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Merrill Lynch’s Abbas and Hays Discuss Growth & Acquisition Strategy

KPMG

20 July 2005

Two of Merrill Lynch Global Private Client’s most senior managers, James Hays, head of US private banking and investment group, and Ausaf Abbas, head of GPC in Europe, the Middle East and Africa, discuss their approaches to acquisitions. This interview was carried out by KMPG’s financial services practise and was part of a recent survey by the business services consultancy entitled: Hungry for more? Acquisition appetite and strategy in the global private banking and wealth management industry. Q: Our survey revealed that wealth management organisations tend to favour organic growth over growth through acquisitions. Is this Merrill Lynch’s preference too? A: In EMEA we’re looking at both routes. The organic route is clearly one we continue to pursue—we have been hiring, growing assets and building revenue at an organic level fairly consistently. However, one of our strategic objectives internationally is to build market share. In a private client world which is consolidating, we want to be one of the consolidators. We already have the products, systems, processes, technology and compliance infrastructure set up, so we can buy assets and enhance value quickly. We don’t need to buy businesses to fill in gaps: it’s simply that we believe offering scale helps clients. In the US there are significant opportunities for organic growth, as well as select opportunities for acquisition. Organic growth comes from leveraging existing relationships with individuals and institutions. We will continue to grow organically by leveraging scale—for example our advisory services, our capital markets business and our foreign exchange businesses. Our greatest domestic opportunity is continuing to make our distribution more productive. Productivity differences between banks can be as high as 50 per cent: our advantage is the competency and skill set of our advisers and our ability to provide a broader product offering. Q: What motivates you to pursue acquisitions? A: It’s not necessarily about geographic expansion: our private client operation already spans the world. Our ability to create products and provide global research ideas is at the forefront of current practice, so we don’t particularly need to buy in skills. Our main motivation is that, having been through a period of restructuring, we now want to grow our international private client business to a level commensurate with our achievements in the US. Our US domestic business currently accounts for some 90 per cent of our global private client revenue. As a large institution, we have increasing ability and flexibility to pursue this goal by investing organically and in acquisitions. Of course, the performance of the market is highly relevant to the inflow of new capital. The market has been flat recently, but we still expect to have revenue growth. Important factors in our success have been the right size of our organisation and the fact that we have confronted the realities of the business market. That has allowed us to do better in terms of profitability. Banks that have their internal organisations in order are also those that are better equipped when it comes to M&A. Obviously, cultural fit and reputation risk are concerns when we’re looking at an acquisition: certain of the more aggressive institutions have more reputational risk, so the process necessarily involves additional due diligence to find out what we are buying tangibly and intangibly. Q: Can you comment on related growth strategies, such as lift-outs and strategic alliances? A: Whether you go for a strategic alliance or choose to go into a new market alone really depends on the domestic circumstances: the state of development of the local economy, the state of local securities laws and the general view towards foreign investment. Joint ventures can provide some great opportunities. Take our joint venture in India, DSP Merrill Lynch, which has been running since the mid 80s. It began as a capital markets organisation, then developed an asset management business in the late 90s; we then launched our private client business two to three years ago. Current estimates of the potential HNW market are some 400,000 individuals with over $1 million, so this enterprise has given us a local presence in a rapidly growing economy full of potential. We’re also very excited about our new Sino-foreign securities joint venture with Huaan Securities in China, where the potential market is also growing rapidly. Lift-outs are not that common in EMEA, but in the U.S. where the M&A market has not been that active, private bankers are looking at lift-outs as a way to increase revenues. Merrill Lynch has been very successful using this strategy: we can buy the competencies and relationships but don’t have to buy the infrastructure, so we pay a lower multiple. Valuations are sometimes three to four times revenues for an entire company: lift-outs cost a fraction of that. The only drawback is that you may not be able to achieve the scale you want as quickly as you want. Q: According to our survey, domestic deals appear to be more popular than cross border deals. Is this true for Merrill Lynch, and do you see this trend continuing in the private banking sector? A: It’s certainly true in EMEA: there tend not to be that many firms which operate on a pan-European basis, but it’s more a question of activity being restricted by domestic regulations, than a cultural issue. From our perspective we may well make acquisitions in certain countries, and the UK would be of particular interest to us, but in the majority of cases there are no international cross-border firms to buy. The other point is that domestic European players are fiercely protective of their own territory and will do everything they can to limit foreign competitors in their markets. From the U.S. point of view, the regulatory environment and recent investigations have not had a significant effect on M&A domestically or internationally, but it has resulted in much greater due diligence and much greater scrutiny of non-core issues. Q: Which geographic regions do you see as offering particular growth opportunities? A: Everybody sees Asia-Pacific as the hottest area: the Chinese wealth management market, for example, is growing at 10-12 percent a year. Coming out of the Asian financial crisis, the region has seen period of considerable stability. With China becoming the manufacturing centre of the world, other Asian countries are able to act in a peripheral capacity and grow on the back of China’s success, so the wealth generated is quite significant. In addition, lower rates of tax mean clients are able to keep more of their wealth, and there tend to be fewer restrictions on investment outside the country, so people are able to invest their capital around the world with relative ease. Q: Are Asian customers open to a global brand? A: We think so. A lot of people in the emerging economies of Asia are looking to American companies as aspirational models, so having a relationship with Merrill Lynch is something they are quite comfortable with. Q: How do you see the impact of demographic and economic trends globally on the growth prospects for private banking? Do areas where wealth is increasing offer the most opportunities, or are other factors also relevant? A: The Middle East is enjoying a huge wealth boom, with hundreds of billions of dollars of extra money flowing into those economies as a result of oil prices being well above $50 a barrel. As we’ve discussed, the Asian economies are growing and benefiting after four or five years of considerable pain, including Japan, which has finally come out of its long recession. The economies of Europe don’t offer such significant or spectacular growth prospects, but there is a lot of difference between stock and flow: obviously the Asian and Middle Eastern economies are currently growing faster, but from a relatively small base, whereas in Europe there is a great deal of existing wealth that can be deployed and re-deployed. The fact that the population rates are growing slower in Europe than in Asia means that individuals have a lot more wealth in their personal name, whereas in Asia population growth is faster and saps per capita wealth. The other interesting trend in global private banking is the onshore shift, meaning a preference for local private banking providers. As local financial services providers become more sophisticated, particularly in locations like Southern Europe, domestic banks are becoming increasingly popular choices for local high net worth individuals. These local entities are now quite adept at managing significant wealth and can offer services that challenge the traditional value propositions offered by centres of expertise like Switzerland.