Second Thoughts In Asia? No Way

A little market turmoil isn't scaring U.S. investment banks

Merrill Lynch & Co.'s timing couldn't have been worse. The U.S. securities giant held the official opening of its 30-person Manila office on Sept. 25--amid a local and regional currency crisis and at the tail end of a five-year bull market. Yet Herbert M. Allison Jr., chief operating officer, couldn't have been more enthusiastic. Speaking at a cocktail reception at the Mandarin Oriental hotel attended by 400 local executives and government officials, Allison was adamant on one point: Despite the market turmoil, Merrill was steaming full speed ahead into the Philippines. This way, we'll get in on the ground floor and establish our commitment, he told the crowd.

U.S. investment banks in Asia face an unsettled picture. Competition is fierce, margins are thin, and currency and stock markets in much of the region are in a nosedive, causing losses at some firms. Yet U.S. houses aren't fazed. Besides Merrill's Philippines launch, Lehman Brothers Inc. just opened a three-person office in Bangkok, which is financial ground zero. A year ago, Goldman, Sachs & Co. sent its top European banker, John L. Thornton, to Asia to try to replicate Goldman's European success there. Publicly at least, U.S. firms view the recent volatility as a mere correction, not the permanent reversal of a trend. "These markets are so compelling that any global investment bank has to be making a commitment," says Peter Clarke, chairman of Merrill Lynch (Asia Pacific) Ltd.

"SENTIMENT-DRIVEN." This isn't the first time U.S. firms have been excited about non-Japan Asia, in general, and the region's superpower, China, in particular. But then U.S. investment banks have blown hot and cold on Asia in the 1990s--unlike local firms or even U.S. commercial banks. The history of American investment banks has been to expand and then contract--depending on whether they were making money worldwide and locally.

Now, however, U.S. firms are in the midst of a big buildup and insist they're in it for the long haul. What's different this time? They have several years of U.S. bull-market profits to plow into Asia. And Asian markets, while tiny compared with the U.S., have grown rapidly in the past few years.

The promise of more American financial staying power is good news for Asian companies and markets, even though it may put pressure on local houses. "I have a love-hate relationship with Morgan Stanley," jokes Philip L. Tose, chairman of Peregrine Investment Holdings in Hong Kong. "I love to hate them." The U.S. houses are helping usher Asian countries into world markets for debt and equity and are also investing directly in local companies. U.S. firms also bring to the party their higher standards for reporting and disclosure and a more critical outlook on research. "They bring a more rational view of the market. Asians have always been more sentiment-driven," says Henry D.C. Lee, a Hong Kong fund manager.

But there are too many bankers chasing too little business. The flood of bankers into Hong Kong has led to a scramble for talent and has inflated compensation. Deutsche Morgan Grenfell and others have been on hiring sprees throughout the region. Merrill opened its Manila office with employees it raided from Jardine Fleming's office there--nabbing its chairman, managing director, two salesmen, and three analysts. It paid them two to five times what they had been making, says Christopher Rampton, a group executive director at Jardine Fleming Ltd. "It's a bit irksome."

The Asian business of the U.S. investment houses is still small: At Goldman, Asia, excluding Japan, makes up about 5% of its overall earnings. But the U.S. houses expect big growth in the future. For example, in Asia most companies are still family-owned. Thus, the mergers-and-acquisitions business is in its infancy. "It's taboo to go around and start taking over other companies in hostile bids," says Rampton. The same goes for the debt markets. "Most Asians have had an aversion to debt. They love equity. But as the countries mature and economies slow down, pressure from investors to use low-cost debt to leverage the returns will increase," says Miles Armstrong, another group executive director at Jardine Fleming.

EVEN RACE. U.S. firms' real advantage in Asia is that they operate globally. The top two Hong Kong investment banks, Peregrine and Jardine, have far more depth and history in the region but are not major players elsewhere. Other important local firms, such as BZW, Credit Lyonnais, and HSBC, lack market dominance. "There is no Deutsche Bank as in Germany, no Lazard Freres as in France, and no Nomura as in Japan," says Philip D. Murphy, president of Goldman Sachs (Asia) and a baseball fan. "It's early April, and nobody is in first place."

As they have done in the U.S., Morgan Stanley, Goldman Sachs, and Merrill have pulled ahead of other American firms in Asia in the past few years. CS First Boston, a leader in the region in the early 1990s, Lehman Brothers, and Salomon Brothers are scrambling to catch up. But the big three are not all following the same strategy: Merrill Lynch has the most comprehensive--and expensive--approach. It is expanding its staff in 16 Asian cities and has bought seats on 10 stock exchanges. Merrill has also defined itself as customer-driven. It has largely shunned the business of investing alongside its clients and has avoided the Asian custom whereby the underwriter buys a stake in the company it takes public. Merrill faces a setback in Thailand. Its joint venture partner was merged into a Thai conglomerate, leaving the venture's status uncertain.

Goldman Sachs and Morgan Stanley, Dean Witter, Discover & Co., by contrast, have far smaller networks of offices and people in each country. Instead, Goldman and Morgan Stanley maintain big staffs in Hong Kong and Singapore, by far the two biggest markets in the region. Their employees fly from there into Indonesia or Malaysia on a deal-by-deal basis.

Of the American firms in Asia, Morgan Stanley has had the highest profile for the longest time. It mounted a big push in 1993 and quickly grabbed a top spot in equity underwriting. It emphasized its independence from New York and its ability to commit capital quickly to local deals. It has focused on China and India because of their potential. In China, Morgan Stanley is the only foreign firm with access to the domestic market--through a joint venture with the China Construction Bank. And Morgan underwrote one of the year's hottest China deals, Beijing Enterprises, a $279 million initial public offering. "We're up 40% over last year across the board," says John S. Wadsworth Jr., head of Morgan Stanley Asia Ltd.

Goldman Sachs is more of a newcomer, but it has done an impressive job of making up for lost time. This year, it lead-managed three of the region's biggest deals, including the initial public offering of China Telecom and the $740 million IPO for China Southern Airlines.

The most distinctive aspect of Goldman's strategy has been to put its own money on the line. Goldman is an active proprietary trader. It also has a big business investing alongside the region's tycoons. Goldman has spent $500 million to buy minority stakes in 20 Asian companies. This has given the firm entree to the handful of powerful entrepreneurs who are key to the region's economy. Goldman even took a 1% stake in China Southern Airlines, which it also underwrote. "If you invest with people, you have a whole different relationship than if you are simply providing them service," says Goldman Sachs (Asia) chairman Thornton.

The other U.S. firms are investing in their Asian operations as well. Salomon Brothers Inc., which recently announced plans to merge with Travelers Group Inc., installed one of its top U.S. bankers, Robert R. Morse, as head of its Hong Kong office. Morse is busy hiring local talent to jump-start Salomon's Asian business. A rich new parent and a large network of Smith Barney Inc. brokers may give it a shot in the arm. It will need it: Competitors say Salomon's Hong Kong office sustained major losses in 1997. A Salomon spokesman will only say the firm is "in an investment mode."

Lehman just laid off about 20 people in Hong Kong but says it is still committed to the region. The firm helped a beleaguered Thai government agency raise money in July--after the stock market crumbled--by designing a "step-up" note that will give investors an extra half a percentage point yield if the agency's bonds are downgraded. The currency crisis "is bad news for the Thais, since they won't have 8%-to-10% economic growth. But there's lots of opportunities for U.S. firms," says Paul Shang, managing director at Lehman Brothers Asia.

Still, U.S. bankers are resigned to a dry spell in the coming months. "There will be a slowdown of foreign capital into the region," says Wadsworth. "It will be tougher to get deals done." But this time, he insists, there's no hint of pulling back. "One downturn won't cause us to flinch." Not flinching depends on whether U.S. houses are smarter this time about matching their overhead costs with the business coming in the door. "The real challenge is not to get too far ahead," says Goldman Sachs Chairman and Chief Executive Jon S. Corzine. Perhaps this time Corzine and others have learned from their mistakes.