While Nomura Holdings took the high-profile, high-risk decision to recruit 8,000 Lehman Brothers bankers in the fourth quarter of 2008, Daiwa Securities SMBC's strategy has been less high-profile and, arguably, less high-risk. Its acquisition of a small, specialist London-based mergers and acquisitions finance unit, Close Brothers Corporate Finance (CBCF), is a more modest affair than buying a complete wholesale bank -- and should therefore allow it to avoid most of the post-merger integration issues that Nomura faces with Lehman. The consideration for the 230-person unit (a subsidiary of London-listed Close Brothers Group) was £75 million ($120 million) and involves a 100% ownership transfer. The deal was announced last Monday, but won't be finalised until approved by the UK's Financial Services Agency.
"We believe the transaction will totally change the landscape in Japan. We can now cover the three biggest markets for international transactions, namely the US (where we have a 20% stake in Sagent Advisors), Japan, and now the UK and Europe," Daiwa SMBC's co-head of global investment banking, Yoshikazu Fukushima, said in an interview with FinanceAsia on Friday.
Daiwa Securities SMBC (DSS), which is a 60-40 joint venture between Daiwa Securities Group (DSG) and mega-bank Sumitomo Mitsui Financial Group (SMFG), already has trading and corporate advisory functions in London involving some 400 staff. The acquisition of CBCF will enable it to offer a better range of client-focused services. The deal can be seen as reflecting a broader trend whereby investment banks shift their attention away from risky proprietary trading and principal investing and towards the 'classic' corporate finance business.
"We have a broad customer base in Japan thanks to our relationship with Sumitomo Mitsui Banking Corporation (the commercial banking arm of SMFG). Many Japanese companies wish to expand outside Japan, where the demographics are not encouraging. The transaction with CBCF means that we can now support them more effectively," said Fukushima. He added that CBCF's expertise in pan-European deals was a special attraction given the appetite for the region among Japanese corporates.
The target, which announced operating income of £57 million in the past financial year, and which focuses on mid-caps, is tiny compared to Lehman. But in light of Nomura having announced a record pre-tax loss of ¥779 billion ($8.2 billion) for the financial year from April 2008 to March 2009, that may not be a bad thing: Nomura's personnel costs to net operating revenue were 157% for the period (swollen due to the guaranteed two-year bonuses promised to key Lehman bankers). That's an incredible figure and shows that the firm's entire net operating revenue was unable to meet the huge new salary base -- the ratio was just 46% in the previous financial year. DSG's latest ratio was 71%, and just 35% in the preceding financial year. (Figures are according to a May 21 Fitch Ratings special report on Japan's Big Three securities groups.)
"In contrast, the risk involved in this deal is very limited. The price is not high, we are not committing much capital, and the economic impact will be small," said Fukushima. The timing of the deal was also sweet, with the pound going through a very weak phase, and depressed market sentiment reducing the price of the acquisition compared to two to three years ago by at least half, according to Fukushima.
Ehsan Syed, the top securities sector analyst at Fitch in Japan, agrees the deal is low-risk: "CBCF's compensation levels would be higher, but there is generally also a higher variable element at Western finance firms, so the impact on Daiwa's profit and loss will be limited." (It's the fact that Nomura doesn't have the variable element with regard to the Lehman bankers that has caused the firm so much pain).
Clearly, this is not some make-or-break deal for Daiwa SMBC. Rather, it is an incremental improvement of the services it can offer its clients. Fukushima explains: "The contribution of the deal to our bottom line will not be big, as is also the case with our domestic advisory business. However, we believe it will increase our clients' satisfaction with DSS and act as a catalyst for further business, such as domestic fund raising (to finance acquisitions)."
With regard to running CBCF, the idea is to give it free rein, although with some Japanese supervision. Ikuo Mori, former senior managing director of Daiwa SMBC and a director of Daiwa Securities Group, will take over as chairman of CBFC. In addition, the corporate finance department and mergers and acquisitions department of Daiwa SMBC Europe "will be transferred into CBCF in order to enable close alliance in cross border deals between Daiwa SMBC and CBCF", the Monday press release stated. That will also help Japanese bankers obtain some valuable international banking skills.
"The acquisition shows that we want to grow overseas, and we want CBCF to continue growing strongly," Fukushima said. Sources close to the deal added that Daiwa SMBC has paid especially close attention to retaining the group of former Hill Samuel bankers who comprise the core of CBCF. That includes hiring a specialist human resources firm to structure remunerations in a way that tie in the bankers for as long as possible. Fortunately for Daiwa, there is likely to be much less of a clash between bonus cultures at SMBC Europe and CBCF than at Lehman and Nomura, since Japanese bankers abroad get paid in a similar manner to Western bankers.
One interesting point is whether DSS will get involved in providing financing, which is balance sheet intensive and thus a negative factor in the current climate. In the past, the environment was so competitive that securities houses with financial muscle (usually linked to their commercial banks) could more easily win advisory mandates. Fukushima hedged his bets by saying only that "bridge loans from our corporate banking side would be an option".
Fitch's Syed estimates that with the weakening of so many investment banks, the environment is now much less competitive, and banks can therefore afford to promise less funding.
In fact, Daiwa SMBC's ability to finance deals will likely have to come via its joint venture partner, SMFG, since Daiwa is not linked to any other commercial bank. That is a weakness for DSG, since it provides leverage for SMFG over the latest reorganisation in the Japanese securities sector, namely SMFG's acquisition (using SMBC as the acquisition vehicle) of retail brokerage Nikko Cordial Securities and the domestic institutional business of Nikko Citigroup earlier this month.
One securities analyst told FinanceAsia privately that he believes SMFG is aiming at a merger of Daiwa SMBC and the acquired Nikko Citigroup operations, since there is an institutional business overlap, while keeping the retail brokerage units (Nikko Cordial and Daiwa Securities) separate on account of their strong brand names. The analyst thinks the most logical structure would be for a holding company to come into existence, with a merged Daiwa SMBC/Nikko Citigroup providing investment products to the two retail brokerage houses. He estimates that SMFG would be able to dominate the new holding company on account of its funding and corporate relationships. Indeed, SMBC also contributes 40% of the staff to the JV, according to the same analyst.
Syed's interpretation of the complex situation is that DSG would not be too worried about a break-up of the JV (assuming an extreme situation whereby SMFG demands a merger between Nikko Cordial Securities and Daiwa Securities, and DSG refuses, leading to a breakup of all business cooperation), precisely because the loss of the treacherous prop trading and principal investment business within Daiwa SMBC could be a blessing in disguise. "DSG could thereby reduce the business lines which use balance sheet and instead focus more on the agency business," the Fitch analyst told FinanceAsia. But Syed estimates DSG would welcome a merger between Nikko Citigroup and Daiwa Securities SMBC, which would combine the institutional businesses, and indeeed, that this is very likely to happen.
For DSG and SMFG, the latest deal with CBCF is a continuation of an important trend. As Fukushima sees it, "the bulge bracket model of investment banking is broken", and Japanese financial institutions are now moving strongly towards the universal banking model. SMFG is so far the only Japanese mega-bank to have acquired a top-tier securities operation, in the form of Nikko. Together with its existing stake in the strong brand name of Daiwa SMBC, now further enhanced by the CBCF transaction, a formidable competitor is emerging. The other two mega-banks -- Mitsubishi UFJ Financial Group and Mizuho Bank -- had better watch out.
