Commentary: Is Deutsche Bank 'Out Of Its Depth'?Thane Peterson and Gary Silverman
It's the biggest acquisition ever of a U.S. financial institution by a foreign bank. But it looks like the same, sorry old story. For nearly a decade, German giant Deutsche Bank has spent billions trying to make a go of it in investment banking. Now, with its proposed $9 billion all-cash purchase of Bankers Trust Corp., the bank is upping the ante, striking a deal to create what would be the world's largest financial institution. But analysts and rivals are properly skeptical that Deutsche Bank will fare any better. "I'm worried Deutsche is getting a little out of its depth," says Mark Hoge, a London-based Credit Suisse First Boston analyst. "It could get messy."
Indeed it could. In buying BT, Deutsche is hoping to build up its presence in the U.S. and extend its reach into the capital markets. But Bankers Trust's finances are shaky, and the deal adds little in the areas where Deutsche is weakest. Analysts worry the merged institution will be plagued by the cultural conflicts and management defections that have undermined an array of initiatives to build a successful investment banking team--from Deutsche's costly attempts to beef up Morgan Grenfell, the British investment bank it bought in 1989, to recent abortive ventures in Silicon Valley. Plus, BT's focus on junk bonds and derivatives seems risky for a conservative bank like Deutsche. "BT is like Long-Term Capital Management with corporate overhead attached," snipes a rival investment banker, referring to the U.S. hedge fund that collapsed this year.
BT isn't coming cheap either. Deutsche's $93-per-share offer is more than twice BT's book value. By comparison, Travelers Group Inc. paid 1.7 times book value in 1997 for Salomon Brothers, another Wall Street firm with a reputation for rolling the dice. And BT itself was trading for just about book value as recently as last month. "It did not seem to me that Bankers Trust was in a good position to negotiate a good price, but they did," says James K. Schmidt, manager of the John Hancock Financial Industries Fund, an owner of BT shares as of October.
CASH HOARD. BT has had a long history of problems. In 1995, Frank N. Newman, a former U.S. Treasury Dept. official, was recruited to clean up the bank's scandal-plagued derivatives operation. But Newman, now CEO, has faltered in his efforts to reduce the bank's exposure to risky businesses. In 1998's third quarter, BT lost $488 million, dragged down by bets in Russia and other emerging markets. And its leverage ratio, a gauge of capital adequacy, slipped for a time below the Federal Reserve's 3% minimum. BT scaled back, especially in emerging markets. "They were basically in a liquidation mode," says Charles W. Peabody, an analyst at Mitchell Securities in New York.
While the Germans are coming to the rescue, raising cash to finance the deal could cost Deutsche a bundle. Sure, the Frankfurt-based bank is cash-rich, with some $27 billion in investments in such companies as carmaker DaimlerChrysler and insurers Allianz and Munich Re--many of them booked years ago at a tiny fraction of today's value. Indeed, Deutsche's shares shot up after news of the deal leaked out, partly because investors are happy the bank is finally spending some of its cash hoard. But that could be a mixed blessing. Deutsche will probably have to pay Germany's punishing capital-gains tax of 50%-plus on any assets its sells.
CULTURE CLASH. The bigger worry: how much BT will actually be able to help Deutsche's flagging investment bank. Strategically, BT is strongest in derivatives and high-yield bonds. It bolstered its equity businesses by buying Alex. Brown & Sons last year and the London-based investment banking unit of National Westminster Bank PLC this year. But BT ranked only 22nd this year among U.S. debt and equity underwriters, according to Securities Data Corp. (table). And BT adds little in mergers and acquisitions, where Deutsche is weakest. Combined, Deutsche and BT would only rank 10th this year in M&A, with 6.6% of deals done, Securities Data says.
BT also may not add much in management firepower. After the merger, analysts expect the investment banking unit to be run jointly by Newman and Josef Ackermann, the Deutsche Bank board member mainly responsible for investment banking. But Newman doesn't have much of an investment-banking track record. And Ackermann, a Swiss, is a rare outsider at Deutsche, having joined the bank in 1996, after being passed over for the top job at Credit Suisse.
Cultural issues may impede the deal. "Merging commercial bankers' style with entrepreneurial, driven investment bankers is hard enough," says Louis Perlmutter, executive managing director of Lazard Freres & Co. "The difference between German and U.S. banking culture makes it that much harder." And Deutsche's record is hardly inspiring. Says one former Deutsche investment banker: "Deutsche Bank doesn't have a very good track record at bringing in outside executives and keeping them."
In recent years, Deutsche has spent heavily to hire high-profile investment bankers from U.S. rivals, such as tech specialist Frank Quattrone and Carter McClelland, both of Morgan Stanley & Co. But after a $1.5 billion restructuring--led by Ackermann and designed to foster cooperation between investment and corporate bankers--was announced this year, most of the highfliers defected.
The result, says one former executive, was that to create an investment bank, Deutsche had to buy one. "They can't build," he says, "because no one will go to work for them." The BT deal may help shore up the ranks, notably in U.S. high tech, where Alex. Brown is strong. But key Alex. Brown bankers have quit, too. And, figures Salomon Smith Barney analyst Matthew Czepliewicz, even without more defections, Deutsche may need to pour in $1 billion more to build a first-class investment banking team.
Despite these risks, Deutsche could be getting a bargain if BT rebounds. After all, the bank earned $866 million in 1997, and its 16.1% return on equity was about equal to Deutsche Bank CEO Rolf E. Breuer's profit goal for his bank. Deutsche board member Jurgen Krumnow told Reuters that the bank expects "enormous synergy effects" from the merger. Analysts translate that into layoffs of around 2,000, about 2% of the combined workforce, and cost savings of some $600 million from eliminating overlapping operations.
Investors liked the concept of the deal. After news of the deal leaked out, shares of Lehman Brothers, J.P. Morgan, and other rumored Deutsche targets in the U.S. soared. Crosstown rival Dresdner Bank added fuel to the fire by saying it, too, might go for a big merger.
No doubt Breuer and Newman may have created the world's largest financial institution. But they may have trouble living with each other.