ubs warburg 2002 global financial services conference

Davis InternationalBanking Consultants1

presentation by Steven I. Davis toUBS Warburg 2002

Global Financial Services Conference

presentation by Steven I. Davis toUBS Warburg 2002

Global Financial Services Conference

GLOBAL INVESTMENT BANKING: A STRATEGY CONSULTANT’S VIEW

OF THE ISSUES

New York24 April 2002


AGENDA

• research methodology for new book

• selected findings from interview process

• outlook: key trends, winners and losers


A) RESEARCH METHODOLOGY

• goal: to gain perspective on key management issues through off-therecord interviews with key players

• 30 interviews covering all global players, most European second tier, many specialists

• make full use of available data base, consultant and analyst research

• key questions: what are the management issues, what is best practice, and what is the outlook?


B) SELECTED FINDINGS FROM INTERVIEW PROCESS


1) A STRAW POLL:

• who is the most respected/feared competitor?– Goldman Sachs - 19 votes– Citigroup - 13 votes– Morgan Stanley - 10 votes– no other with more than three votes

• who has the most successful culture and operational model?

– Goldman Sachs (almost all votes)

Selected findings


2) THERE IS AN UNIVERSALLY ACCEPTED OPERATINGMODEL - AND IT IS CALLED GOLDMAN SACHS

• all segments agree - US and European newcomers to global bulgegroup, European tier 2 and specialists

• what are the key elements of the operating model:

– ‘one bank’ with total communication and collaboration across businesses– one comp/bonus pool after remunerating stockholders: recreate

the partnership!– highly selective client focus with exceptional service quality– single investment banker capable of selling full range of products – target client CEOs for M&A and equity products which generate other transactions– regular cull of low performers

Selected findings

Davis InternationalBanking Consultants7Source: Sanford Bernstein

M&A

• Increase debt league table ranking• Soliciting M&A business

from debt clients• Use balance sheet to provide

one stop shopping• Use merchant banking funds

to maintain a stable of clients

Equity underwriting

• Build equity research tattract IPO

• Expand investment banking coverage of target IPOs

• Target financial sponsors• Use merchant banking

funds to maintain a stable of clients

JP Morgan Chase

Citigroup

Morgan Stanley

Goldman Sachs

Lehman

Deutsche Bank

Dresdner Wasserstein

Bank of AmericaSecurities

Bear Stearns

CSFB

3) VIRTUALLY IDENTICAL BUSINESS MODELS FOR GLOBAL LEADERS

In brief, high cost-high volume: ‘ our engine is too big for this race track’ - JP Morgan

Selected findings


4) SEVERE CHALLENGE FOR MID-SIZED COMPETITORS

• lots of terms - ‘Tier 2’, ‘deep - country specialist’, ‘best of breed local’, ‘multi-specialist, ‘junior corporates’, ‘national champion’ - but the same mountain to climb

• the pan-European concept is dead: ‘Europe’ is 15 different markets with an equal number of competitors involved

• the problem for European Tier 2 banks: reluctance to assume market risk; hesitation to merge corporate and investment banking arms, uncomfortable with large bonus pools, uncompetitive product capabilities

• the opportunities: retail distribution, research and trading of local securities, close relationships with local issuers and investors, introduce clients to securities markets, some product strengths

Selected findings


M&A

Equity Issues

Corporate Bonds

High Yield

Equity Trading

Derivatives

M&A8.6%

Corporate Bonds 2.6%

High Yield Bonds 0.8%

Equity Trading52.6%

Note: Figures do not add to 100% because of net estimated loss of 5.2% on Government bonds

Derivatives 27.6%Equity issues

13.0%

5) SIMILAR PROFIT PROFILES IN US AND EUROPE(Estimated profit contribution 2001)

Europe

M&A

Equity Issues

Corporate Bonds

High Yield

Equity Trading

Derivatives

Derivatives 28.7%

M&A8.8%

Equity issues9.4%

Corporate Bonds 2.5%

High Yield Bonds 5.2%

Equity Trading45.4%

USA

Source: Lehman Brothers

Conclusion: central importance of derivatives and secondary trading

Selected findings


6) NO SIMPLE SOLUTION TO COST MANAGEMENT PROBLEM

• ‘right-sizing’ doesn’t exist in this volatile, dynamic business

• best practice: maximize variable element in all major cost categories; cull people regularly rather than only in down markets

• cutting back office costs is a real challenge - both technologically and culturally: IT alliance/outsourcing not particularly successful

• results: people have to be cut in a sustained down market to meet stockholder expectations

Selected findings


C) OUTLOOK: TRENDS, WINNERS AND LOSERS

Outlook


1) MOST TRENDS POINT TO FURTHER MARGIN PRESSURE

Outlook

Commoditization of derivatives, etc.

Commoditization of derivatives, etc.

Lower cost tradingplatforms enable leaders

to cut margins

Lower cost tradingplatforms enable leaders

to cut margins

DB, UBS, BarCap and othersbattle for US leadership

DB, UBS, BarCap and othersbattle for US leadership

Existing overcapacity (for 2000 revenue base) Existing overcapacity

(for 2000 revenue base)

Continued margin

deterioration

Continued margin

deterioration

At least eight players struggle for share of

M&A/equity leadership

At least eight players struggle for share of

M&A/equity leadership

Major clients reducenumber of providers

Major clients reducenumber of providers

Slower revenue growth after 1990’sSlower revenue

growth after 1990’s

Credit-led strategies under-cut overall

margins

Credit-led strategies under-cut overall

margins


Cross subsidization: low return businesses are supported by a declining number of high margin businesses

Source: Sanford Bernstein

NASDAQInv. Grade Debt

UnderwritingFixed Income

ResearchEurobonds Underwritng

& Secondary

CorporateSecondary

EmergingMarkets

Fixed Income

MortgageBackedIssuance

EquityArbitrage

EquityDerivatives

(Some)Fixed IncomeDerivatives

High YieldUnderwriting/

Secondary

M&AAdvisory

EquityUnderwriting

M&A and Equity Underwritingbear the weight of the business portfolio on their shoulders.

Lowor No

Margin

HighMargin

EquityBlock Desk

EquityResearch

Money Mkt.Repo-Matched

BookPreferred

CommercialPaper

PlacementEquity

FinancingUS Governments Munis OECD Gov’ts Futures Clearing

Outlook


Steady historical decline in margins on key US investment banking products

Source: Salomon Smith Barney & Thomson Financial Securities Data Corporation

0

1

2

3

4

5

6

Total EquityUnderwriting

High Yield debt

M&A advisory

Investment grade debt

%

4.56%

4.07%

1.89%

1.09%

0.42%0.14%

0.11%0.32%

Outlook


2) ALMOST UNANIMOUS VIEW THAT CONSOLIDATION WILL CONTINUE

• ‘eight into three won’t go’ - losers will be under pressure to do a deal

• prospect of lower ROE’s will also drive consolidation

• consensus view that 5-6 globals will emerge: no prizes for guessing possible combinations!

• longer revenue drought will increase likelihood of deals

Outlook


5 - 1010 - 2010 - 25

5 - 15

10 - 15

15 - 255 - 15

15 - 25

20 - 40

US listed stocks European cash equities Derivatives

Source: McKinsey estimate based on sample of selected players

Breakdown of global broker-dealer cost base, 1999-2000(% of revenues)

Variable• Sales compensation• Bonuses

60-70%

40-50%

20-30%

3) MORE COST REDUCTIONS ON THE WAY

Outlook

Overhead• Research• Equities management

Semi-fixed• Sales/trading salaries• Back office costs

• ‘a paradigm shift in research’: who will pay for vast research capabilities

• a big issue: scalability for all players as revenue growth slows and deal size falls


4) MANY GLOBAL PLAYERS WILL STRUGGLE TO REPLICATE IDEAL OPERATIONAL PROCESSES

• challenge of converting product silos to client focus

• shortage of uniquely skilled master salesmen - the investment banker!

• ‘seamless relationship management’ a challenge for massive, complex organizations

– Citigroup experiments with double coverage– “no one individual can sell all products”

Outlook


5) TOP ADVISORY/EQUITY FIRMS UNLIKELY TO LOSE HEGEMONY

• Greenwich Associates research on duration of average lead relationship:

Outlook

Fortune 500 (number of years)Fortune 1-100 13.3101 - 200 12.6201 - 300 11.4301 - 400 9.4401 - 500 9.2

Sales SizeOver $2.5 billion 11.5$1.0 - £2.4 billion 8.9$500 - $999 million 7.0

Lead investment bank

Source: Greenwich Associates


Factors determining mandate for M&A advisory

Source: Greenwich Associates

• Credit-led strategies will gain some ground, but most CEOs will continue to value existing relationships and skills

Outlook

Most important

Credibility with company’s CEO and board of directors 51%

Capability of M&A specialists 49%

Creative and innovative ideas 43%

Understanding of company’s M&A strategy 39%

Understanding of industry 29%

Capability of relationship manager 26%

Historical relationship 24%

Past record in structuring and closing transactions 21%

Ability to arrange financing 16%

Equity research capability 15%

Lower fees 14%

Execution support from M&A transactions teams 11%

International expertise 5%


Global investment banking fees received: league tables by individual institution

1993 2001

Merrill Lynch 8.4% Merrill Lynch 7.2% Merrill Lynch 9.0%

Salomon Smith Barney 6.7% CSFB 6.9% Goldman Sachs 7.5%

UBS Warburg 6.2% Goldman Sachs 6.7% CSFB 7.2%

CSFB 6.2% Salomon Smith Barney 6.7% Salomon Smith Barney 6.7%

Goldman Sachs 5.8% Morgan Stanley 6.5% Morgan Stanley 6.3%

Morgan Stanley 5.8% J P Morgan 5.3% J P Morgan 5.5%

Lehman 4.0% UBS Warburg 4.0% UBS Warburg 4.6%

J P Morgan 2.9% Deutsche 3.6% Lehman 3.6%

Deutsche 2.8% Lehman 2.9% Deutsche 3.5%

Bear Stearns 1.7% Bear Stearns 2.1% Bank of America 2.4%

Top 10 Total 50.5% 51.9% 56.3%

1997

Source: Freeman & Co

Outlook

• Remarkable stability over time in investment banking market shares


0 5 10

15

20

252000-2005 Expected Market growth

(%)

Pre-tax ROE

Equity

Fixed Income

Corporate bankingpre tax ROE

10%

Specialised Financingpre tax ROE

23%

Average market growth : 10%

Proportional to

9M 2001 income

Advisory + Cap MarketsAverage pre tax ROE

62%

6) SOME SIGNS THAT EUROPEAN TIER 2 COMPETITORS ARE IMPROVING CHANCES OF SURVIVAL

Investment banking at BNP ParibasReallocating capital to higher value products

Outlook

Source: BNP Paribas


• key strategies: reduce pure lending relationships, focus on higher value products, reduce ‘nice to have’ capabilities, match products with client needs, introduce bonus pools, more selective customer focus, merge corporate and investment banking, etc

• the major variables: size and activity in home market, top management acceptance of Goldman operational model, exportable products, making the right bets

• the big issues: what is your client franchise, what products do they need, and can you supply them on competitive basis?

Outlook

European Tier 2 strategies, con’td


• the good news: there are successful role models in the middle ground:

– Carnegie in Sandinavia– Fox-Pitt Kelton in financial services– Macquarie in global cross-border leasing and structure finance– Cazenove in UK corporate finance and brokerage

• the bad news: none of these winners comes from a commercial/universal banking background!

• who’s ahead in the European race - perhaps Société Générale, BNP Paribas, SEB

Outlook

European Tier 2 strategies, con’td

ubs warburg 2002 global financial services conference

Documents

goldman sachs

merge corporate

global players

led strategies

research

outlook

products

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