Europe's Merger Shock
The deals have come so thick and fast that they have crowded nearly everything else off the front pages. A $39 billion marriage between Britain's Guinness PLC and Grand Metropolitan PLC groups is finally getting the green light. Across the channel, Italy's Assicurazioni Generali is trying to snap up Assurances Generales de France in the biggest hostile bid in French history. Anglo-Dutch media group Reed Elsevier PLC is buying Amsterdam-based publisher Wolters Kluwer, to form one of the world's largest publishing groups. And these are only the biggest deals.
If you're an investment banker or a stock market player and you didn't make money on any of these takeover plays, don't despair. Merger mania in Europe is just beginning. Corporate chieftains from Munich to Madrid know that Europe's single market is no longer a vague dream in the minds of a few visionaries. It's real, and it's almost here. Managers are under huge pressure to cut costs and to focus. To do that, they have to play on a European, if not global, scale. That spells more mergers and acquisitions.
Until recently, the Old World's 15 national markets were essentially 15 rich niches in which individual companies could prosper. In the new single market, companies will use one currency, operate under one set of regulations, and vie for money from investors who measure them all against the same financial benchmarks. So industries are screaming for consolidation.
The political fallout from this corporate-driven merger wave could be heavy. So far, Europe's leaders have tried to have their cake and eat it, too, pushing monetary union while promising voters to protect jobs and social benefits. But as companies restructure to stay competitive, politicians will face severe pressure. In a single market, executives will coldly assess which locations in Europe are most desirable for investment. Their scrutiny, says Thomas Mayer, senior economist at Goldman, Sachs & Co. in Frankfurt, "will expose inappropriate fiscal and wage policy more ruthlessly."
IRRELEVANT FRONTIERS. For the time being, most of Europe Inc.'s mergers are being driven by solid industrial logic, with companies buying others in the same sector. That sets what is happening apart from much of the spin-off frenzy that shook up Corporate America in the 1980s. But already Euromergers are starting to change. When France's Francois Pinault made an audacious bid to break apart Worms on Sept. 19, he turned the spotlight on other potential targets, such as Paris-based Schneider and Milan's Compart, that might be quarry for would-be European raiders trying to unlock value by spinning off assets. Investment bankers in London are makingp lists of vulnerable companies. "There will be European KKRs," says Roger Abravanel, senior partner at McKinsey & Co., referring to U.S. leverage buyout firm Kohlberg Kravis Roberts & Co.
On the Paris Bourse, raids used to be as rare and frowned-upon as oysters in August. Now, in the space of less than one month, France has seen hostile, multibillion-dollar bids for the country's second-largest insurer, a venerable family-controlled conglomerate, and the third-biggest retailer. And in Italy, Generali's $9.4 billion bid for Paris-based AGF shows that management knows it must look beyond nearly irrelevant frontiers--or accept obsolescence.
Where will the action be in the next weeks and months? Auto parts manufacturers, banks, and perhaps even a major Continental carmaker could get swept up in the merger wave. The food industry, still dominated by legions of small, regional companies, is an obvious candidate for consolidation. And in the longer term, generational change at tens of thousands of family-owned European companies will spawn many more corporate marriages. Today's deals are just the organ music.
Who'll survive in the new financial-services era?
Antoine Bernheim knew it was now or never. The chief executive of Italian insurance giant Assicurazioni Generali had negotiated for months to buy French insurer Athena. But in early October, rival Assurances Generales de France moved to steal the bride as part of a deal to acquire Athena's parent, Worms. Bernheim saw his best hope for entree into the rich French insurance market slipping away. So with help from investment bankers Lazard Freres & Co.--where he also is a senior partner--and Generali's longtime bank, Mediobanca, he quickly launched a $9.4 billion hostile bid for AGF.
That stunning move, announced on Oct. 13, is among a half-dozen recent mergers and attempted takeovers that herald a new era for Europe's financial services. Converging forces, from monetary union to the growth of private pensions, have unleashed a powerful wave of consolidations (table, page 24). A quantum leap in competition will soon separate the winners from the losers in corporate lending, asset management, and consumer banking. In the next few years, a handful of trans-European giants will emerge to dominate the financial-services industry.
The survivors will be those with the critical mass to spread costs over a huge customer base. They'll also need a wide geographic reach, since their clients will be shopping outside their home turf, and a wide range of competitively priced products. "There is going to be a huge revolution in European banking and insurance," says John Bennett, fund manager at Global Asset Management in Edinburgh. Besides the big, all-Europe banks, some strong niche players will survive--in distinct geographic areas, such as Scandinavia, or in specific market segments, such as mortgage lending. The losers are likely to be midsize banks with mainstream products.
FULL-SERVICE MODEL. To stay alive, finance providers are trying to give their products the longest possible reach. For many, the goal is to provide one-stop shopping for corporate and individual customers alike. Deutsche Bank, for instance, is on the prowl for a French insurance company. It hopes to use its agents to sell everything from Deutsche Bank mutual funds to financial-planning services. And Zurich Insurance Group, which is in talks on a $36 billion merger with the insurance arm of Britain's BAT Industries PLC, plans to use BAT's 14,000 Farmers insurance agents in the U.S. to sell products from subsidiaries Kemper Financial Services Inc. and Scudder, Stevens & Clark Inc.
The Netherlands' ING Group is a model for a full-service finance company--and is likely to survive the shakeout. It has a presence in every European country and is looking for a big acquisition. Formed in 1991 by a fusion of insurer Nationale Nederlanden and NMB Postbank, ING has grown to $250 billion in assets by selling customers several services at once. "As the government cuts back on the social-welfare state, we go to our corporate clients and offer them total financing and insurance packages," says Berry Weijts, an insurance manager at ING's Venlo branch, near the German border.
Indeed, Europe's faltering public pension systems are key drivers of consolidation. For instance, the German parliament voted on Oct. 10 to reduce retirement benefits from 70% of a recipient's average wages to 64%. Italy last year made a similar cut. So consumers are scrambling to increase their own retirement savings.
Private pensions will dramatically change the asset-management business as individual investors pour into equity markets. "Growth is likely to be 8% to 12% in this area over the next 10 years, as opposed to 2% in other financial services," says Jacob Wallenberg, CEO of Sweden's S-E-Banken. To capitalize on the trend, he merged his company on Oct. 2 with Sweden's second-largest insurer, Trygg-Hansa. They now form Scandinavia's biggest financial institution, with $40 billion under management.
Another engine of consolidation is the quest for sheer size. In the race to dominate Europe's financial landscape, say industry experts, bigger is usually better. Bulked-up banks and insurance companies can spread their costs over a broader customer base. For example, at German insurance behemoth Allianz, costs are about 25% of the company's total premiums of $43 billion. That's about five percentage points lower than the European average, says Michael Muth, a Munich-based co-leader of McKinsey & Co.'s insurance practice.
Such giants can better afford the mainframe computers that are at the heart of today's complex financial transactions. These machines, and their software, cost hundreds of millions of dollars a year to maintain and upgrade. And since big institutions manage mammoth amounts of assets, they can hire expensive specialists in an effort to maximize returns.
NO TURNING BACK. Winners and losers are already starting to emerge in the financial fracas. In insurance, powerhouses such as Allianz, Zurich, and France's Axa will continue to dominate. But hundreds of small, local insurers will be gobbled up in the next several years. In banking, companies based in countries such as Switzerland or the Netherlands have an advantage, since consolidation has already reduced overcapacity and fattened margins. But Germany, for one, remains grossly overbanked: The top three players, Deutsche, Dresdner Bank, and Commerzbank, together have only a 15% market share.
Consolidation will come in fits and starts. Today's sky-high equity values make stock-swap deals particularly attractive, for instance. But there's no turning back now, however deals are transacted. Indeed, as Bernheim learned the hard way, companies that don't move in for the kill could end up going hungry.
By David Woodruff in Frankfurt, with Stanley Reed in London and William Echikson in Brussels
EMU: NO MORE IFS OR BUTS
As the Bundesbank calls the tune, Europe Inc. gets ready
Until recently, it was still fashionable in some European circles to voice doubt about whether monetary union would really happen in 1999. Last week, Germany's central bank put an end to all that. When the Bundesbank raised short-term interest rates and four other central banks instantly followed suit, it was a clear signal that EMU is already a reality in the minds of Europe's financial powers. And the Buba made clear that it will call the shots as financial union approaches. Until a new European central bank is created in 1999, the Bundesbank will be its proxy. "This is the European central bank in operation," says Allison Cottrell, an economist with PaineWebber International (UK) Ltd. in London.
Corporate Europe is already positioning itself for the new reality. In May, governments will announce which countries can enter the new union and set preliminary exchange rates. Between now and then, Continental financial markets will start to radically restructure, as investors and executives anticipate a more level playing field in everything from interest rates to corporate debt ratios to price-earnings multiples in national stock markets.
Meanwhile, greater financial transparency under EMU will reveal inefficiencies previously disguised by exchange-rate differentials. New competition, lured by the prospect of a huge, unified, deregulated market, is severely pressuring Europe's banks and insurers, formerly coddled and protected. Hence the spate of European financial megamergers, with some $40 billion in deals announced in mid-October.
Many investment strategists now think that the prospect of monetary union will push key elements of financial integration forward by May, well ahead of EMU's official Jan. 1, 1999, kickoff date (table). In the debt markets, it's already happening. As bond investors have come to believe in EMU, 10-year yields in most European countries have converged around Germany's 6% level, even in nations that may not be allowed into EMU at first. For instance, long rates have dropped dramatically in Italy, to 6.55%, and in Spain, to about 5.92%. "The market has already priced in the first-round participants in EMU," says Michael Dee, a London-based Morgan Stanley & Co. managing director for international fixed-income securities. "Now it's starting to focus on round two."
Clearly, investors like the idea of a new monetary order in Europe, administered by a new central bank that's as hawkish on inflation as the Bundesbank. The bank admits that it weighed "international" factors, as well as domestic economic concerns, in setting German rates. Translation: The Buba wants to stamp out inflation in every potential EMU partner, not just in Germany, between now and May.
It's a tempting environment, and one that's bringing sophisticated new financial players to Europe, especially from the U.S. They are already pressuring traditional lenders to be more innovative. Nearly 60% of European corporate borrowing is bank debt, but alternatives are springing up. In March, Germany's Siemens issued its first syndicated debt in 25 years, a $1.2 billion, three-way deal denominated in Dutch guilders, German marks, and French francs that shifts into a single euro-denominated issue in 1999. The concept, pioneered by J.P Morgan & Co., is designed to give borrowers a Europewide investment base ahead of EMU.
And with Bankers Trust New York Corp. leading the way, a junk-bond market is developing on the Continent this year for the first time ever. Companies have done a dozen junk issues, worth about $1.4 billion, so far this year. "That market is going to expand dramatically," predicts Morgan Stanley's Dee.
For companies, the benchmarks for financial performance will get tougher. In the core EMU countries, exchange rates are already starting to move up and down in tandem. As that happens, creditworthiness rather than exchange-rate risk has become portfolio managers' central preoccupation when they evaluate debt issues. Strategists also predict that stock market valuations, such as price-earnings and dividend payout ratios, will converge. At the same time, as EMU forces governments to cut their budgets, Europe's stock markets could just keep on booming. "The optimistic case is that one can draw parallels between Europe now and the U.S. in the mid-1980s," says Peter Sullivan, European equity strategist with Goldman, Sachs & Co.
With the financial markets already anticipating EMU, the next big shifts are likely to come from governments. EMU-related austerity measures contributed to Italy's budget crisis and have put major strains on Chancellor Helmut Kohl's coalition in Germany. But the biggest squabbles are yet to come. If interest rates come up too quickly, Europe's still fragile economic recovery could choke. And conflicts seem certain when European governments meet next May to decide which countries get into EMU in the first round. But given the financial momentum behind EMU, it looks as if by next spring there'll be no turning back.
By Thane Peterson in Frankfurt