Investment Banking: Gray Days for Deals in Europe

For Europe's financiers, debt is where the action is

A year ago, Europe's young investment bankers rarely worried about the future. Britain and the Continent were deal heaven. New businesses were emerging, and old ones remade themselves. Bank loans were out; equity financing was in. U.S. and European banks collectively spent billions in recent years beefing up their European staffs.

Now, those bankers are getting a stiff dose of reality as the U.S. downturn hits Europe with unexpected force. "A lot of people haven't been through this sort of thing before," says Wayne L. Moore, co-head of investment banking for Goldman, Sachs & Co. in Germany. "They've seen investment banking growing rapidly since 1991, and they think it is nothing but a growth business."

With Europe's stock markets down even more than their U.S. counterparts, last year's torrent of deals has dried up. The value of European mergers and acquisitions is down 45% through Mar. 23, to $215 billion, compared to the same period in 2000. Equity offerings, another key source of fees for investment banks, are down more than 50%, to $13.7 billion. The number of deals has fallen by nearly two-thirds. "The equity markets are virtually shut for new issuance," says Klaus Diederichs, head of European investment banking at J.P. Morgan in London. He doubts investors will warm to stocks before next fall.

Don't mourn yet, however, for the lost generation of investment bankers. The fire may be out for the M&A and IPO teams that stoked the New Economy via telecom, media, and technology-equity offerings that accounted for one-third of the $1 trillion value of takeovers of European companies. But the action has shifted to two areas that investors and analysts sneered at last year--Old Economy takeovers and debt. "A year ago, the Old Economy had diminished self-esteem. Now its confidence is being restored," says John Studzin-ski, deputy chairman of Morgan Stanley International in London.

The only deals worth $10 billion or more announced in Europe this year involve Old Economy businesses. BHP Ltd. of Australia is offering $12.2 billion for Billiton PLC, Britain's mining monster. British insurer Prudential PLC has agreed to pay $24.5 billion for U.S.-based American General Corp. Nestle is paying $11.8 billion for Ralston Purina Co., the American pet-food purveyor.

MARVEL. At the same time, weak stock prices and falling interest rates make debt the logical way to fund new purchases and pay for last year's excesses. Witness France Telecom's extraordinary placement of a $16.4 billion bond issue after the initial public offering of Orange, its wireless unit, yielded far less than expected. Bonds are "where the action is," even for hedge funds that wouldn't touch them last year, marvels Bill Winters, global co-head of credit markets at J.P. Morgan in London.

True, a boost in fixed-income activity and some Old Economy deals probably aren't enough to offset the vaporized New Economy business. But they'll help, which is one reason the banks haven't warned of mass firings. Charles Miller Smith, chairman of Britain's Imperial Chemical Industries PLC and one of Europe's most prolific dealmakers, thinks that plummeting interest rates could usher in a new wave of restructuring, especially in Old Economy companies, such as pharmaceuticals, food, and utilities. "If [the corporate] cost of capital gets down to 4%, I would be surprised if a whole series of industries doesn't use debt to consolidate," he says. "The more mature a business is, the more important scale is."

The same market turbulence that is killing the banks' equity-issues business is helping their bottom lines elsewhere. Investment banks thrive on volatility because, for many, their most profitable--and biggest--business is stock, bond, currency, oil, and derivatives trading. In fact, one investment banker says that, relative to its trading operations, his bank's M&A unit is "a hot-dog stand outside the casino." Goldman, the only top investment bank to report results so far this year, got about 75% of its $1.8 billion in European revenues from trading in its fiscal first quarter, which ended on Feb. 23. Globally, fixed income and currency trading revenues were up 133% from the last quarter of 2000, and 11% year-on-year. Even equity trading (not IPOs) was up 37% year-on-year, while investment banking revenues were down 7% to $1.1 billion. Trading will grow in importance over the year. That's because most banks will have stopped collecting fees from last year's bonanza of deals.

There are signs that market shifts are affecting the competitive balance between banks. London-based UBS Warburg, which has solid ties to old-line companies, leads the European M&A league tables, according to Thomson Financial, with $66.8 billion in deals. Morgan Stanley Dean Witter, a perennial European and global leader, is a close second, with $65 billion. But Goldman, which was the European leader last year thanks to such tech megadeals as Vodafone Group PLC's $203 billion takeover of Germany's Mannesmann, is now 10th, with just $18 billion in deals.

Of course, mergers don't come in smooth streams, and no one thinks that Goldman will be down for long. But Goldman's top executives are worried about losing so many deals, and they're prepared, says one, to shift staff from tech, telecom, and media to keep Old Economy clients covered.

Certainly, European investment banking, already a battleground between U.S. and European all-stars, will turn more cutthroat if activity stays low. Some bankers believe Morgan Stanley and Goldman will reap the spoils. "There will be a flight to quality," says a senior executive at an American bank. "Last year, anyone who showed up with a team would get work."

The picture will likely be more nuanced. A turn toward debt should favor Citigroup and J.P. Morgan Chase, both strong debt-market players, over Goldman and Morgan Stanley. At least, they hope so. "It is nice that the market has turned to the one area--fixed income--that has always been an asset at Salomon and Citi," says Win Bischoff, chairman of Citigroup Europe. Deutsche Bank, another bond champ with a weak corporate-advisory arm, may do well, too.

Oddly, the banks claim no plans for wholesale cuts in the squads they hired in better days. After all, talent is ammunition in the fight for market share. Still, the banks admit they're culling underperformers more zealously. That could mean cuts of up to 10%, says a top London banker. If the New Economy doldrums linger, more will surely walk the plank.

By Stanley Reed with Heidi Dawley in London and David Fairlamb in Frankfurt

    Before it's here, it's on the Bloomberg Terminal.