It has been characterised as the pointy-heads versus the red braces: a contest between the five global accountancy firms that are steadily carving out new and competitive businesses in corporate finance, and the investment bankers, who have traditionally viewed such business as their preserve. It is a bid by pointy-heads, offering independent advice, clever financial structuring and a range of support services, to win market share from bankers that they view as overly focussed on selling financial products. Like all such characterisations, this illuminates only part of the picture.
To begin with, the accountancy firms have been recruiting a lot of investment bankers. That has contributed much to the success of their corporate finance divisions. The old distinction between the dull bean counters who stayed in the background and the colourful, hot-shot investment banker is fast disappearing.
And the corporate finance divisions of the accountancy firms are pitching as aggressively for deals as the bankers. They operate predominately in the private markets, however. The accountancy firms may have large client lists, including many of the world's blue-chip companies, but they do not have the investor distribution networks necessary to place large public equity or debt issues successfully, nor the balance sheets to underwrite them.
Prosperity brings disharmony
In the north, the puzzle, particularly to the advocates of globalisation, is why something that has brought unprecedented prosperity should be so vilified.
It seems as if those who are better off do not know that they are more prosperous and happier, a psychological dysfunction requiring more help from psychiatry than economics. Moreover, they ask, what can possibly be accomplished by taking to the streets? In democracies, if one is unhappy with the way things are, go to the voting booth. Yet, for all the vilifications of the protesters, in a relatively short time, they have been remarkably successful. The protesters got the media to look at what was going on, and it is to the credit of the media that they reported honestly what they saw: there was a darker side to globalisation that its advocates had tried to sweep under the rug.
Popular pressure succeeded in extending debt relief to 20 countries, after years of foot dragging by the IMF. Popular pressure has at least opened up the debate about transparency and disclosure, and it has at least changed the rhetoric, so that the IMF talks more about participation and poverty - though a recent US General Accounting Office report suggests that this may be little more than rhetoric.
At least part of the success is due to a simple fact: there is at least a modicum of validity in some of the charges of the protesters. Yes, the countries that had been most successful - those in east Asia - in their export-led growth strategy had taken advantage of globalisation, but they had done so on their own terms. They had pursued egalitarian policies that had ensured that as GDP grew, poverty was reduced.
Firms sell their firepower
So, playing to their strengths, the accountancy firms promote their advisory role and their ability to draw on a range of tax, legal and due diligence skills to structure and transact deals - mergers and acquisitions, management buyouts, asset disposals, privatisations, capital raisings - in the private markets. On the relatively few occasions that the deals involve a public issue, the firms help their clients to select the investment banker or broker that will most competitively undertake that end of the operation.
"We are a classic intermediary, selling our intellectual firepower. We survive on our native wit and cunning," says John Griffith-Jones, head of corporate finance at KPMG in London.
Bankers pour on scorn
Scornful investment bankers, however, call it a flawed model. Without the ability to trade in the securities markets or act as brokers, the accountancy firms cannot be credible competitors for large and important deals, say investment bankers. The firms will, instead, remain condemned to a diet of small-scale deals, which some bankers candidly admit are more trouble than they are worth to them.
By common consent, KPMG and PricewaterhouseCoopers (PwC) have led the way among the big five accountancy firms in competing successfully for corporate finance deals. Comparison is difficult, however, because there are often significant differences in the way these businesses are structured and what they comprise. In some cases, for example, due diligence is included, while in others, it is not. Ernst & Young has chosen to treat real estate corporate finance separately from the rest of the corporate finance business.
A common factor is that they are all chasing a substantial slice of the so-called mid-market, a stratum that is not precisely defined but may range from deals as low as £10m up to £1bn (although £500m is most commonly viewed as the top end).
While the deals may not be particularly large, they are frequently undertaken for large companies. "We have a lot of very big clients," says Paresh Mashru, the London-based global head within Andersen's corporate finance division. "Our clients are the same as those that the financial institutions unit at a bulge bracket investment bank might have, except we are doing the middle-size deals. If two major banks merge, it is unlikely that we will be the adviser. But, if a major bank wants to sell one of its divisions or acquire a smaller firm in another country, it may well choose us to do the deal," he adds.
Momentum picks up
Corporate finance is not new for the accountancy firms. Most have been doing that kind of business since the 1980s and it gained some momentum in the mid-1990s. Growth has been greatly helped by the parallel expansion of venture capital funds and private equity investors, who play a key role as both buyers and sellers of corporate assets, and with whom the accountancy firms have developed close relationships.
But there was a qualitative change during the later part of the decade in the importance that accountancy firms attached to corporate finance, helped by buoyant markets. The activity acquired a more strategic role. For example, around 1998-1999 KPMG decided to accord corporate finance its current weight in the firm's business mix. "We decided it was a very interesting area - another leg of the business that was emerging - and we could make something of it. What is more, it is a synergistic leg because if you are doing a deal, you need tax and legal expertise. So, it fits the KPMG stable," says Mr Griffith-Jones.
In the case of PwC, the merger in 1998 between Price Waterhouse and Coopers Lybrand helped to create a critical mass for the corporate finance and recovery business, says its London-based global head, Philip Wright. With 6000 professional staff in 30 countries and revenues of $1.5bn (10% of the total, excluding consultancy, in the 1999/2000 financial year), Mr Wright claims PwC's corporate finance and recovery division is the furthest ahead among the big five accountancy firms in establishing itself in the market. Its revenues from the business are estimated to be more than twice the combined total of the next two - KPMG and Andersen.
Playing field changes
As well as the changes inside the accountancy firms, external developments in the later 1990s were altering the playing field. Many of the medium-sized firms in the corporate finance market were disappearing, including investment banks such as Schroders, Robert Fleming, Hill Samuel and Hambros. And many of the bigger banks and bulge bracket investment firms seemed to be vacating the mid-market.
In broad terms, "the investment banks don't make money from their advisory business", says Simon Perry, the regional managing partner for London corporate finance, at Ernst & Young. "They make money by selling products. And they need larger transactions to get an adequate return on their capital. So there is a space emerging as the investment banks move up market, in terms of the deal size they want to transact. This creates an opportunity for the accountancy firms to take a leadership role."
Mr Griffith-Jones says: "The investment banks have left a vacuum into which we have moved. It is a dreadful mistake that they have made. As the market for bigger deals gets tougher, they will come rushing back," he predicts.
The banks' concentration on bigger deals may have allowed the accountancy firms to gain market share in the mid-market but the latter sector remains very competitive. Whereas there are some dominant players chasing the large deals, the middle market is more fragmented with more intermediaries, each with smaller shares.
Small market shares
"It is not a very consolidated market at the moment because there is nobody with a high market share," says Mr Wright. "The big five [accountancy firms] have come from nothing in the UK. Now they are appearing significantly in the league tables, as names have dropped out. This is likely to be repeated in the rest of Europe. Names will continue to drop out," he says.
These trends are reflected in the league tables. Measured by total deal values, the corporate finance divisions of the accountancy firms are still some way down the M&A adviser rankings. But in volume terms they do much better, reflecting the smaller but more numerous deals on which they act as advisers. KPMG, for example, is only 34th by value of its worldwide deals in the first nine months of this year, according to deal monitor Thomson Financial. In volume terms it is fourth, advising on 246 transactions, with an average deal size of just $36m. PwC is placed 10th worldwide by deal volume, with 137 transactions and a somewhat bigger average size of $64m.
Both firms have seen a sharp fall in such business this year, in common with everybody else, because of the cyclical downturn in economic activity. The slowdown has slashed worldwide M&A transactions by almost half in value terms compared with 2000 (on an annualised basis) and by some 25% in volume terms, according to Thomson Financial data. To some extent, however, the accountancy firms have an advantage at such times. While there may not be a big appetite for mergers and takeovers, there is a rapidly rising number of distressed asset disposals, as hard-pressed companies seek financing, and corporate restructurings. The accountancy firms are well placed to capture a good share of this type of deal flow.
The corporate finance divisions of the accountancy firms have made the biggest inroads in to the M&A market in the UK. By value, their UK rankings this year range from Andersen at19th to Ernst & Young in 31st position. But in terms of transaction volume they virtually scoop the pool, taking five of the top six spots. KPMG is top (a position it has held for a few years), followed by Ernst & Young (second), PwC (third), Andersen (fifth) and Deloitte & Touche (sixth). Citigroup is the only non-accountancy firm in the top six places.
In the pitching arena
Despite this success, many of the other players in the middle market still adopt a superior attitude to the accountancy firms in the corporate finance arena, often insisting they represent no serious threat or even that they do not come across them when pitching for deals.
Ishbel Macpherson, head of emerging companies at Dresdner Kleinwort Wasserstein (DKW) in London, says: "Only once in the past two-and-a-half years have we been on the same pitch list as an accountancy firm. Obviously, we are aware that they are trying to move into our world. But, at the moment, we do not see them."
Yet DKW is only two places ahead of KPMG Corporate Finance in this year's league tables for UK transactions under £1bn, even measured by value, and a good way behind in number of deals done.
John Llewellyn-Lloyd, chief executive of Close Brothers Corporate Finance, a small London investment bank that specialises in deals of around the same size range as the accountants, says: "Only KPMG and PwC have been really successful in this market. But there is certainly room for a few more players in the middle market, particularly in Europe, where there are big opportunities."
However, there is some evidence that the accountancy firms are starting to win deals that might once have gone to the investment bankers. The head of a mid-market team at one European investment bank concedes that the accountancy firms are now "very serious competition" in the disposal of company subsidiaries and other assets. "It is hard to compete with them in this area," he says, asking not to be identified. "I have lost a disposal deal to an accountancy firm on more than one occasion, especially if it is a complex transaction. We have found ourselves up against good people at the higher levels, and a wall of people at the lower levels," he says, citing a £200m transaction in the engineering sector.
Deal sizes rise
Average M&A deal sizes involving the accountancy firms are starting to rise, too. In the past four years, PwC has advised on some 26 deals that have been worth more than $500m (seven more than $1bn). The most recent was investment company Seton House Acquisitions' July $620m acquisition of Britax International, the UK automotive dealership company (KPMG was another adviser on the deal). The accountancy firms are also becoming involved in an increasing number of buyside deals, as opposed to disposals, and even hostile takeovers.
Deloitte & Touche claims to have been the first of the accountancy firms to advise on a hostile takeover (Guinness Peat Group's £45m bid for Bluebird Toys) in March 1998, as well as the first to advise on an initial public offering in 1997. "We believe we are the market leader by number [among accountancy firms] in public takeovers. In the first half of the year we were advising on nine," says Robin Binks, head of corporate finance lead advisory (public takeovers) at Deloitte & Touche in London.
The general strategy, say the senior corporate finance partners at the accountancy firms, is to penetrate the areas where the banks are least good or least interested. "At each point, we are chewing away at the soft underbelly of the big bank system," says Mr Griffith-Jones. It is an approach - which a partner at one accountancy firm calls the "Pacman strategy", alluding to the computer game - that has proved highly rewarding. Together, the big five accountancy firms' corporate finance divisions are estimated to be collecting about $3.5bn in annual revenue. In some cases, such activities represent 5% of a firm's worldwide revenue. For the UK, the proportion accounted for by corporate finance is higher, at 10-15%. At Ernst & Young, the figure is said to be 20-25%. And, corporate finance has also proved one of the most profitable of the accountancy firms' activities, at least until the economic slowdown began cutting annual profit growth to around 10% in some cases.
Bankers are poached
Accountancy firms' seriousness in attacking the corporate finance market is evident from the way they are poaching investment bankers. Andersen has recruited an industry team from CSFB and other accountancy firms have poached teams from UBS Warburg, helping to strengthen sector specialisation, which is a key battleground in winning M&A mandates.
Before joining Deloitte & Touche four years ago, Robin Binks had been an investment banker at SG Warburg and head of a public company. David Beever, chairman of KPMG Corporate Finance, had been a Warburg managing director before joining the accountancy firm in the mid-1990s. Of roughly 20 KPMG corporate finance partners in London, 11 came from investment banks. And many of the high-flying auditors that might once have been attracted to the investment banks are moving into corporate finance divisions.
Despite this build-up, investment bankers argue that the model the accountancy firms have adopted has severe limitations. They say the success of many transactions depends on the kind of close involvement with the equity markets that comes from trading stock and talking to fund managers daily. "Unless you do these things, it is difficult to argue credibly, that you are capable of giving best advice on any equity-related issue," says Philip Yates, head of European M&A at Merrill Lynch in London.
Accountancy firms may say they can give the M&A advice and leave a broker to give the market view but Mr Yates says: "We find increasingly that it is necessary to offer the whole package to clients: the banking advisory and the capital markets side. The accountancy firms can't offer this." Moreover, the equity view is needed up front, not after the other decisions have been taken, says Mr Yates.
What the investment bankers see as a virtue, however, the accountancy firms see as a weakness that creates conflicts of interest. "Investment bankers are not very popular with many big public companies," says a corporate finance partner at one accountancy firm. "The investment bankers are not going to give them the best advice. They are going to stuff companies with the most expensive financial product. And if you are running a company that is in financial distress, you should be wary of going to an investment bank. You can not be sure the guys behind very thin Chinese walls are not busy shorting your stock," he says.
"As well as independent advice, we bring transparency to deals by separating the cost of advice from the cost of product," says Francis Small, national head of corporate finance at Ernst & Young in London. In a big transaction, involving large fees, a company will not understand what it has got for those fees, he says.
And, the accountants say, they help to drive down total fees for the client by shopping around between brokers. The accountancy firms' costs are also a good deal lower than those of the investment banks because they do not have expensive dealing rooms and high bonus structures.
More emphasis on smaller deals
Although investment bankers insist that client relationships are paramount, the accountancy firms accuse them of not giving a high priority to smaller deals of, say, less than £200m or deals which do not involve a rights issue, or some other form of financing.
"Some bigger companies complain that when they want to sell an asset, their investment banks either put their C team on to the job or have a minimum fee criteria that soaks up much of the disposal proceeds," says Mr Binks at Deloitte.
Mr Yates at Merrill Lynch, which recently created a mid-market team in the European M&A group, vehemently rejects any suggestion that he deploys a C team for such deals. "Our people are judged not on the size of the deals they work on but by the quality of their contribution. We know small deals can often be more complex than large ones," he says.
Merrill is not the only investment bank to be putting a new emphasis on the mid-market - albeit sometimes defining this market in a higher value bracket than the accountancy firms. So, as these firms move up the ladder, the competition looks as though it will get tougher. In their confident mood, however, the big five accountancy firms believe they have only just begun to penetrate the corporate finance market. "We are still new. It is still a relatively young business for us. There is a huge opportunity. We are nowhere near exploiting our franchise," says Andersen's Mr Mashru.
