Why Investment Banking Mergers Stink

This morning, DealBook linked to a Breakingviews piece on rumors of Credit Suisse possibly buying Bear Stearns. I immediately broke into a cold sweat even considering the possibility. Why?  Because investment banking mergers are quite simply one of the most efficient ways of destroying the buyer's shareholder value, especially when one considers the probabilities of a deal actually being successful. I can't think of another type of M&A transaction that is fraught with more risks than the investment banking merger or acquisition. Examples of failed investment banking deals are too numerous to mention, with the 2000 acquisition of DLJ by CSFB and the 1998 ingestion of Citicorp by Travelers as shining examples of deals gone bad, both financially and culturally.

In fact, I'd argue that the best buyers of and/or investors in these businesses are strategic partners, either the sovereign wealth funds (SWFs) that can open doors in new and valuable markets not currently penetrated by the investment bank, or firms that operate in other markets and can bring many of the same business-building benefits of the SWFs. In each case, the culture of the firm isn't changing and cost savings through integration is not a key component of making transaction economics work. Time and time again buyers get this wrong, either due to hubris, stupidity or both.

Here are some of the reasons why investment banking M&A deals are doomed to fail from the outset:

• The franchise is the people, not the brand. While most investment banks will tell you that the power of the brand is what helps them secure business, the brand isn't worth much without the people supporting that reputation through real-life actions. DLJ is a great name, but what is the DLJ franchise really worth without D, L, J, their lieutenants and the transactors actually getting deals done? Not much. Clients deal with people, not with brands, so the branding argument only goes so far. And generally when these investment banking M&A deals happen some group of people get disenfranchised, fear and uncertainty prevails, and those who stay are staying for their guarantees and not for the relationships and camaraderie they've felt by being part of the firm. Because that firm is gone and will never exist again. The real value of the deal goes up and down the elevator every day, and it is very, very hard to secure their loyalty (and, therefore, their value and the value of the purchased business) in the wake of the chaos that ensues during the integration phase.

• A changed culture threatens the buyer, the seller and merged firm. In each and every one of these deals there are winners and losers; the whole notion of a "merger of equals" (which is how the Citicorp/Travelers deal was billed) is a bunch of malarkey. In that deal Traveler's Salomon unit won, and in the DLJ deal it was a non-issue as they were simply bought. Well, what about those who have lived and worked in a culture and are now being asked to shift gears and operate in another? From first-hand experience I can tell you that it sucks, especially when you think the culture of the buyer sucks and you are simply being absorbed by it. This point relates to the first, as cultural unhappiness can lead the real driver of the deal - the people - to simply leave for greener pastures. Why not? Every high-quality person in the losing firm is getting barraged by calls from headhunters and friends asking them to jump ship for a fresh start and a big payout. Why deal with the headaches and the sadness of seeing your firm changed in ways you dislike when there are loads of others willing to give you a big hug, both culturally and financially? And believe it or not, the same applies to highly-sought after professionals on the winner's side. It is no fun for them, either, as concessions made to the losers can also wreak havoc on the culture and hierarchy among the winners. So many of them frequently bug out and further depress the likelihood of the deal succeeding.

• Clients are frequently confused during the firm integration process, damaging relationships. A banker's relationships are their own personal assets, assets they monetize for the benefit of their firm and themselves. And when an M&A deal stands in the way of realizing the value of these assets, bankers get very protective. They work hard to maintain legacy relationships, even if this results in duplicate coverage from the combined entity. Is this what the client wants? Of course not. But they generally aren't asked to choose. A power struggle ensues between the bankers from the two firms, sometime resolving itself fairly quickly but often times dragging on for years. Over time, this has a corrosive effect on relationships and on the firm's brand, depressing the value of the assumed "synergies" that were so certain to appear once the deal was consummated. Ha!

• Bankers are perpetually free agents, and an investment banking M&A deal is akin to imposing a collective bargaining agreement. It simply doesn't work. The individual attention that would be required to get each and every key person - of both buyer and seller - on the same page with respect to strategy, reporting lines, client ownership and compensation would take a millennium, maybe more. But this is what it would take to give one of these M&A deals a chance of succeeding. To be clear, I am not talking about a merger of two commercial banks, where one is looking at a map like a game of Risk and filling in gaps in branch networks, deposit bases, credit card portfolios, etc. These are deals of efficiencies and of scale, and while I don't mean to understate the importance of cultural and human resources issues in these transactions they are much, much more straightforward than where the lion's share of the assets - namely, goodwill housed within each and every employee - can disappear within months. This is not a smart bettor's risk/reward profile - it more akin to a drunken gambler sitting with $2k in their pocket playing blackjack at a $500 table where they expect to win. Is winning possible? Yes. Is the probability distribution negatively skewed with a mean return well below zero? Yes.

In sum, If CS wants to bulk up its prime brokerage or mortgage trading businesses, simply hire the people you want from Bear, BofA, whomever. Be surgical. Be strategic. Give each hire the attention they deserve to make sure both they and the firm are successful. There is no reason to try and buy the entire asset. The problems that will emerge will consume valuable management time, be a major distraction in particularly challenging markets and invariably cause share price to fall. Believe me, both you and your investors will thank me in the morning.

 

Comments

[john]

I'm not a specialist of investment banking but it's kind of weird to hear investment banker argue with force against the very same deals they broker for other companies every day.
They help companies buy other ones, therfore destroying the culture of the bought company, many valuable people leaving each time. Certainly, the human factor is really important in the investment banking business, but is it a unique feature ? Are other businesses bought & sold on a regular basis without any human particular characteristic ?
My 2 cents, correct me if i'm wrong.

[Sami]

I agree. Reading about any investment banking merger in history was the result of trouble or the thought of bankruptcy of the target bank.

and generally talent walk out the door and there goes the franchise value.