M&A matters

October 6, 2009, 8:05 pm

via dealbook

The energy giant Exxon Mobil has agreed to pay about $4 billion for a minority stake in a oil field off the coast of Ghana, a region that has emerged as a major new petroleum province, a person with knowledge of the matter said Tuesday, The New York Times’s Jad Mouawad and Zachery Kouwe report.

Exxon’s acquisition of 23.49 percent of the Jubilee oil field underscored the interest that energy companies have shown in the 700 miles of Western African coastline that stretches from Sierra Leone to Ghana. Last month, the Italian oil giant Eni agreed to buy two fields off Ghana from the Vitol Group, a major oil-trading firm.

The Jubilee stake, which was owned by Kosmos Energy, a company based in Dallas and backed by major private equity firms, had attracted several companies and had started a bidding war between international and state-owned players, including Chinese companies.

But in a letter sent to the other bidders on Monday, Kosmos said it had “entered into a binding agreement with an exclusive bidder,” said the person, who declined to be identified because the negotiations were private.

Because of higher oil prices since the beginning of the decade, companies have increased their spending on exploration. While major companies like Exxon have focused on developing large oil and gas projects, much of the riskier and more prospective exploration has been undertaken by smaller, independent producers like Anadarko Petroleum, Tullow Oil and Kosmos.

Last month, for example, Anadarko announced that it had made a major discovery after drilling the first deepwater well off the coast of Sierra Leone. The company, along with Tullow Oil, owns the rest of the Jubilee field.

Fadel Gheit, an analyst at Oppenheimer & Company, said that Exxon was paying a steep price for the reserves at a time when oil companies were struggling to gain access to resources in traditional regions, like Russia or Venezuela. Exxon needs to find 1.5 billion barrels of reserves each year to replace the oil and gas it pumps annually.

“The world is getting smaller in terms of access,” Mr. Gheit said. “And Exxon has to run harder just to stay in place.”

A representative from Kosmos did not return calls or respond to e-mail messages seeking comment. Exxon also declined to comment about its bid.

“Exxon Mobil routinely evaluates potential development opportunities around the world,” Patrick McGinn, a spokesman for Exxon, said.

Kosmos, along with Anadarko and Tullow, have been particularly successful in Ghana where they have found oil in all of the eight wells they drilled in recent years. The partners have found four major fields — Jubilee, Odum, Tweneboa and Mahogany — and have identified four more potential prospects.

Jubilee, which was discovered in 2007, should start producing oil by the end of next year, and is expected to eventually pump about 120,000 barrels a day. Kosmos has estimated that Jubilee could hold recoverable oil and gas reserves of as much as two billion barrels. That puts the field in the same class of discoveries that have been recorded in the Gulf of Mexico in recent years.

The purchase also guarantees a big payday for the private equity companies that own Kosmos — Warburg Pincus, with 55 percent, and the Blackstone Group

The acquisition still requires approval from the government of Ghana.

October 5, 2009, 9:30 am

Gary Gorton is the Frederick Frank Class of 1954 professor of management and finance at the Yale School of Management.

In the movie “It’s a Wonderful Life,” shown each year on television around Christmastime, there is a bank run on the Bedford Falls Savings and Loan. For most people, this is the only reference point for understanding a banking panic, unless you happen to have lived through the Great Depression and experienced firsthand the bank runs of the 1930s. Of course, it is good news that we did not have a generalized bank run between 1934, when deposit insurance was introduced, and 2007.

But now, having been through the Panic of 2007, it is clear that there is a lack of historical awareness and understanding of banking panics. And, what makes it worse is that the Panic of 2007 was not like the Bedford Falls Savings and Loan, where Bedford Falls’s citizens ran to their local bank to withdraw cash.

In August 2007, it was firms running on other firms, in a market that is not known, or seen, or understood by most people, including regulators, academics, journalists and politicians. Without seeing the panic directly, it has been difficult to make sense of the events. Effects were mistaken for causes. Many “explanations” have been proposed, and many evildoers have been nominated. But, the noise level, the hysteria, the witch hunts, the show trials and the finger-pointing are not productive in terms of financial reform. Real reform must be based on understanding what happened.

From the founding of America until 1934, banking panics were almost regularly occurring events, and exactly the same kind of finger-pointing and blame games happened over and over again, then as now.

The basic problem is straightforward. When you deposit $100 in a bank, the bank lends it out to someone who deposits the $100 in another bank until they need it. Then the second bank lends out the $100, and so on. The single $100 of currency ends up supporting a much larger amount of demand deposits (checking accounts). The demand deposits, created through this leverage, are counted as money, since you can spend demand deposits by writing checks. Since people can always go to their banks and demand currency back, banks are — by definition — dependent on short-term funding.

In the era before the Federal Deposit Insurance Corporation, people — upon realizing that a recession was looming — would quite rationally decide to withdraw currency from their bank, for fear that their bank might become insolvent in the recession and they would lose their savings. No one knew which banks were the weak ones, so rational depositors at all banks wanted to get their money back. Now, of course, the banks had lent the money out and they could not get the money back on demand. The bank loans were illiquid — that is, there was no place to sell these loans. So, the entire banking system was then insolvent, in the sense that it could not honor the (legal) demands of depositors for cash.

Society could have chosen to liquidate the banks, penalizing them for having created demand deposits (leverage) to use as money. This did not happen. And, indeed it took about 100 years until society decided that it was best to put people in a position where they did not have to worry about their checking accounts; deposit insurance was enacted.

In the last 30 years or so, as the global economy has expanded, another banking system, which works almost the same way, has developed. This is a banking system that also creates money, demand deposits of a sort, for corporations and institutional investors. A large pension fund seeking a place to save cash for a short time, earn interest and be assured that the cash is safe, cannot deposit in a regulated bank because the amount guaranteed by government deposit insurance is limited. Instead that firm will deposit the cash with a financial firm for a short time (typically overnight), earn interest and receive a kind of guarantee by accepting a bond as collateral for their deposit (usually a AAA-rated bond). This market is the sale and repurchase (“repo”) market.

The Federal Reserve used to count repo, rightly, as money (in a monetary aggregate called M3) and so some limited information about this market was collected. But the Fed’s calculation of M3 was discontinued in mid-2006, as the repo market was in fact growing to enormous size. So, there is no data on the overall size of the repo market, but a reasonable guess is that it is at least as large as the regulated bank sector, $10 trillion.

In a repo market transaction, the AAA bond which is used as collateral is a kind of currency, and the repo is the counterpart to the demand deposit. It’s different from the usual demand deposit. When the institutional investor deposits cash and receives the bond as collateral, that bond can be “spent” in that it can be used as collateral in another unrelated transaction. And, then that third party can use the bond again somewhere else.

But, you say, should we allow that? The same thing happens with demand deposits. We can always have 100 percent reserve banking: make the bank keep the $100, in the above example, and not lend it out. But, then we don’t have loans (which have always been the assets of banks); clearly that would be a problem.

A problem with the new banking system is that it depends on AAA collateral to guarantee the safety of the deposits. But, there are many demands for such collateral. Foreign governments and investors have significant demands for United States Treasury bonds, and these are also needed to collateralize derivatives positions. Further, they are needed to use as collateral for clearing and settlement of financial transactions. There are few AAA corporate bonds. The demand for collateral has been largely met by securitization, a 30-year-old innovation that allows for efficient financing of loans. Repo is to a significant degree based on securitized bonds as collateral, a combination called “securitized banking.”

The shortage of collateral for repo, derivatives and clearing-settlement is reminiscent of the shortages of money in early America, which is what led to demand deposit banking.

Securitized banking is like the pre-F.D.I.C. banking system. If the depositors become concerned that their deposits are not safe, they can withdraw from the bank by not renewing their repo. Why would depositors become concerned? After all, they have the collateral, and if the bank fails they are allowed to sell the collateral and keep the money. But, if there is a concern that many collateral holders will be selling at the same time, it may be best not to engage in repo. You can see how the panic could happen.

Subprime bonds are not significant enough in quantity to cause a systemic crisis. But if depositors are not sure where that risk is and which banks are vulnerable, and if they are concerned about being able to sell collateral, they might withdraw. Unlike in “It’s a Wonderful Life,” firms are now running on firms.

From the banks’ point of view, repo is financing, so if depositors withdraw, then the banks are in the same position as banks in the 19th century. There is no place to sell enough assets to meet depositor demands, and the securitized banking system is insolvent (as the accountants dutifully record).

Policy makers need to recognize that the securitized banking system is important for economic growth. It needs to be protected and its vulnerabilities need to be addressed. That sounds a lot like advice given in the aftermath of the Panic of 1837.

(via Harvard Biz review)

To many executives, it might seem like a shrewd move in a recession to swoop in and acquire firms on the cheap—buy low, cut costs, and defy the usual prediction that most mergers will fail to produce economic value in their first two years. And there’s a grain of truth to that assumption. While M&A activity has been severely depressed since 2008 and fell dramatically in early 2009, acquiring companies during that period tended to outperform their industry peers in market valuation, according to a global study by Towers Perrin and Cass Business School examining 204 deals, each worth more than $100 million.

But outperforming peers during the worst days of the economic crisis simply means that acquirers’ stock prices fell by a lower percentage; the companies lost less value than others but did not necessarily create new value. The fact that they could afford to buy at all was a sign of financial health, a factor that alone could account for the better stock market performance. Studies by Boston Consulting Group analysts have shown that in a weak economy acquiring companies add only marginal value by cutting costs. As the economy strengthens, successful mergers will be those that have invested in profitable growth—which requires integrating and motivating employees who will work quickly and smoothly, minimize disruptions, increase market share, innovate, and adapt to emergent trends.

To extract lessons about how to manage the human side of integration, I looked deep inside a dozen successful acquisitions as part of a three-year study involving more than 350 interviews in 20 countries. My goal was to identify the practices of industry leaders. The mergers ranged from global deals, such as Procter & Gamble’s purchase of Gillette, to regional transactions, such as Shinhan Bank’s acquisition of Chohung Bank in South Korea. Several, like Mexico-based CEMEX’s purchase of RMC in Europe to double its size, reflect another M&A trend: an increase in emerging-market companies’ buying established Western ones. India’s Tata Motors, for instance, acquired the British icon Jaguar from the U.S. automaker Ford.

These acquirers overcame the usual barriers to successful mergers: employee shock, protests, and anxiety, all of which can fuel supplier unrest, government disapproval, and customer defections. For example, P&G faced the prospect of “blood on the floor” in its postmerger management ranks as headhunters went after Gillette talent, a former Gillette executive recalled. It also had to confront government inquiries in Gillette’s home state of Massachusetts, possible unrest in India in response to attempts to eliminate certain distributors, and other business disruptions. Yet P&G managed to retain a greater percentage of acquired talent than many buyers do (it held on to 90% of the top managers from Gillette who were offered jobs), and it enlisted employees (even those whose positions were being eliminated) in keeping suppliers, distributors, and customers happy. P&G met cost and revenue targets within the first year, incorporated Gillette processes considered superior to P&G’s, and continued to position itself for overall growth even as the current recession loomed.

Shinhan Bank’s acquisition of Chohung encountered much more resistance. About 3,500 Chohung employees and managers shaved their heads and piled the hair in front of Shinhan headquarters. To quiet the labor union and stem the flood of customer defections, Shinhan agreed to delay formal integration for three years. Yet well before the deadline, the combined banks’ holding company, Shinhan Financial Group (SFG), achieved de facto integration through merger task-force teams and heavy investments in “emotional integration” events (SFG’s term) designed to forge relationships and form social networks while also raising the wages of Chohung employees. Shinhan held informal happy hours and sponsored employee retreats, which included sing-alongs and mountain climbing. The internal investment in talent integration paid off; SFG’s stock well outperformed the South Korean market.

Using three cases that highlight different goals, I will describe the key strategies underlying effective integration and summarize the consistent lessons learned. In the first case, the cement company CEMEX wanted an acquisition’s employees to absorb its processes quickly and operate to global standards; the company needed to share its know-how with the people it had acquired. In the second case, P&G sought to catalyze internal change by adding Gillette’s successful methods to its own and retaining Gillette employees. In the third case, Publicis Groupe allowed the talent at acquired companies to take the lead in building new capabilities; mergers were treated like reverse takeovers, with the acquisitions transforming the buyer.

Turnaround

Investors did not initially like CEMEX’s decision to buy the British cement maker RMC, and some CEMEX leaders sensed negative perceptions among RMC employees that a “company from the third world” was reversing history by taking over a major business operating in developed markets. For the acquisition to be deemed a success, either by RMC employees or by capital markets in London, CEMEX had to show some early wins. The biggest was turning around RMC’s troubled cement plant in Rugby, England.

The factory loomed large on the western outskirts of Rugby, near residential areas; its construction interfered with local TV reception, and the plant emitted dust reputed to cause health problems. It was so unpopular that the television series Demolition named it one of the top 12 buildings people in the UK would like to see torn down. Many employees were ashamed to admit they worked there.

(via dealbook)

Morgan Stanley is outrunning archrival Goldman Sachs as 2009’s busiest adviser on mergers as optimism grows that the crippling effects of the financial crisis on deal-making may be easing.

Morgan has overtaken Goldman Sachs as the top-ranked adviser for global and United States mergers and acquisitions, working on deals worth $490.9 billion this year, as global M&A plummeted 41 percent to $1.392 trillion, according to Thomson Reuters and Freeman & Co., which have released their preliminary third-quarter data.

The New York Post, noted however, that while Morgan Stanley still maintains a $22 billion advantage over Goldman in the value of U.S. deals completed, Goldman’s share of M&A fees — $334 million or 9 percent of the market — is well above Morgan’s 5.4 percent.

Morgan’s strong showing under new merger chief Robert Kindler not only spells prestige and fees, but marks a rebound for the bank after it fell to fifth position in 2008.

“I’m having fun,” Mr. Kindler, a former Wall Street lawyer who joined Morgan Stanley three years ago from JPMorgan, told Reuters.

Mr. Kindler told Reuters it was “way too early to call the bottom of the M&A market” but said he saw promising signs.

“The two things that are most encouraging is that (strategic buyers) are back doing deals that make industrial sense and the credit markets are back open. That’s very good for M&A. The negative is that we have a volatile equity market,” he told the news service in a telephone interview.

The value of deals totaled $369.3 billion in the third quarter, down 54 percent compared to the same quarter in 2008, according to Thomson Reuters data.

For the year to date, fees for completed deals fell an estimated 57 percent to $11.9 billion.

European M&A in the year to date has more than halved to $433.8 billion — worse than U.S. and Asian declines of 43 and 38 percent respectively.

If Morgan Stanley can maintain its lead until the end of the year, it will top the tables for the first time since 1996, based on Thomson Reuters data.

That would mark a decisive recovery from 2008, when the bank fell to fifth in the rankings and the demise of Lehman Brothers and fire sales of Bear Stearns and Merrill Lynch cast doubt over the viability of standalone investment banks.

Scott Moeller, who heads the M&A Research Centre at Cass Business School in London, said Morgan would have been keen to improve its ranking because M&A advice gives banks access to top executives and can lead to a lot of follow-up fees.

“It’s very important from Morgan Stanley’s perspective that last year be perceived as a fluke and not a trend, and this year’s results so far seem to prove that,” Mr. Moeller, who worked at Morgan Stanley for more than a decade, told Reuetrs.

From 2005 to 2007, Morgan ranked second behind Goldman. It suffered last year partly because it did not advise on the $113 billion spinoff of cigarette-maker Philip Morris.

This year, it has worked on seven of the top 10 deals, including two drug industry mega-mergers — Wyeth and Pfizer, and Schering-Plough and Merck — a joint venture between miners Rio Tinto and BHP Billiton, and the restructuring of General Motors.

Mr. Kindler, who took the helm in February after the death of predecessor Gavin MacDonald, told Reuters that the most notable trend was that a handful of top firms were consolidating market share.

“We’ve basically maintained our M&A strength,” he said. “Success in M&A is really the result of many, many years of consistent client coverage.”

(via dealbook)

Wall Street’s biggest firms have seen their overall share of deal-making erode over the last decade as boutique and midsize firms lure away rainmakers and provide niche expertise.

In the first nine months of 2009, the so-called “bulge bracket” firms claimed a 35.8 percent share of merger advisory fees, down from 49.1 percent at the start of the decade, according to data from Thomson Reuters and the consulting firm Freeman & Company.

Many boutique firms have taken advantage of worries about pay and other restrictions at top investment banks to woo away bankers, increasing the pace of a trend that was apparent even before last year’s financial crisis, Reuters said.

“Top M&A bankers would rather work at a boutique where they can practice their craft in a pure-play sort of way and not have to cross-sell a bunch of other banking products like the big firms do,” Michael Hecht, an analyst with JMP Securities, told Reuters.

The changes in market share come at a time when overall M&A activity is at a six-year low.

Announced global M&A totaled $369.3 billion in the third quarter, down 54 percent from a year earlier.

In the first nine months of this year, Morgan Stanley grabbed the top spot among global M&A advisers, outpacing Goldman Sachs.

In the period a year earlier, Morgan Stanley ranked sixth.

Morgan Stanley also had the biggest increase in market share, gaining 1.8 percentage points, to 5.2 percent of the M&A market.

That is less, however, than the 6.2 percent share that Morgan Stanley claimed in the first nine months of 2000, according to the data from Thomson Reuters and Freeman & Company.

“The bulge bracket firms continue to be the leaders in the M&A market, but firms like Centerview, Greenhill, Evercore and others have played, and will continue to play, an outsize role,” Francis Aquila, a partner with law firm Sullivan & Cromwell in New York, told Reuters.

Centerview Partners ranks No. 42 in terms of market share, while Greenhill & Company is No. 18 and Evercore Partners stands at No. 16, the data shows. And boutiques and midsize firms have hired leading bankers as they have picked up steam.

“Increasingly you’re seeing teams of two to three guys moving to boutique firms as the larger banks face compensation constraints under TARP or face pressure to have their compensation systems revamped,” Scott Humphrey, head of BMO Capital Markets’ U.S. mergers & acquisitions group, told Reuters.

Banks that accepted money under the Troubled Asset Relief Program face rules on what they can pay top performers.

“Some people are scratching their heads and wondering how they can get paid what they’re worth and they’re defecting to smaller firms,” Mr. Humphrey said.

In the last year alone, Moelis & Company hired the former head of Bank of America-Merrill Lynch’s European investment banking unit and Greenhill hired leading financial bankers from UBS and Morgan Stanley.

The midsize investment bank Jefferies lured away nearly three-dozen UBS bankers — the bulk of the firm’s health care investment banking team.

Top bankers often bring along highly profitable relationships with large companies.

“Engagements are relationship-driven and senior bankers with significant relationships are reached out to for their advice and experience,” a top M&A banker, who spoke on the condition of anonymity, told Reuters.

The trend can also be seen in one of the quarter’s top deals.

While Cadbury has relied on three large banks for its defense against an unsolicited bid by Kraft Foods, Kraft has used a mix of advisers that include the boutique bank Centerview Partners, the restructuring experts Lazard and Citigroup and Deutsche Bank .

Separately, many corporations have gravitated to smaller firms to get independent advice, analysts said.

While large firms have the advantage of being able to provide financing packages to their clients to help make deals, smaller firms give corporations an independent viewpoint that is not complicated by financing needs.

“The other part is corporate governance and boards of directors wanting a truly independent point of view when considering an acquisition and not just some large bank trying to earn a fee on the deal financing,” Mr. Hecht told Reuters.

The rise in bankruptcies and restructurings has also helped firms like Lazard that provide specialized restructuring advice, analysts said.