Analysis: Big M&A banks move down-market in hunt for fees

May 26
9:47 AM 2012

The slow market for merger deals is driving big-name investment banks into combat with smaller rivals for business from companies they usually ignore.

Goldman Sachs Group Inc (GS.N), Morgan Stanley (MS.N) and JPMorgan Chase & Co (JPM.N) have emerged as the top banks on middle-market merger and acquisition deals announced this year, displacing advisory shops that specialize in the area.

Bankers at smaller firms said some clients are flattered by the attention they are getting from banks that have avoided them for years, and occasionally use the competition to negotiate lower fees.

"It's a big challenge for us when those big brands come down market," said Christian Schiller, head of middle-market banking at Cascadia Capital LLC in Seattle.

The eagerness of so-called bulge-bracket firms to provide advice on acquisitions under $500 million illustrates how tough the investment banking business has become. Despite bonus cuts and layoffs, the big banks still have hordes of bankers making annual salaries of $400,000 to $500,000 who have to earn their keep.

"It's pragmatic - some income is better than no income," said William Hickey, co-head of investment banking at Sandler O'Neill & Partners.

Eight of the 10 biggest investment banks in 2011 recorded a decline in overall fee revenue from an already weak 2010, and the pace of deal assignments in the first quarter continued to fall.

James Freeman, a 17-year veteran of Credit Suisse who now runs his own eponymous advisory shop, said that bankers at the big firms are chasing smaller deals to justify their high salaries but that returns are negligible.

"There's a big bank next to us on every deal we pitch, but it's not economical for them to be that far down market," said Freeman, whose company provides data on deal fees to Thomson Reuters and other data distributors.

If big firms are having trouble paying for high overhead in slow times, they should consider further job cuts, he suggested.

An executive at one large investment bank said that middle-market deals may not be big banks' sweet spot but they can be lucrative.

"You can earn very meaningful fees," said Marc-Anthony Hourihan, head of U.S. mergers and acquisitions at UBS AG (UBSN.VX).

Goldman and Morgan Stanley averaged fees of $2.5 million apiece on their middle-market assignments through May 1, while J.P. Morgan topped the fee rankings with an average of $3 million, according to data from Thomson Reuters and Freeman.

Those figures are a far cry from a bank's cut on a $10 billion deal, which averages about $35 million, according to the data. On large deals, the fee is usually split among two to four advisers. Spokespeople at Goldman, Morgan Stanley and J.P. Morgan declined to comment.

Banks representing buyers of companies generally get a fixed percentage of a deal's value. Fees are usually slightly lower for representing sellers, but banks often use "ratchet pricing" on those deals, which yields a higher fee if a company is sold above a predetermined value.

Bankers at the larger firms also say that their new focus makes sense since their big clients are pursuing smaller deals. Corporate executives today are being rewarded for conservative "bolt-on" acquisitions that expand product lines or sales rather than for hard-to-execute megadeals premised on squeezing out costs.

"It's difficult to find big targets that have good growth profiles," said Hourihan.


What no one disputes is that deal announcements have been shrinking in big and small categories alike. The number of announced deals valued at $500 million and higher fell 24 percent in the first four months of 2012 from the already weak period a year earlier, according to Thomson Reuters. Total value of the deals fell 32 percent. Middle-market deals are down 20.7 percent by number of transactions and 17.4 percent by total value.

By delving into smaller deals, the Wall Street giants have displaced some perennial specialty banks in the middle market. The advisory arms of KPMG and PricewaterhouseCoopers - the top middle-market advisers in the first four months of last year - have dropped to a tie at sixth place in 2012 thus far. They ranked number one and two in all of 2008, 2009, 2010 and 2011, according to Thomson Reuters data.

A KPMG spokesman declined to comment, while a PWC spokeswoman said the company focuses on annual, not quarterly, rankings.

A senior banker at a boutique firm in New York said clients are taking notice of the competition.

His bank recently prevailed against Goldman, Morgan Stanley, Deutsche Bank (DBKGn.DE) and two smaller firms for an assignment advising a California-based financial company about a divestiture. The chairman of the firm then negotiated a 20 percent cut in the agreed-on "success" fee and a 50 percent retainer cut. "He said he'd give the business to a larger bank if we didn't go along," said the banker, who spoke on condition of anonymity.

Ever-optimistic deal bankers late last year were forecasting a strong 2012 calendar spurred by excess cash on corporate balance sheets, the expiration of Bush-era capital gains tax cuts at the end of 2012 and the desire of private equity firms to do deals in case Congress raises taxes on their funds' gains.

However, volatile financial markets and very poor credit markets in the second half of 2011 halted deal activity. While conditions are improving and backlogs of potential deals are growing, cash-rich but risk-averse corporate executives and their boards are taking longer than expected to restart the acquisition process, bankers said.

As a result, bankers who have long specialized in smaller deals expect the competition to persist.

"When the business cycle slows, the bulge-bracket firms tend to go anywhere where they can print business," said Sandler's Hickey, whose firm specializes in the financial industry deals. "They'll go back up market when business picks up."


The competition, meanwhile, has spawned some combative marketing. Boutique banks often complain that their bigger rivals use senior bankers to woo clients but that junior staff end up doing the actual work.

Some boutique banks are advising clients to demand the right to fire a big bank that staffs junior bankers on a deal.

On the other end, big banks are telling potential clients that specialty M&A shops are more likely to push a customer to consummate a sale or acquisition because they need the fee. One deal can cover a boutique banker's costs for a year.

Managing directors at big firms, for their part, are expected to generate $10 million of annual fees to justify their compensation, said Doug Schmidt, who runs Chessiecap Securities, which works on deals under $30 million that he says are too low to attract big banks.

Schmidt, who has worked at larger banks such as the now-defunct Drexel Burnham Lambert, uses his website to remind potential clients that big banks may not give clients the love they deserve:

"Goldman Sachs may be the best divestiture firm in the world, but the fees on even its small deals can make your head spin ... When business is slow some big banks may be tempted to reach down for smaller deals by deploying junior resources and relying on their brand to carry the deal through. But when they do, they often end up creating an unhappy client who feels like a second-class citizen."

This article is copyrighted by Reuters

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