>Achleitner's new brilliant move, or his disaster? Daniel, please don't be
>so coy: who was gliding along in cloud-cuckoo-land, and who is now fishing
>in troubled walters?
>HK
OK, OK, man, give me a couple of minutes to write it :-) Here's the work so far on a note which has already destroyed a good night's drinking, and looks like it's making an attack on the possibility of sleep tonight. I'm posting the first 2500wds -- the rest is probably gonna be speculative, dull investment shit. Not to imply that this extract isn't dull too (and, I alarm myself to notice, written in a pretty horrible sub-FT journalese to boot). But all the facts are there, and this is what I think. The title of the note is going to be "Beyond Good and Evil, part II" (part I being my original note on this merger).
Beyond Good and Evil, II -------------------------
After a great victory ? What is best about a great victory is that it rids the victor of fear of defeat. "Why not also lose for once?" he says to himself; "now that I am rich enough for that."
Friedrich Nietszche (1844-1900)
While staring in the face of the prospect of achieving critical mass in both investment banking and retail banking, at a very attractive price to its shareholders, Dresdner Bank has managed to throw away the entire deal, seemingly for the reason that it did not like Deutsche's attitude toward Dresdner Kleinwort Benson. The reasoning behind this decision is difficult to fathom ? it seems that the management board was opposed to the chief executive, and one wonders whether such a deep rift can ever be healed. However, the fact appears to be that the deal is dead, calling for yet another thorough reassessment of the sector. To a certain extent, it is now necessary to reverse some of the decisions in our recent note on the German banks, the first "Beyond Good and Evil"; however, we maintain a distinctly more negative stance on the sector than we had before the beginning of this whole sorry episode, and given that there are stocks like ABN AMRO, BNP Paribas and Barclays in the European investment universe, we would not blame anyone who decided that they would rather not be involved with the German sector at all.
Moving on from here, we have decided to relax our aggressive Sell recommendation on the German banks, mainly because it is so difficult to make any definite calls. Commerzbank remains a Sell, because the problems which the Deutsche/Dresdner deal gave it have only been pushed a year into the future at best. Dresdner is moved to a borderline Hold/Sell ? its fundamental weaknesses are very great, but we are nervous about being outright sellers because of the possibility that Allianz will arrange a takeover for it. Deutsche is moved to a weak Buy, as the breakdown of the deal gives it a way out of a bad transaction; however, much will depend on the management's reaciton to the collapse of the deal.
The only really clear story in Germany is HypoVereinsbank, and this would be our pick of the sector. If we had to own just one German bank, we would definitely pick the only unambiguous gainer from the whole messy situation. But, we repeat, there are enough good stocks outside Germany that one might be forgiven for giving up on the entire sector until the mists clear.
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(superscript: Investment summary)
An unholy mess The collapse of the Deutsche/Dresdner deal is an appalling mess. It leaves both banks in need of a new strategy, with Dresdner looking much less likely than Deutsche to find one. It casts a cloud over the judgement of the management teams who put the deal together, including that of Allianz, who are widely regarded as brokers of the deal. And it means that Deutsche and Dresdner are now both in possession of a war-chest, and in search of deals that will bring them critical mass ? a combination of features which investors have learned to fear. All in all, 5 April 2000 was not one of the best days in German banking history.
However, not everything is bad. The Deutsche-Dresdner deal, as we argued in our recent note, was a transaction which had a degree of industrial logic, but an almost complete absence of market logic. Whatever one's views on the future viability of the investment banking-driven strategy which Breuer and Walter had prepared, everyone could agree that this deal was being struck at the wrong exchange ratio (too favourable to Dresdner), and that too much was being given away to Allianz in order to persuade it to allow the deal. Since the deal was bad, presumably its failure can be regarded as good?
Perhaps. If the deal returned Deutsche and Dresdner to their pre-merger positions, we would have to say that Deutsche was now undervalued and Dresdner was, at best, fairly valued ? the difference representing the value that Deutsche proposed to transfer to Dresdner in the skewed exchange ratio. However, that is not the case. Both banks have damaged their businesses during the merger process. Deutsche's aggressive attempts to segregate the rich customers which it intended to keep from the poor ones which it intended to leave in Bank 24 have been difficult to sell to the customers, and anecdotal evidence suggests that Bank 24 will lose market share because of it. Dresdner Kleinwort Benson has, of course, been seriously damaged by the uncertainty regarding its future and it is hard to believe that the temporary stay of execution brought about by the board's decision will steady the ship in any meaningful sense. We have reduced our price target for Deutsche, and continue in our negative view of Dresdner.
The bystanders to the Deutsche/Dresdner deal might offer more attractive investment prospects. We would still avoid Commerzbank, although we are now somewhat less aggressive bears of the stock, because there has been new information about its problems since our last note. At its results presentation, Commerzbank admitted that costs at the London investment bank were still running higher than market forecasts (including our own), and that, partly as a result of the inability of the London arm to hire people at anything less than premium rates, the RoE target for 2000 would be missed ? the fact that Kohlhausen was able to make this statement as early in the year as March gives some idea of the severity of the problem. Although the failure of the Deutsche-Dresdner merger gives Commerzbank some respite in the German corporate market, it still does not look anywhere near covering the London cost base and earning a return on capital.
HypoVereinsbank is a much cleaner story, as it is not a competitor of Deutsche and Dresdner except in the German retail market, and it will almost certainly benefit from the after effects of the Bank 24 "clearout". This stock is our top pick in Germany, although we would not blame investors who decided to stay out of the entire German market until things returned to normality. Of our current top 20 stock picks, only two are German (Deutsche and HypoVereinsbank), and Deutsche is well below the 20% upside which we would regard as indicating a Buy reccomendation (note the reduction of Deutsche price target ? this comes mainly from a higher discount applied to unrealised capital gains, and poorer growth projections for Bank 24).
Figure 1 Top 20 stock picks and upside to recommendations
{deleted, for compliance reasons}
The story so far:
At the time of writing, the facts seem to be that it was Dresdner Bank's decision to call off the merger, that this was a result of an unanimous decision of the management board, and that the sticking point was Deutsche's insistence on selling the Dresdner Kleinwort Benson investment banking business. The first two of these statements came from the Dresdner Bank press release, while the third was confirmed by Rolf Breuer, who said that the refusal to consider selling off all or part of DKB "called into question the logic of the deal". This last statement is perhaps surprising given previous statements characterising DKB as a "jewel in the crown" of Dresdner Bank, and given the extremely low projected staff cost savings from investment banking in the original presentation of the merger, but this just goes to show that the due diligence process of a merger can turn up the most unexpected things.
Stock market reaction Perhaps surprisingly, the market's instant reaction to the breakup of the deal was positive in both stocks ? although given the complexity and uncertainty surrounding the deal, and the fact that the original announcement of this merger was also received positively by the market, we should probably be wary of reading too much into this fact. Dresdner bank is now back to almost exactly where it was the day before the two banks announced that they were in merger talks ? Deutsche is still some way below this point:
{chart not included}
Deutsche Bank has stated that it is not in talks with any other banks, and has no immediate plans to do any alternative deal. Dresdner has made a somewhat weaker statement ? one board member has stated that there is "no plan" for Dresdner to carry out any sale of Kleinwort Benson, while the Dresdner Bank press office has refused to comment on rumours that Citigroup
is planning to bid for the entire Dresdner Bank group. The "no comment" stance is in line with Dresdner's history ? in the past year, it has refused to comment on rumours about BNP, HypoVereinsbank and Chase Manhattan; on the other hand, they admitted that the talks with Deutsche were going on on the same day the original rumour was published in Bild. It seems somewhat far-fetched to think that any outsider to the Deutsche negotiations could have been running the slide-rule over Dresdner during Deutsche's due diligence process and kept the matter a secret, so we tend to be sceptical of these immediate rumours; however, this is certainly not to rule out a takeover of Dresdner in the very near future (see below).
The Blame Game At times like these, exercises in blame assignment are likely to be both unfair and unproductive for the companies themselves. However, for investors, it is crucial to know who caused which problems which led to the breakup of the merger, because this may give some indication of what the players involved intend to do in the future. So, with as many caveats as it is possible to make, given the early stage and lack of concrete information, below we give our assessment of what went wrong.
Dr Rolf Breuer (Deutsche Bank)
Breuer cannot be blamed for wanting to sell DKB, or at the very least break it up, keeping the corporate finance team and losing the rest. Dresdner KB was a very similar investment banking business to Deutsche's existing franchise, but less powerful a player. Breaking it up was the natural, sensible thing to do, and we can only assume that the "jewel in the crown" remark was an unfortunate rhetorical flourish in response to a question which Dr Breuer had been hoping to postpone answering.
In many ways, the part of the responsibility for the collapse of the talks which can be laid at the feet of Deutsche Bank was a result of its earlier success. The integration of Bankers' Trust had astonished the market, set new benchmarks for speed and efficiency, and gained Deutsche a new reputation for being "good at acquiring". The secret of success in integrating BT was the speed with which the execution process was forced through, and the immediate imposition of the new corporate identity and culture (one can argue that this tactic itself was a result of the previous disastrous experience in trying to take things slowly at Morgan Grenfell). However, it appears in hindsight that in order to work, the speed-driven approach to merger integration relies on having the right kind of culture at the target company. The BT investment banking businesses which Deutsche acquired did not have a particularly strong culture of their own ? the majority of staff were there as a result of BT's previous takeovers of Alex Brown and NatWest Markets. With Dresdner Bank, in retrospect it seems that the Deutsche Bank integration team may have severly underestimated the cultural resistance.
The failure of Breuer's grand strategy to break into the big league has obviously raised questions about his future as chairman of Deutsche; however we do not see any need for him to go. He should actually be believed when he claims that his interest is in running a goo dbank rather than a big one, although Deutsche Bank's actions in the past perhaps give little evidence that this is the case. The Dresdner merger was a strategic move aimed at profiting from changes in industry structure, as we argued in the previous note. However, there are other trends at work in the banking business, and not all of them require such grandiose strategy. Since the failure of the deal was not Dr. Breuer's fault, we suspect that, like Michel Pebereau at BNP Paribas, he will just return to playing the hand that fate has dealt him.
Herr Bernhard Walter (Dresdner Bank)
If the market rumours are to be believed (and indeed, if we are to make any sense of public statements), Herr Walter is actually fairly blameless, notwithstanding the fact that it was Dresdner Bank which pulled the rug from under the negotiations. The fact that the management board was unanimous in rejecting a deal which the chief executive was so closely identified with implies that either the CEO's public statements concealed a reality completely at odds with the picture given to investors, or that Dresdner has had a boardroom revolt. Given the recent history of the Dresdner bank board (the public disagreements in the German business press, the collapse of talks to integrate Dresdner's retail bank with Bank 24 last year, the on-off HypoVereinsbank rumours, etc), we suspect that the latter is the case. In either case, however, Walter's position looks decidedly shaky.
Dresdner's problem was that it lacked a strategy before the Deutsche merger came along, and seemed to go into the deal for want of alternative ideas. As a result, it seemed to overlook the implications for staffing and directorships of a merger with a bank whose overlap with Dresdner's own business was almost total. This perception gap, coupled with the recent traditions of political in-fighting on the Dresdner board, plus the unhealthy relationship with Allianz, was a recipe for disaster. Looking forward, Dresdner still lacks a strategy, and any potential acquisitor with significant overlapping business lines would do well to poner the reasons why the Deutsche deal fell apart.
Paul Achleitner (CFO, Allianz)
Although Achleitner is not the head of Allianz' management board, the former Goldman Sachs financial analyst is widely regarded as being the man behind the Deutsche-Dresdner deal. Having responsibility for the management of Allianz' strategic industrial shareholdings, Achleitner was a key player, both in causing the deal to happen, and in defining the strucutre of the deal ? a structure under which a significant amount of value was transfered from Deutsche-Dresdner to Allianz in exchange for lifting its opposition to the deal.
Again with the benefit of hindsight, the strucutre of the deal was a little bit too rich for Allianz to be robust. The fact that Deutsche had to more or less give away its fund management arm DWS and its insurance subsidiary Deutsche Herrold, and give Allianz a shareholding in Bank 24 as payment for Allianz' release of its stake in Dresdner Bank, meant that there was much less value in the deal for Deutsche Bank than there might have been in a simple link-up between the two banks. For this reason, having made so many compromises already, Deutsche was unwilling to compromise further on the issue of Dresdner Kleinwort Benson. It is also possible that as an ex-corporate financier, Achleitner was too keen on the elegant (if overcomplicated) structure of the deal, and underestimated the cultural differences between Deutsche and Dresdner ? two banks whose rivalry has always been intense. As an illustration of the difference between arranging deals for a fee, and carrying them out on one's own account, Achleitner's involvement in the Deutsche/Dresdner transaction is hard to beat.
If you've reached this far, send me an email offlist -- a bit of moral support on these allnighters is always welcome.
cheers
dd
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