One plus one is greater than two. Or so say the advocates of banking consolidation. They believe the sum is greater than the total of individual parts and to prove it, their frenzied M&A activity has bred a proud new banking behemoth: the gigabank.
Indeed, acquisition-hungry commercial banks are blurring the lines between financial institutions. Banks worldwide are continuing to evolve toward one-stop supermarkets, emulating the European model of Allfinanz. Most analysts agree with Goldman Sachs, which predicts the banking industry will be dominated by a handful of giants by the year 2000. That’s soon. Meanwhile there has never been a wider gap between the largest and the tenth-largest banking institution.
All that consolidation may well benefit a large multinational corporation that can now depend on one investment bank with worldwide operations. Equally, the process means research coverage by one top-notch Wall Street or City analyst gets distributed through a global network of institutional salespeople.
As for smaller companies, many say bigger is not better. They’ve seen acquired boutiques shift their investment banking focus to larger-cap stocks. (see Out of the limelight). ‘Typically, the smaller the banking firm the more senior the people at every level, which benefits the clients,’ says Roger Pondel, a partner at Los Angeles-based investor relations agency Pondel Wilkinson Group. ‘The firm’s executives get more stratified as the operations grow, and you find junior executives serving clients. The big firms have to cater to the big companies, so they have executives who aren’t experienced at dealing with the smaller companies.’
While the main priority of commercial banks is serving their core client base, they do not make acquisitions to be passive shareholders. The question is, how much autonomy will they grant their subsidiary investment banks? Some regional investment banks and brokerages that once were saviors of the small caps have no choice now but to take the new, more profitable deals. A good portion of their corporate finance business will now come through their large commercial parents, undoubtedly stealing some of the spotlight from their smaller customers.
Seeking coverage
Small-cap companies are also challenged to drum up sell-side interest in their stock in this new era of big banks. Because smaller clients produce little fee income or trading commissions, they encounter apathy from sell-side analysts who have their sights set higher.
‘The acquired brokerages need to concentrate on the larger-cap companies for obvious reasons: there’s more trading and they make more money,’ admits Pondel. ‘This means the research smaller companies get is not as good.’
Rusty Page, consultant and ex-NationsBank IRO, has experienced this phenomenon. ‘Sell-side analysts that I take some clients to say, Gosh we’re so busy, we’ve got so much going on. I’ve got my plate filled simply with those companies that we are doing business for.’ Translation: no time for the small fry. ‘This consolidation of regional brokerages by banks has not proven healthy so far for smaller growth companies,’ Page adds. ‘They either lose that coverage and sponsorship within the equity market, or they simply can’t get it.’
Many will agree that bigger is indeed better for the banks’ larger corporate clients. The goal of becoming the single trusted advisor for multinational clients has prompted a number of banks to make international acquisitions: Canadian Imperial Bank of Commerce acquired Oppenheimer, while Swiss Bank acquired Dillon Read to form SBC Warburg Dillon Read. Multinational companies are then faced with the choice of working with several regional firms around the world or a single bank with a global presence.
While the single international banking advisor is a good theory, no bank can be equally strong in all regions. Corporations often want to work with experts in each region, and the best bank in the US may well not also be the best in Europe. Despite the banks’ goal to do all things in all places, companies may find that a handful of banking relationships still yields the best global results.
Banks buying their way into the securities business obviously face some danger, not least of which is the melding of two different cultures with different sets of rules. In the case of NationsBank’s acquisition of Montgomery Securities, the culture clash was particularly dramatic. After a fiery bout with NationsBank CEO Hugh McColl, Montgomery chief Thomas Weisel jumped ship with several senior executives to start his own operation, Thomas Weisel Partners. His main complaint, and a common one among acquired firms, was the lack of autonomy.
Sometimes banks may find themselves trying to digest all the individual pieces rather than focusing on their customers. In the short term, management resources are directed more internally than externally. ‘It’s pretty obvious when you look at what’s been happening in the French banking sector recently,’ warns one senior banker. ‘People in some French banks have been spending a lot more time at the water cooler trying to figure out their fate instead of actually doing business.’
Take heart
There is hope, however, for small caps bereft of analyst coverage and corporate finance attention. As traditional competitors train their sights on higher market caps and abandon their core franchise, new opportunity is created for the independent boutiques. Firms like Hambrecht & Quist or Volpe Brown Whelan, for instance, have been eager to pick up the underdog IPOs where Montgomery and Robertson Stephens left off. Although the boutiques enjoy strong profitability ratios in the near-term, the small fish casually swimming among the consolidation sharks will need to establish their specific niche and dominate it. Moreover, they will need to compensate for lack of products by performing extremely well and providing the kind of services that megabanks cannot.
‘I think you’ll have a lot of turnover,’ says Ed Kuhlenkamp, senior VP at Edelman Financial of the consolidation shake-up. ‘Investment bankers jump out on their own because a lot of them would rather be in smaller companies with less bureaucracy. They are no-nonsense people who don’t want to deal with the inner workings of a large company.’
From a wider perspective, consolidation marks just one of many changes reshaping the securities industry. Even the Wall Street titans have had to reinvent themselves to keep in step, with Goldman Sachs going public and Merrill Lynch going online, for example. But perhaps the greatest change is the eroding role of investment bankers. As deal-savvy, cost-conscious clients trim their operations and conduct much of their due diligence internally, the banker’s traditional role of counsel and confidant becomes less consequential.
Michael Seely, president of IR/PR firm Investor Access Corp, explains: ‘I don’t think smart companies look at their investment banker as a confidant so much as an executional arm, and an expensive one. Most CFOs hire bankers to get the deal done, but they’ll decide whether the deal should be done themselves.’
The M&A flurry may seem to have slowed, but while most of the mainstream boutiques have either been snatched up or otherwise remain staunch advocates of independence, the new wave targets niche players in foreign markets.
Anyway, what could be less likely than consolidation momentum slowing?
