September 27, 2010 6:08 pm
The late-summer rush of global mergers and acquisitions will have come as a relief to the M&A advisers and banks that strengthened their M&A divisions at the start of the year, hoping takeover activity would pick up as economies recovered.
Deals were slow to emerge in the early part of the year, but by July and August the value of bids on the table was more than $145bn, according to Thomson Reuters. These bids ranged from the mining concern BHP Billiton’s $39bn bid for PotashCorp of Canada, to the offer of roughly $8.5bn by Vedanta, the Indian mining group, for a majority stake in Cairn Energy’s Indian subsidiary, Cairn India.
Data provider Dealogic estimates that M&A deals in natural resources companies (miners, oil and natural gas producers, fertiliser makers and so forth) had reached $316bn by the end of August; this is on course to beat the previous annual record of $384bn, set in 2006.
The earnings from structuring these deals and advising companies will be a welcome boost to the coffers of banks hit by the financial crisis, even if the multimillion-dollar fees they receive cause alarm elsewhere. Last year’s takeover of Cadbury by Kraft, the US food group, rekindled the tensions over the scale of rewards attached to deals. Some politicians were spurred to look at the conflicts between the short-term incentives accruing to banks and some shareholders, versus the broader long-term economic benefits of takeovers.
Earlier this year in the UK, Vince Cable, business secretary, reported to parliament (after considering M&A activity in the light of the Cadbury takeover): “It is clear that many of those involved in a takeover have a vested interest in the bid proceeding and being accepted … In 2009, fees paid to advisers in the global M&A market were typically around 0.2 per cent of total deal value, with the top 10 advisers each earning between $500m and $1bn.”
The cost of M&A and the bankers’ fees for advising on and financing deals has long been a bone of contention between investors and banks. But pressure on banks to cut their fees has been building since the financial crisis began, with regulators, politicians and shareholders demanding lower costs, in the long-term interests of companies, shareholders, staff and the wider economy.
The banks that earn most from this work are a small band of US-based institutions led by Goldman Sachs. JP Morgan topped the charts in the first half of this year, earning $2.3bn in investment banking revenues. Goldman Sachs earned more in the same period for advising on M&A than any other bank, according to Dealogic; between January and July, its revenues for advising on M&A were $654m, which represented a market share of 9.4 per cent (JP Morgan was ranked second, with Morgan Stanley third).
Credit Suisse led the field in European M&A, and UBS in the Asia-Pacific region. Investment banks, led by the US groups, earned $7bn in total from advising on transactions globally in the first six months of the year – up from $6.2bn in 2009. The volume of M&A work rose by 7 per cent in the first half to $1,230bn, with deals worth roughly $600bn in each quarter.
Activity in emerging markets and Asia was notably buoyant. The total value of deals in these regions ($388bn) was up by nearly two-thirds on the corresponding period in 2009, and accounted for a third of global M&A – the highest share on record. Nonetheless, the US accounted for 41 per cent of the fees earned by banks for advising on deals. The total value of deals was $408bn, down 10 per cent on the year before, but the number of deals, at 5,232, was the highest in a six-month period since 2007.
Hostile bids were down nearly 40 per cent, from $96bn in the first half of 2009. Most of these took place in the UK, followed by the US and Australia, which, between them, accounted for 97 per cent of the total.
Hostile bids are extremely lucrative for banks; the bigger and more complex a deal, the more it costs – even if it fails. Prudential’s failed $35.5bn bid for AIA, the Asian arm of US insurer AIG, cost its shareholders more than £377m ($588m), of which about £124m went in advisory fees to bankers, lawyers and accountants. Last month, the Pru detailed for investors what that £377m in fees included: £100m for hedging the currency risk involved in a UK group buying an Asian business, as well as £153m as a break fee to AIG.
Then there was the £66m of advisers’ fees for hundreds of hours spent on structuring the deal, including the cost of the 900-page prospectus.
The cost of the abandoned transaction was lower than the Pru had led investors to expect. Nonetheless, some leading shareholders, such as Schroders, have called on the chief executive or the chairman to be made accountable.
There was also £58m in underwriting fees; most of it was paid to the global co-ordinators – HSBC, JP Morgan and Credit Suisse – for devising the deal and promising that the Pru would get the $21bn it would have needed to fund it from issuing new shares in a rights issue. The banks claim that, had the rights issue gone ahead, they would have made $740m in underwriting fees and $112m in advisory fees. Investors, however, are aghast that the banks were paid £58m even though the rights issue never took place.
Pressure mounts to curb ‘deadweight costs’
Top UK shareholders have been lobbying hard for banks to reduce the fees they charge for promising companies that all shares issued will be snapped up and that they will get the money they need to finance their acquisition ambitions. Over the past year, many of the country’s biggest investment groups have complained to politicians and regulators about banks fattening up their margins.
Earlier this year, the Association of British Insurers said that the “enormous” fees charged by banks amounted to a “deadweight cost” for investors, and may also be skewing the outcomes of takeovers. Investors claim that banks have been taking an increasing share of underwriting fees, while passing to shareholders most of the actual risk of being left with unwanted shares.
Partly in response to this lobbying, Philip Collins, chairman of the Office of Fair Trading, said earlier this year that the competition regulator was looking at bank fees.
Shareholders’ complaints focus on the fact that in the past, bankers would have charged companies a 2 per cent fee to ensure a successful rights issue, keeping a quarter for themselves and spreading the rest among investors who guaranteed they would buy up all shares issued. But now banks charge up to 4 per cent and keep about half for themselves, while routinely ensuring success by pre-marketing issues. They also normally advise companies to offer new shares at wide discounts to the old shares to attract buyers.
The Institutional Shareholders Committee, which represents more than a third of UK shareholders, has also launched an investigation into the rise in fees. The ISC itself has little power to change the fee structures of banks, but this is a sign of the intense public pressure on banks to justify their charges. It may also be an omen for bankers who were hoping that the past few months of activity signalled a return to the bonanza years before the crash.
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