Contrary to those who advocate spinning off business lines to enhance shareholder value, J. Christopher Flowers and Milton R. Berlinski believe big conglomerates do well for the shareholders over the long haul. While acknowledging that some spinoffs have served shareholders well - notably the recent spinoff of Signet Banking Corp.'s credit card unit - the two investment bankers argue that a mix of businesses produces the steady growth in earnings that investors seek in a banking company. As key players in Goldman, Sachs & Co.'s bank merger and acquisition team, the two could have a profound influence on the wave of mergers that is reshaping the industry. Goldman represented First Fidelity Bancorp. in its announced $5.4 billion sale in June to First Union Corp., the largest bank sale in history. It has been retained by Chase Manhattan Corp. as an adviser, as that bank faces pressure from shareholders to spin off businesses. Chase has reportedly been in talks with Chemical Banking Corp. on what would be a blockbuster deal.
Goldman also is representing Bank of Boston Corp. in that company's tortuous attempts to find a merger partner. With more than six senior people focusing on banks, and 80 people in the financial institutions group, Goldman has one of the preeminent groups on Wall Street. It was the number one bank M&A adviser last year, and ranks second for the first half of this year.
Although they could not comment about pending negotiations, Mr. Flowers, co-head of the financial institutions group, and Mr. Berlinski, vice president in charge of banks and investment managers, agreed to discuss their views with American Banker last week.
Q.: Why have there been so many bank mergers and acquisitions this year?
FLOWERS: I think there are many reasons, including the dip that stock prices took late last year. People were taking their time thinking about consolidation, and then all of a sudden they went through a period where their stock prices went down, and they realized that could really put a damper on their plans, so when prices recovered banks took advantage of that.
Secondly, nobody has paid that much attention to the nationwide banking bill, but the fact is we are seeing some of its effects. We are seeing big banks in the Southeast branch out and that has affected the psychology of the marketplace.
The psychology of the marketplace is also saying we are getting a lot closer to the end of this consolidation and that now is the time for action. Banks are also worried about the next recession and when it may come, and slowing revenue growth.
There is of necessity a greater geographic spread this time around. A greater effort to put together banks without overlapping territories. Sometimes the market accepts it, sometimes it does not accept it so well. But in the future there will be an increasing trend toward nonoverlapping transactions.
BERLINSKI: The Northeast is by and large consolidated and we will see a move toward the Midwest. Geographic diversity is going to be more and more a common thread in these deals.
Q.: There has been some criticism that the prices paid in recent deals have been too high, what do you think?
FLOWERS: There have always been companies that can command terrific prices. This market has had a sweet spot whose size has been moving up, frankly. For terrific companies that are the right size you can get terrific prices, and that has always been the way it has been.
One thing that has struck us about 1995's activity is the size company that is perfect has moved up a lot. First Fidelity did very well, Midlantic did very well, and both those deals were very good deals. Smaller companies that used to be much sought after are not as attractive as they were before.
These big banks will be less vulnerable because of their geographic and business diversity to downturns. And I don't think it was particularly good for Texas to have every bank go bust except for two of them.
Q.: There are some critics, like Heine Securities' Michael Price, who say some acquisitions can hurt shareholders by putting together illogical parts. Mr. Price, for example, says the sum of Chase Manhattan's parts is greater than the whole? What do you think?
FLOWERS: While I cannot comment on Chase, I have heard that argument many times in my life. Generally speaking that is an incorrect argument. And the reason for that is severalfold. The first, basic, and most obvious is you can't take them apart for tax reasons. Or to put it another way, the tax cost of taking them apart more than outweighs the benefits.
Secondly, it is typical that these businesses are intertwined with each other in a very significant way and they are not in fact easily separable. They rely on different parts of each other to make the whole thing fit together. That may be true from a funding point of view, that might be true from a customer service point of view. It might be true from a technology point of view.
It is very typical to have one line of business generate a lot of deposits, or another line generate a lot of assets. Take them apart and it is a mess, put them together and it is not a mess.
Also, companies tend to have volatile businesses and less volatile businesses. And the notion that you are going to take a volatile business, and it could be a volatile business that generates good returns on average, and isolate it so that it in a bad year it goes bankrupt is not really a very good idea. You stick it on top of a big flow of other income and you can weather a downturn.
It's like Warren Buffett is in the catastrophe reinsurance business. If you took that business all by itself and there is an earthquake he goes bankrupt. But you stick it on top of everything else, and he makes a fortune.
I understand what people are saying intellectually, but the fact is it is not very typical for that to be a good idea, or even doable.
BERLINSKI: It also doesn't mean that each of these things together can't all perform well to produce good returns.
Q.: Given that, can you explain why a lot of banks trade at a lower multiple than speciality companies?
FLOWERS: One distinction, and I don't know how much it is noted, is that banks are a capital intensive business. Banks need capital and that holds down their multiples.
BERLINSKI: Also, the growth rate expectations of some of these speciality businesses are large. But it goes in cycles. Auto finance companies - four years ago you couldn't give them away. Today people are willing to pay 20 times earnings for them because they think they've got 15% to 20% annual growth. Well that is going to change. What the banks have is steady-freddy growth, and as a result don't have a boom and bust cycle in terms of 20% growth and no growth. You have 10% to 15% growth.
Q.: Which of the nonbank lines are getting the most attention as acquisition candidates by banks, is it the investment management companies?
BERLINSKI: Investment management is the highest priority for banks, and also the area with the most availability. We had a record year in terms of transactions both large and small, probably got $250 billion of assets that will change hands that we will handle.
Q.: What do you think about mergers of equals?
FLOWERS: We think mergers of equals can make good sense, we really do. It certainly doesn't mean they all make sense, but we believe there are some that have. For example, the merger of Chemical Banking Corp. and Manufacturers Hanover strikes us as an eminently sensible deal.
I mentioned that I thought the optimal size has moved up in a merger partner. In today's world, odd as this may sound, to merge two smaller franchises to create a bigger one with more market share and more appeal to someone outside the region could well make sense in certain markets.
Q.: Are there any mergers of equals being done with an eye toward being acquired?
FLOWERS: There are people thinking about that, yes.