The list of this year’s newly weds is as long as ever and contains some of banking’s premier names.
Driven by fears of being left behind in the latest consolidation phase, chief executive officers have put all their energies into doing deals both within and across sectors and borders.
But with the ink barely dry on these nuptial contracts, industry analysts are already taking a view on their chances of success. Merging is a high-risk strategy and many of the predicted benefits fail to come through.
With this in mind, The Banker set out to discover which of the recent mergers will lead to a happy marriage and which will end in acrimony and possibly divorce (although most banking marriages struggle on even when things are going badly wrong).
To do this we put together a panel of 13 experts to deliver their judgment. We asked them a total of more than 1000 questions to analyse the strengths and weaknesses of this year’s headline deals. They were asked to give marks out of five for both the likely benefits (a list of five items) and potential pitfalls (six items).
By working out a bank’s average positive and negative scores across the categories and summing the results we arrived at a table of mergers with the highest-rated at the top and lowest-rated at the bottom. The results are sobering if not surprising.
While analysts had the pick of high-profile investment banking deals such as Chase/JP Morgan and Credit Suisse First Boston (CSFB)/Donaldson Lufkin & Jenrette (DLJ), and cross-border tie-ups such as HSBC/Crédit Commercial de France (CCF) and HypoVereinsbank/Bank Austria, they put a UK domestic retail merger at the top of the table.
Although less exciting than some of this year’s more daring schemes, our experts rated Barclays’ £5.4bn ($7.7bn) friendly takeover of former UK building society Woolwich as the most likely to succeed.
The takeover boosts Barclays’ weak performance in the mortgage market while saving Woolwich from an uncertain fate as a mid-sized player in a rapidly consolidating mortgage market.
Barclays chief executive Matt Barrett’s strategy was largely welcomed by panellists as a positive step away from the group’s ill-fated global ambitions, despite the intense competition in the UK home-loan market. Barclays’ future ambitions, like NatWest’s after its takeover by Royal Bank of Scotland (RBS), are now more likely to revolve around the High Street rather than Wall Street.
Most panellists have high expectations that Barclays can replicate the success of the Lloyds TSB merger some years back. Lloyds’ record in returning value for shareholders far outstrips that of many banks with an international profile.
But though the Barclays/Woolwich merger consistently scored well, both for its expected rewards and for its lack of serious impediments, it was not the merger tipped to create the most value for shareholders.
Top of the shareholder value-creation list – and by a decent margin – comes the RBS/NatWest deal that ended in March after a long tussle with Bank of Scotland. Although it ranked fourth overall, this deal ranks above all others if only positive aspects are taken into account.
As well as creating the greatest expected increase in shareholder value, the RBS/NatWest tie-up comes top of the list for expected economies of scale and top of the list for projected cost savings. After HSBC’s takeover of CCF at the start of April, the RBS deal is also the least likely to suffer from power struggles and conflicts at the top.
Almost all panellists praised RBS for its clear leadership. Philip Middleton, European financial strategy partner at KPMG, says: “It was a hostile bid, but once it was accepted everything was very cleanly executed. RBS knew who and what they wanted and went straight in and rounded up heads.
It was a case of ‘you’re in, you’re out’, with no chance for lingering guerrilla warfare.” Despite the panellists’ obvious admiration for RBS’ decisive move on NatWest, they marked it down for the problems the deal creates.
If the takeover of NatWest had not ranked as the merger most beset by IT problems and the second most likely merger to create a group too large to manage, RBS might have come out tops. Instead, the Barclays takeover of Woolwich wins not for its own projected benefits but rather because panellists saw more risks in other deals.
Angus Hislop, financial services partner at PricewaterhouseCoopers, summed up the common view: “RBS’s takeover of NatWest involves bigger risks and bigger gains than Barclays’ solid bet on Woolwich.” After Barclays/Woolwich, come two deals signed by acquisitive Scandinavian finance house Nordic Baltic Holding (NBH), taking up second and third places in our ranking.
First the announcement of a e4.8bn friendly takeover of Denmark’s second largest banking group, Unidanmark, by NBH subsidiary MeritaNordbanken created the largest Nordic banking group.
Then in October, NBH’s NKr24.3bn ($2.9bn) bid topped the auction for the Norwegian government’s 35% stake in the country’s second-largest bank, Christiania, cementing NBH’s regional dominance. NBH quickly announced that it would buy the remaining shares in Christiania. Panellists liked the strong logic to both NBH deals that create the largest banking footprint in Scandinavia.
They had nothing but admiration for NBH chief executive Hans Dalborg’s acquisitive run against the background of regional banking consolidation. In fourth place comes RBS’ raid on NatWest.
It was not at the top of everyone’s list of mergers likely to succeed, but RBS’s victorious bid in the long-running battle for NatWest was one of the most exciting deals of the year. So far, RBS’ execution of the post-merger logistics has been decisive.
When asked whether the merger suffered from power struggles, most experts laughed: “Who is left to fight? RBS fired everyone.” In the end, RBS kept only two from NatWest’s executive team.
After the top five clear winners come less stunning deals: the $21bn cost-cutting merger of large US Midwest banks Firstar and US Bancorp; Denmark’s Danske Bank’s DKr26.1bn ($3.1bn) purchase of mortgage lending and banking rival RealDanmark; HSBC’s continental expansion through the purchase of CCF; Chase Manhattan’s $7.75bn purchase of Robert Fleming; and Citibank investment banking arm Salomon Smith Barney’s £1.35bn January purchase of Schroder’s investment banking business.
Highlights of these mergers include projected cost savings at Firstar/US Bancorp and Danske Bank/RealDanmark, and cross-selling opportunities at Salomon/Schroder.
The Firstar/USBancorp deal was remarkable in that it brought together two brothers, one from each side of the merger (see page 62): Jerry Grundhofer is chief executive of Firstar, while US Bancorp’s chief executive is his elder brother, John “Jack” Grundhofer.
The combined bank will be the eighth largest in the US. Financial institutions consultant Bert Ely, of Washington-based Ely & Company, particularly liked this deal: “There is an inevitability to it in terms of bank consolidation that makes it perhaps the most natural deal this year.”
Further down the list, HSBC’s £6.8bn takeover of CCF soon after the group’s £6.2bn acquisition of Edmond Safra’s private banking empire in late 1999 may have been a solid transaction by an experienced cross-border acquirer that gave it a toehold in continental Europe, but it failed to ignite the panel’s imagination.
Professor Roy Smith of New York University’s Leonard N. Stern School of Business says: “No foreign company has yet managed to turn around a former state-owned French company, but if they did it, then it would be seen as a bold move.”
Further down the list, the jury is also still out on Chase Manhattan’s $30bn acquisition of JP Morgan. Although a couple of panellists liked the deal, most saw more problems than solutions.
While Chase scores high marks for increasing its market share, the deal falls down on fears over IT strategy, cultural problems and loss of staff. Says one of the bank analysts on the panel: “Experts felt that both Chase and Credit Suisse have been trying to move in on the bulge bracket, but that neither of these deals will give them the muscle they need.”
Worryingly for Chase is the fact that its merger with JP Morgan ranks top of the list of deals likely to be dogged by power struggles and top of the list of mergers that create organisations that are too large to manage. One panellist said the deal has the greatest potential to unravel: “Here you have two large institutions with little natural logic for merging.”
In its defence must come Chase’s strong track record. Mergers with Manufacturers Hanover, Chemical and more recently acquisitions of US west coast technology investment bank Hambrecht & Quist and US M&A boutique Beacon Group have given Chase an unrivalled experience of successfully infusing new blood. In five of the deals rated by the panellists, the problems were more highly rated than the benefits.
On this basis, it might be argued that HypoVereinsbank’s takeover of Bank Austria, UBS’s $11.8bn purchase of PaineWebber, Chase’s tie up with JP Morgan, CSFB’s acquisition of Wall Street investment bank DLJ, and Dresdner’s takeover of Wasserstein Perella should never have seen the light of day.
Although the cross-border acquisition of Bank Austria appears to have ended up in negative territory, most panellists agreed that it was a brave deal. However, while experts understood the economic grounds for this deal, most worried about the political, cultural and hidden stumbling blocks that may cross HypoVereinsbank’s road to success.
Panellists also queried UBS’ $12bn expense on US brokerage PaineWebber. Some believe UBS, which is still struggling in the wake of its merger with Swiss Banking Corporation, might have better concentrated its efforts internally.
“UBS has long been under pressure to do something,” says NYU’s Professor Smith, who is not convinced by the deal. CSFB’s purchase of US investment banking boutique DLJ from French insurance group Axa was also slated by the panel and ended up as the second-lowest ranking deal. Like Chase, Credit Suisse has had its sights on the bulge bracket ever since it merged with First Boston and more recently with Barclays de Zoete Wedd to give it international investment banking reach.
But this latest deal has proved accident prone since it was announced at the end of August. Despite a $1.2bn bonus pool set aside to keep DLJ staff, in early October CSFB lost an entire 18-strong DLJ team of investment bankers to Lehman Brothers in the same week it lost DLJ’s head of European investment banking.
In London it has lost more than 10 DLJ corporate finance and sales people, and in the US, the co-head of investment banking joined UBS.
The deal had nothing but critics. Among them, professor Smith commented: “This deal does little for Credit Suisse shareholders. I’d say this was a deal for a deal’s sake. Plus the fact that Zurich may be surprised by how much trouble DLJ can make.
Then again, they may have learned a thing or two from [taking over] First Boston. They also have Allen Wheat.” This year’s wooden spoon goes to Dresdner Bank for its $1.37bn purchase of Wall Street investment banking boutique Wasserstein Perella, which left most panellists wondering what in the world Dresdner was doing.
The answer is merging it with its existing in-house investment bank Kleinwort Benson, to become Dresdner Kleinwort Wasserstein.
After the failure of Dresdner to merge first with Germany’s largest bank, Deutsche Bank, and then with Germany’s fourth-largest bank, Commerzbank, the deal had an air of desperation to it.
Almost all panellists questioned the high price paid for a private partnership with no published financial data. In the end the panellists did not see eye-to-eye on every deal, but did agree that consolidation is far from over.
Says Merrill Lynch’s Martin Green: “We are witnessing in slow motion a one-off event: the consolidation of the global banking industry. No one contests that there are too many banks under too much pressure or that there will be more mergers in the next 12 months.”
At a time when merger mania has spread from the US to Europe, a growing body of academic research is questioning whether recent mergers have delivered on their promises. A new picture is beginning to emerge in which cost savings can be outweighed by the unquantifiable costs of merging.
Our poll clearly confirms that there is a growing suspicion that mergers seldom deliver cost savings through better management or economies of scale.
Experts ranked the benefit of cost savings last in seven out of the 14 deals included in the survey, behind cross-selling opportunities, increased market share, improvements in shareholder value and economies of scale.
Mr Ely is cynical about many of the benefits of merging, and says that “promised cost savings rarely materialise”. In theory, many of the supposed benefits of merging are closely linked. Economies of scale and better management should lead to cost savings, which in turn lead to increased shareholder value.
But in practice, panellists let their fears be known that many deals actually destroy rather than create shareholder value – at least in the short term. “In most deals, the financial upside is in better management, not economies of scale,” says Professor Smith. Mounting academic research into the mergers of the past decade suggests that the majority have been disappointing.
Professor Ingo Walter of New York University’s Leonard N. Stern School of Business says: “There have been about 55 studies into this and there is no evidence of economies of scale in large mergers.”
According to Steven Davis of Davis International Banking Consultants, extensive analytical studies of key data, such as returns on equity, cost to income ratios and stock market performance both pre- and post-merger, provoke “essentially negative conclusions”.
His recent book Bank Mergers: Lessons for the Future concludes that the vast body of academic research demonstrates that mergers either add no value or actually reduce shareholder value.
He suggests that organisational problems are systematically underestimated, that acquirers tend to overpay for targets and that the much-vaunted cost and efficiency gains seldom materialise. The real winners are the IT consultants drafted in to pick up the pieces of struggling bank mergers.
In the rush to wed, many banks confine due diligence to financial matters, putting IT problems aside until after a deal has been struck. In The Banker’s research, IT problems ranked top of the list of problems that can confound even the most straightforward merger – above culture clashes, power struggles, loss of control and loss of customers.
Mr Hislop says: “There are always IT problems in big banking mergers, largely because of unrealistic deadlines, cost targets and a lack of management understanding. The devil is in the detail.” Merrill Lynch banking analyst Martin Green agrees, saying: “Most mergers fall down on IT.
Few boards have got the message that integrating IT systems is critical.” Without successful IT integration, many of the reasons for doing a deal in the first place vaporise into thin air.
