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Thursday, 15 November 2018

Mullin: Move over Wall St; mid-market coming through

Keith Mullin, IFR Editor-at-Large

Scotiabank acquiring Howard Weil; Canaccord Genuity bidding for Hawkpoint in the UK, buying a stake in Australian advisory firm BGF Equities, and acquiring China investment bank The Balloch Group; Raymond James buying Morgan Keegan; Cowen & Co forming an exclusive corporate bond and convertibles alliance with CRT Capital, …

and buying both Algorithmic Trading Management, and LaBranche & Co; Stifel Financial entering into a strategic alliance with Miller Buckfire and buying Stone & Youngberg. Any of this sound familiar? I thought not.

OK. How about Robert W Baird & Co reporting record revenues up 50% in 2011 and planning to continue recruiting top talent in 2012 to keep pace with its deal flow? No? William Blair & Co acquiring Guidance Capital and continuing its global expansion with the opening of a subsidiary in São Paulo? Err … Rodman & Renshaw taking over Hudson Holding Corp? Oppenheimer & Co taking over Riparian Partners? Ladenburg Thalmann buying Securities America? Gossip (denied) that Piper Jaffray may be up for sale, or at least considering the sale of its Asian business?

The above is just a small selection of the crazy amount of chatter, event-driven activity and business expansion announced in the past weeks and months involving US mid-market or specialist investment banking firms. The list just goes on. To be honest, it’s not an area of the market I’ve spent a huge amount of time around. But I’ve been noticing increasing waves of news emanating from the off-Wall Street investment banking sector over the past year or so, and have been doing quite a bit of digging. I’ve got to say it’s pretty compelling.

Take a look at the year-to-date US IPO league table. Jefferies is fourth, but perhaps more tellingly, there’s US$19m of deal credit between ninth and tenth ranked Deutsche Bank and Stifel Financial, while Stifel and FBR Capital Markets rank ahead of Barclays Capital, Goldman Sachs and UBS; Goldman, in 13th place, ranking just above Oppenheimer. For sure, I don’t expect that to last, but we are closing in on the end of the first quarter, so I say fair play to the mid-market shops.

Because off-Wall Street firms are to some extent plying a slightly different trade to the bulge-bracket, elements of their business tend towards being counter-cyclical. Their cost base, typically, is certainly thinner. So while the bulge bracket frets about the impact of regulatory change; works overtime to slim headcount to take account of dramatically lower trading volumes to feed its flow monsters and on account of reduced deal flow; cuts risk-weighted assets; and generally tries to get its financial house in order; most off-Wall Streeters – while impacted in many ways by the same issues but in a much less concentrated way – continue about their business.

Not about scale

By definition, few of the mid-market firms depend as absolutely as the bulge-bracket does on scale and flow. When JP Morgan or Goldman Sachs switch on the lights in the morning, they’ve got to generate a huge amount of business just to pay the electricity bill and have the office plants watered. Mid-market shops typically don’t have to feed thousands of mouths – although there are exceptions. While Wall Street is cutting, a lot of off-Wall Street is expanding. They’re hiring playmakers, teams and adding businesses; they’re making acquisitions or are merging – with each other or are taking the bulge-bracket shilling.

The off-Wall St investment banking segment takes in a motley variety of entities; from some actually pretty large firms through to boutiques; from public companies to private companies to closely-held private partnerships. They include full-service multi-product investment banks to one-product shops, from sector specialists to regional firms. One thing’s for sure: there’s a whole world of parallel activity out there. Off Wall Streeters work on deals with the bulge bracket, but at the same time they’re building their own deal and business pipelines around all aspects of capital markets, advisory and trading.

“Since the mid-1990s, nearly 50 regional investment banks – including San Francisco’s Montgomery Securities, Hambrecht & Quist and Robertson Stephens – have been acquired by major financial institutions.”

At the larger end, they’re pretty significant generators of revenue. And across the spectrum, they’re increasingly global, evidenced by a physical presence in Europe (predominantly but by no means restricted to London) and Asia (where a major focus is the China mid-market). The marketing-speak of these firms differs inasmuch as their business strategies differ. But there is one unifier across the board: whether the focus is on a single client segment or a limited number of segments or whether there’s a single or limited product focus or a regional bias, the emphasis is on service provision, and on superior service provision at that.

JMP Securities, the full-service investment bank based in San Francisco, puts it well. The firm said it was founded in response to the consolidation of established independent research boutiques by large commercial banks. “Since the mid-1990s,” it laments, “nearly 50 regional investment banks – including San Francisco’s Montgomery Securities, Hambrecht & Quist and Robertson Stephens – have been acquired by major financial institutions. Such industry consolidation has pressured a new breed of bulge-bracket investment banks to compete for large market-capitalisation clients and has greatly reduced Wall Street’s focus on the middle market.” That ethos underlies the thinking right across the board.

Capturing dealflow

I ran a league table of the top 35 US ECM bookrunners from the beginning of 2011 to March 12 2012 to get a sense of US underwriting stratification. The results were illuminating. Total deal proceeds in the almost 15 months of activity – IPOs, follow-ons, block trades etc – were almost US$214bn. The top 10 accounted for US$190bn of that, equivalent to 89%. That points to a market heavily dominated by global behemoths and suggests no juice for anyone else. The banks ranked 11 to 35 raised less than US$20bn.

But looking at the data another way tells a completely different story: of the 799 deals in US equity capital markets in my sample period, the banks ranked 11 through 35 ran the books on 382 transactions. That’s almost 48% and gives an altogether different impression of how the market breaks down. I didn’t de-dupe the data to account for multiple bookrunning slots, so that number should be treated with a little bit of caution, but on the bald numbers, close to half the companies that came to market in the US opted to mandate a mid-market or specialist investment bank.

So while the volume players dominate the mega-deals (no surprises there), the non-bulge bracket captures a significant chunk of deal flow that occurs at a lower level of magnitude. Some of the mandates handed out to the banking groups undoubtedly stem from lending relationships, but the majority of firms in this segment are independent shops with no banking carrots to offer.

Perfect fit

Their small but fully formed status makes them attractive targets. To that point, and speaking to the point that JMP was making above, Scotiabank just acquired Howard Weil, the privately-held energy investment banking boutique, to boost its energy business. Scotia had the corporate banking, hedging and M&A side covered. The latter had already been transformed by the 2005 acquisition of energy M&A specialist Waterous & Co, which projected the Canadian bank way up the advisory rankings.

The addition of Howard Weil offers Scotia the full-on equity research, sales and trading, and ECM footprint that it lacks and is likely to be revenue-accretive from day one. Howard Weil’s coverage universe of 115 companies has a 70% overlap with Scotiabank’s lending relationships. It’s a great fit. The relatively modest (by numbers) combination of Scotia Waterous’s 110 employees in Calgary, Houston, Denver, London, Latin America, Singapore and Hong Kong, with Howard Weil’s 53 staff could create an energy investment banking powerhouse.

With offices in New Orleans and Houston, Howard Weil knows the energy equity business back to front. It was on recent IPOs for Matador, Bonanza Creek, Laredo Petroleum and Pioneer Southwest Energy Partners. In 2011 it was involved in 21 deals worth almost US$7bn. It has a heavy research orientation across the energy spectrum (coal, natural gas hybrids, oilfield services, exploration and production and European integrated oils/independent refiners). The combined business will provide research coverage on over 220 energy companies.

It’s worth pointing out that the sector-focused investment banks seem to be capturing some good flow. Healthcare investment bank Leerink Swann has garnered a pretty creditable league-table ranking, for example. This year, it has won bookrunning slots on deals for Array BioPharma (US$60m follow-on); Cempra (US$58m IPO); Verastem (US$63m IPO); Chelsea Therapeutics (US$24m follow-on); and Vical (US$50m follow-on).

Mid-market bulge-bracket?

The area that does slightly concern me around off-Wall Street is the point at which firms operating in this segment attain such scale that they start to rack up a significant cost base that potentially puts them in a twilight zone of being betwixt and between the core mid-market and the Wall Street bulge-bracket – a sort of mid-market bulge bracket – where the benefits of being modest in size and which lend themselves to superior service provision can start to disappear. I wrote back in February that I was concerned that Jefferies was potentially taking a gamble by growing so rapidly without any certainty about business volumes following the dramatic increase in headcount.

In the same vein, I do wonder where the combination of Raymond James and Morgan Keegan will leave the sizable investment bank that will result. Ditto Canaccord Genuity. Canaccord has been one of the most serially acquisitive firms in the industry. Its recent bid for London-based mid-market investment bank Hawkpoint Partners from Collins Stewart, in a deal that values Hawkpoint at almost US$400m, is the latest in an impressive string of deals that has catapulted the former Canadian venture capital firm into a completely different league.

The Hawkpoint bid is in process, but it was only back in November that Canaccord acquired 50% of BGF Capital, the investment bank with offices in Melbourne, Sydney and Hong Kong. In January 2011, it had acquired The Balloch Group, the boutique investment bank in China founded by Howard Balloch, former Canadian ambassador to China.And it had not long since ingested the acquisition of Genuity Capital Markets, one of Canada’s leading investment banking partnerships. Its build-out had begun in earnest with the 2006 acquisition of US investment bank Adams, Harkness & Hill.

The Raymond James/Morgan Keegan combo is being positioned as the premier alternative to Wall Street

Pro forma headcount with Hawkpoint will exceed 2,500 people, broadly half of whom are in capital markets. Canaccord has 49 global office locations to Hawkpoint’s 16. Combined revenues across investment banking/corporate broking, advisory, securities and fixed-income are a tad over US$815m. While Jefferies’ expansion is organic, Canaccord is an artificial construct. It’s hard to see how a single driving culture can be allowed to develop and evolve when the focus is on doing acquisitions at breakneck speed without leaving time for consolidation. I’m not being a naysayer here - the results to-date have been impressive - but I’m just sounding a note of caution.

Raymond James CEO Paul Reilly, by contrast, said that even though his firm and Morgan Keegan have similar cultures, he would run the integration process over a number of years. The Raymond James/Morgan Keegan combo is being positioned as the premier alternative to Wall Street. Unlike Jefferies’ organic build-out or Canaccord’s frenzied acquisition-driven build-out, James/Keegan will be a slow combination of two already sizeable firms.

Raymond James has over 500 capital markets professionals, similar to the team at Morgan Keegan. Reilly was clear that the timing of the takeover was geared to getting the deal at good price. In good markets, he said the firm would have had to pay a multiple of the US$930m purchase price. I’m all for opportunistic acquisitions - Regions Financial has been shopping Morgan Keegan for some time so was up for a compromise price - but I’ll be very interested to see how the takeover proceeds.

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