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The creation of a German colossus will reshape European and global finance

After months of wheeling and dealing, Deutsche Bank's driven chief executive, Rolf-Ernst Breuer, is delivering a blockbuster of a deal. His plan to merge Deutsche, Germany's biggest bank, with its third-biggest, Dresdner Bank, would create a behemoth with $1.25 trillion in assets. The new Deutsche would be the largest bank in Europe, the second-biggest in the world, and twice the size of the U.S.'s Citigroup (table). The deal is designed to put Deutsche firmly in the select global league of superbanks.

It's a bold stroke that few had anticipated before news of the planned $30 billion deal leaked on Mar. 6. By any measure, the new Deutsche would have massive clout--and a lock on the huge and growing $840 billion-a-year business of issuing bonds denominated in Europe's euro currency. Deutsche was already No. 1 and Dresdner No. 2 in the market. It would have a strong position in trading European equities and derivatives. Combined assets under management would be nearly $1 trillion. Nearly one major German company in three would have Deutsche as its principal banker.

Europe is just the beginning. The deal, to which finishing touches were being put on Mar. 8, serves notice on the huge Wall Street houses, such as Morgan Stanley Dean Witter and Goldman, Sachs & Co., that Breuer intends to give them a run for their money in global investment-banking, a business they have long dominated. "This deal gives us the skills and the resources we need to take on even the biggest U.S. firms," brags a senior Deutsche Bank executive. "We've been wanting to do something like this for years."

ALSO-RAN. Breuer has made no secret of his ambition to transform Deutsche into a global investment bank. So far he has had at best partial success. Like most German banks, Deutsche is a universal bank with both investment and commercial banking operations. So Breuer needs to bulk up investment banking and then spin off retail banking to achieve his goal. Shelling out $9 billion last June to buy Bankers Trust Corp. was one step in that strategy. But it failed to catapult Deutsche into the top echelons of global investment banking. "Deutsche made a hash of what was a wonderful business at Bankers Trust," says one senior New York investment banker.

So why is Breuer now gambling that buying another German bank will do the trick? Dresdner does own London investment bank Dresdner Kleinwort Benson, which has a nice line in lucrative high-tech initial public offerings. Even so, it is way behind major IPO players such as Morgan Stanley and Merrill Lynch & Co. And while the new Deutsche will be the world's fifth-largest investment bank in revenues, that's mainly because of its low-margin bond underwriting. The combined outfit is an also-ran in mergers-and-acquisitions. "We don't see them on leveraged buyouts or telco deals," either, adds an investment banker in London.

WEAK EARNINGS. Even with the dowry of DKB, Dresdner seems a strange vehicle to carry Breuer's huge ambitions. Dresdner CEO Bernhard Walter has struggled to revitalize the bank, which was demoralized by a series of tax scandals in 1997 and 1998. And he has failed to please shareholders. Despite spending lavishly on McKinsey & Co. consultants, Dresdner has weak earnings and is losing money on its retail operations.

All the same, Breuer reasons that the deal will bring the financial clout and strategic focus he needs to challenge the American giants. Until now, Deutsche has been hamstrung by retail banking, which makes little money. The underperformance has preoccupied top management for years, blunting the bank's push into investment banking--and allowing marauders like Goldman and Morgan Stanley to sweep into Germany and scoop up hugely profitable deals, such as privatizing Deutsche Telekom.

Strange though it may seem, Breuer might be able to slip the yoke of retail banking with the deal. He was planning to knock together Deutsche's brick-and-mortar retail network with its Bank24 online bank and brokerage anyway. Now, he'll add Dresdner's retail operations to the mix, then spin off the enlarged Bank24, which can then be floated on the market and used as currency for future deals. "It's a great move for Breuer because it frees him from the constraints of domestic retail banking," says Ralf Dibbern, a banking analyst at Hamburg private bank M.M. Warburg.

It's a great deal for giant Munich insurer Allianz, too. Chief executive Henning Schulte-Noelle will get 40% of Bank24 in part payment for Allianz's 21.7% stake in Dresdner. And he'll get to swap a 5% stake in Deutsche for the bank's large mutual-fund subsidiary, DWS, as part of the deal. A key goal for Allianz is to build up its asset management business. "The real winner is probably Allianz more than either of the banks," says Matthew Czepliewicz, bank analyst at Salomon Smith Barney in London.

Whether or not Breuer's impending deal delivers the global payoff he wants, it guarantees a major shakeup in Europe's financial-services industry. Analysts say it is only a matter of time before Commerzbank, Germany's No. 4, is the target of a bid--probably a hostile one, given chief executive Martin Kohlhaussen's longstanding opposition to being taken over. With assets of $380 billion and a market capitalization of $19 billion, it is too big to be a niche player and too small to be a competitor for the likes of the new Deutsche. Bayerische Hypovereinsbank (HVB), Germany's second-biggest bank, will be forced to rethink its go-it-alone strategy, too. "Such a big merger has huge competitive implications," says a senior Dutch banking executive. "If they play their cards right they could pose a big threat to banks' corporate business right across Europe."

FIERCE BATTLE. Indeed, Germany's neighbors have been in a frenzy of dealmaking for months. Last summer, France's Banque Nationale de Paris acquired Paribas after a long takeover battle. In October, Spain's Banco Bilbao Vizcaya snapped up Argentaria Bank. In December, Italy's Banca Intesa and Banca Commerciale Italiana merged. Britain's Royal Bank of Scotland bought National Westminster Bank on Mar. 6 after a fierce takeover battle. And on the same day, MeritaNordbanken, the Finno-Swedish financial group, unveiled a deal to buy Danish bank Unidanmark.

The logic of most European financial-sector deals so far has been domestic consolidation. But that process is nearly complete in many markets, such as Spain, Switzerland, and the Netherlands. So Deutsche's maneuver could well unleash a wave of cross-border deals as foreign rivals strive to keep one jump ahead. Analysts say early moves could come from big Dutch banks ING Group and ABN Amro Holding, from Spain's Banco Santander Central Hispano, and possibly from Switzerland's Credit Suisse Group. Last year, Credit Suisse approached Commerzbank, and according to industry scuttlebutt, ABN Amro is interested in it, too.

Until now, German banks have been wallflowers at this frenetic mating dance. That's partly because protected and subsidized public-sector banks still control over half the banking market in Germany. On top of that, Germany's tax system has been a major damper on dealmaking. Punitive capital-gains taxes of as much as 60% are levied on profits when one company sells another. But as of Jan. 1, 2001, disposals will be tax free. "This could be a catalyst," says Johannes Reich, head of equity research at Frankfurt private bank B. Metzler seel. Sohn & Co.

Certainly, abolition of the tax is concentrating corporate minds wonderfully--and is blasting away long-standing logjams to deals. It's one reason why insurer Allianz--long one of Deutsche's fiercest rivals--persuaded Dresdner to merge with Deutsche. Last September, Breuer unsuccessfully tried to negotiate a cost-cutting merger of Deutsche's and Dresdner's retail operations. Rebuffed by Allianz, he unsuccessfully approached Commerzbank with a view to taking it over.

CULTURE SHOCKS? Meanwhile, Allianz tried to bring Dresdner together with HVB, in which the insurer also has a large stake. Initially, the idea went nowhere because HVB board members opposed it. But in January, a frustrated Walter approached Deutsche again. He then discussed the idea with Allianz' Schulte-Noelle, who decided that a deal with Deutsche might make sense after all. Allianz' new chief financial officer, Paul Achleitner, a veteran dealmaker from Goldman's German operation, was on hand to do the financial engineering.

Of course, Breuer's deal could run into antitrust problems. However, regulators seem to understand the need for banks to merge--Europe being so heavily overbanked--and don't often object to these huge deals. The word in Frankfurt and Brussels is that neither the German nor the European Union trustbusters are likely to stand in the way of Deutsche's deal.

The merger faces other big hurdles, however. Combining two financial groups successfully is always a formidable task. Cultural differences often bedevil managers' efforts to knit two institutions together. And it is difficult to lay off staff in Germany. So the players may find it difficult to make the economies they'd like domestically. That means the first wave of job losses will probably be in the City of London through a speedy restructuring of overlapping investment-banking operations.

Breuer is clearly intent on turning Deutsche into Germany's and the Continent's most powerful corporate and institutional bank. Without the distraction of a weak retail bank to worry about, the new Deutsche will be better placed to use its strong corporate relationships to benefit from the restructuring and M&A boom currently resculpting the Continent's business landscape.

That's certainly what Breuer would like to see happen. But despite all its financial clout, the new bank will still be short of expertise in corporate-finance advisory work where the fees are fattest and the Americans have made most inroads. The new Deutsche may be a global titan, but its ambitious boss may again discover that while size matters, it isn't the whole story in building a global investment bank.

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