Damage Control At Deutsche

The failed Dresdner deal leaves German banking in turmoil

It was the deal to transform German finance. But Deutsche Bank's planned $30 billion merger with arch-rival Dresdner Bank died in a hail of mutual recrimination on Apr. 5. Instead of entering an era of much-needed consolidation, Germany's banking system is in total confusion. Dresdner is in play--and industry executives throughout Europe are mulling their own acquisition plans.

The deal, unveiled on Mar. 9, dissolved after four weeks of acrimonious wrangling over Dresdner's investment banking subsidiary, Dresdner Kleinwort Benson (DKB). Dresdner's board reneged, saying it no longer trusted Deutsche. Deutsche's chief executive, Rolf-E. Breuer, in turn accused Dresdner of spoiling the merger by refusing to contemplate the sale of DKB. Either way, it's a huge setback for both banks. And it's doubtful whether either Breuer or Bernhard Walter, the chief executive of Dresdner, will keep their jobs.

If the Deutsche-Dresdner deal had gone ahead, it would have created Europe's largest bank, a $1.2 trillion powerhouse with global investment banking ambitions. Instead, both banks, as well as Allianz, the giant Munich insurer that brokered the deal, are walking wounded--their strategies in tatters and their credibility weakened.

Deutsche, for sure, is reeling. Breuer had hoped to free the bank from its costly retail banking network and focus its huge resources on investment and wholesale banking. He had already shelled out $9 billion for Bankers Trust last June, but needed a bigger balance sheet and a stronger domestic base to fight the likes of Goldman Sachs & Co. and other U.S. houses that have made serious inroads into Europe. Dresdner would have given him both.

Breuer now may have little alternative but to mount a hostile bid for Dresdner. If he does so, he'll need Allianz's help because the insurer owns 21.7% of Dresdner as well as 5% of Deutsche. Allianz could well be tempted. In the merger, it would have walked away with the lion's share of the two banks' combined retail operations as well as Deutsche's mutual fund subsidiary, DWS. That would have given Allianz a nationwide distribution network for its savings products, a main strategic goal.

Breuer needs to move fast. If he doesn't, a foreign bank, such as Citigroup or BNP-Paribas, could swoop in with a rival bid. Or a German bank such as Hypovereinsbank, which earlier discussed a possible merger with Dresdner, could jump in.

BRINK OF SUCCESS. Certainly Breuer has some nerve-racking days ahead. He is now at loggerheads with several key Deutsche staff, particularly Josef Ackermann, head of the investment banking division. Ackermann was irritated that Breuer didn't consult the board enough during negotiations. He was doubly annoyed when Breuer dithered over DKB--apparently favoring its integration into Deutsche's own investment banking operation. Ackermann and several top Deutsche executives wanted to sell DKB or keep only its successful corporate finance division and fire about 7,000 employees.

Ironically, Breuer was on the brink of a major success. Deutsche was getting ready to announce that first-quarter profits had risen more than 50%. If he hadn't attempted the deal, Breuer would have been hailed for revitalizing the bank.

Even so, his problems pale alongside those of Dresdner's Walter. DKB has been hemorrhaging talent since the merger was announced. Its highly rated, seven-member utilities team walked on Apr 4. So did T.J. Lim, co-head of global markets. Morale throughout Dresdner is at rock bottom. Walter had already spent millions on McKinsey consultants before deciding that Dresdner could not go it alone. Now it is alone, and vulnerable to takeover. Besides, Walter has alienated Allianz by calling off the deal.

Allianz, whose shares plunged 14% as soon as the deal fell through, will have to rethink its strategy, too. It still, for example, needs somehow to unravel its cross-shareholdings with Dresdner and Deutsche, which, respectively, own 10% and 7% of Allianz shares. "There's no denying it's a big setback," says a senior executive. "We thought this deal would give us the entree to the mutual fund market we were seeking. Now it's back to the drawing board."

That goes for top financial executives around Germany and Europe. Even though the Deutsche-Dresdner deal sank, Europe still desperately needs a huge wave of consolidation--and Germany is where it must begin.