The Return Of The Deal

After years of cost-cutting and market turmoil, M&A is coming back in Europe

As CEO of Citigroup's (C ) Global Corporate & Investment Bank, responsible for Europe, the Middle East, and Africa, Michael Klein has every reason to be confident. Seven of the 10 biggest deals Citi has done around the world so far this year -- including the $2 billion acquisition of British tavern chain Pubmaster by Punch Taverns PLC -- have come from Europe. And the operation he manages from the bank's European headquarters at London's Canary Wharf is generating record revenues. "We're generally pretty positive," he says, when asked about the opportunities going forward. "We're operating at a higher level than ever before in the region."

Many of Klein's investment-banking rivals are also brimming with optimism. After three years of cost-cutting and market turmoil, a time that saw total investment banking revenue in Europe plunge from $62 billion in 2000 to $49 billion last year, dealmaking is staging a comeback. Recent noteworthy transactions include the sale of a $2.5 billion chunk of shares in electricity company Enel (EN ) by the government of Italy, the $5 billion divestment by German financial-services giant Allianz of most of its stake in cosmetics maker Beiersdorf, BP's (BP ) $8 billion merger with Russian energy concern TNK, and a $2.5 billion rights issue by ABB Group (ABB ), the troubled Swiss-Swedish engineering group. "I am encouraged because our traditional businesses such as M&A and equity financing are showing signs of life," says Peter A. Weinberg, CEO of Goldman Sachs International (GS ) in London, which ranks first in European M&A deals so far this year, with $142.5 billion.

Signs abound that the fat days for the investment-banking community are back. Many European companies, among them telecom operators and insurers, recently have buttressed their balance sheets by cutting debt or raising fresh capital, and they're poised to start making strategic acquisitions again. Meanwhile, the steady rise in equity prices this year means that laggard companies are better able to restructure by selling off noncore assets at reasonable prices. "There has been a 15% to 20% pickup since business bottomed out in June," says Karl Dannenbaum, CEO of Lehman Brothers Inc. (LEH ) in Germany. "There's a feeling that the good times are coming back."


The spurt of deals in Germany is particularly significant: The country has long been considered Europe's sleepiest investment-banking market. And the size of Germany's M&A market is still less than half that of Britain's. Blame Corporate Germany's foot-dragging on mergers, asset sales, and workouts. Analysts, however, say Germany is expected to generate more deals in the coming months as it comes to terms with its need to restructure. "The value of M&A [in Germany] is on the low side if you think what could be done if people got going," says Andrew Pisker, CEO of London-based Dresdner Kleinwort Wasserstein. "But once some big deals get done you could get a snowball effect."

Despite the new activity, deal volumes are still far below their 2000 peak. But even a limited revival in M&A and equity underwriting could propel the European profits of some investment banks to record levels. That's because most banks have cut staff and costs over the past three years, so rising revenues fall right to the bottom line. What's more, investment banks have made up for some of the earnings lost on the M&A and equity fronts in the bond markets, which have boomed as a result of record low interest rates. Banks have also pulled in profits in side businesses such as credit derivatives and settling trades for hedge funds. "European investment banks don't need a raging bull market to prosper," says Weinberg.

The results for the first half of 2003 are proof of that. Most banks reported decent earnings, though the equity and M&A markets were still in a funk. Additional revenue from M&A and equity will be icing on the cake. On Nov. 11, for example, UBS (UBS ) reported a 35% surge in its third-quarter investment-banking net profits. Citigroup and Goldman Sachs Group Inc. also reported healthy gains in Europe.

What could mar this pretty picture? A lingering surplus in the number of banks chasing deals. Although an estimated 12% to 15% of capacity has been taken out of the European investment-banking business since 2000 -- mainly through job cuts -- little real consolidation has taken place. No firms have been driven out of the business, and none of the mergers once thought likely has come about.


Some industry experts had expected less prominent players such as ABN Amro Bank and Dresdner Kleinwort Wasserstein to beat a retreat. DrKW did cut its headcount by around 2,000, or almost 25%. But it's now selectively hiring again in what the bank calls "very targeted areas" such as equities and corporate finance. Many observers also speculated that Merrill Lynch (MER ), Deutsche Bank (DB ), Credit Suisse Group (CSR ), or Bank of America (BAC ) might merge their investment-banking operations, which would have reduced capacity and competition. But that didn't happen, as an upsurge in the bond business helped banks ride out the doldrums. "I wouldn't be surprised to see more mergers," says DrKW's Pisker.

But for now, the European market is getting even more competitive. Bank of America Corp. plans to export its U.S. strategy to Europe, using sales of fixed-income products as a base from which to move deeper into equity and advisory businesses. One sign that its efforts are bearing fruit in the Old World: Telecom Italia (TI ) chose Banc of America Securities as joint bookrunner for its recent $4 billion global bond issue. "We expect to continue building up investment banking in Europe over the next two to three years, as we did in the U.S.," says William Fall, president of Bank of America's international operations.

For their clients, the intense competition among investment banks has a big upside: lower fees. Three years ago, banks could charge 3.5% of the total value of the privatization of a state-controlled company or the sale of a tranche of government shares. Now they're lucky to get 1.5% and, in some cases, are said by competitors to waive the fees altogether to get their hands on the business. Yes, business is back for the bankers. But they still have to fight for it.

By David Fairlamb in Frankfurt and Stanley Reed in London

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