG's top-dollar hires in London from Wall Street have kept their families and houses in the U.S., ready to head back home once their bonus guarantees run out.
Deutsche Bank can't afford a revolving door in investment banking. New revenues take time to build: six months to a year in capital markets and a year or two in other lines, according to McClelland. Kopper is caught in a vise between fast-rising costs and revenues that are improving slowly at best. One Hong Kong rival puts it bluntly: "How long are they going to be willing to run at a loss out here? And what kinds of events will cause them to rethink their approach?"
None so far. With only a few years left before retirement, Kopper is understandably in a hurry to make his mark on the bank and on Germany Inc. Despite the high risks, he maintains--with perhaps a hint of the old Deutsche arrogance--that his strategy can succeed. If it does, Kopper will be remembered for changing the face of global investment banking.