An unlikely partnership reveals depth of crisis

"By turning to SBC, Warburg has signalled that its circumstances are rather worse than most outsiders realise."

Warburg and Swiss Bank Corporation are about as compatible as the cat and the canary, or so it seemed in the City until last night. Few investment banks have fought so publicly, and with such venom, as these two over the past couple of years. If Warburg had really had a choice, it probably would have preferred someone else to break into its cage.

But the shocking truth of yesterday's announcement is that the decline of Britain's leading investment bank has gone so far that it has had to take very seriously an offer that in other, prouder, days would have been rejected out of hand. The story of Warburg of late has been a sorry one of drift and decline from its ambition to become a global investment powerhouse, punching at the same weight as the Americans and the big Continental rivals.

The abortive link-up with Morgan Stanley at the end of last year was a humbling moment, when Warburg admitted to itself and the world it could not live up to its rhetoric. Senior Warburg executives have never ceased to talk ruefully in private of the missed Morgan Stanley opportunity, the clearest sign that their hearts were never in the gung-ho talk, for public consumption, of soldiering on alone. With a stream of defections this year, there was no doubt that Warburg was in crisis. But by turning to SBC, Warburg has signalled that its circumstances are rather worse than most outsiders realise.

All the genteel talk of merger that accompanied the Morgan Stanley approach has disappeared. The Swiss are proposing a straight absorption of investment banking and a break-up of the group, giving the Mercury Asset Management subsidiary its freedom.

SBC is the last of the Swiss giants to be seeking to push its competitive presence in the City by acquisition. UBS bought Phillips & Drew, the broker, while Credit Suisse long ago linked up in London with First Boston. SBC has managed to elbow its way into UK corporate finance, past its Swiss rivals, making enemies of much of the City establishment on the way.

But for all its domination of vital areas such as derivatives, SBC remains an outsider in London, deploying the Swiss parent's vast capital resources aggressively to win market share. From SBC's viewpoint, absorbing a bank at the heart of the City establishment is like marrying into an ancient family, and makes dynastic sense.

The key to understanding yesterday's news is the dowry, in the form of capital, which SBC has in enviable amounts but Warburg does not. And capital has become the sine qua non for any investment bank with serious international aspirations. It is a very expensive business.

Warburg's capitulation before this fact marks the end of an era in the City and British investment banking. Even if this deal breaks down, which after last December's fiasco cannot be ruled out, Warburg's days are numbered.

It would be doubly hard this time round to make a convincing display of independence while yet another search is conducted for a buyer. The biggest threat to this deal is simply a counter-bidder, and the rumours about Smith Barney that emerged yesterday may be more than just coincidental.

Where Warburg has been forced to go, others will follow, pushed by those same relentless competitive pressures bearing down on international investment banks. Kleinwort Benson has already put itself up for sale; Fleming, Schroders, Cazenove and Smith New Court cannot be far behind. After SBC and Warburg, no partnership could be too unlikely.

Murdoch may have the last laugh

Rupert Murdoch is renowned for once saying: "I may not be much good at what I do but I'm the best when it comes to [expletive deleted] the opposition". If that was his purpose in all the hype and pre-publicity that surrounded BSkyB's bid for Channel 5, he seems to have succeeded with a vengeance. All the speculation had him bidding uncommercially high so as to ensure success. In the event his BSkyB-led consortium delivered the lowest of the four bids, a measly £2m. Put that next to CanWest's rich offering of £36m and the pair of £22m offers from Virgin and Pearson and the City's gob-smacked reaction is understandable. If Mr Murdoch, for whom Channel 5 holds special attractions, thinks it worth only £2m, what on earth is CanWest doing? Mr Murdoch seems to have bluffed it into bidding too much.

The real value of Channel 5 is much more likely to be what he and his partners at Granada, along with the US cable giant TCI, music and film company PolyGram, European broadcaster Kinnevik and two investment houses, Goldman Sachs and Hoare Govett, pitched in at. Consider the following. The BSkyB bid envisages about £120m for retuning, £20m more than Virgin, and more than double what Pearson says it would have to spend.

A bid of about £20m, retuning costs of £90m and programming costs of £115m a year, according to one model used in the City, would require that Channel 5 win 4.83 per cent of the national television advertising market in the first year of operation, rising to 7 per cent in 2005, just to break even. A tall order.

The BSkyB bid could get away with a much lower national market share in the early days, and still give its shareholders a return on their investment. CanWest, by contrast, will have to create a runaway success with viewers to break even. In the more likely event that it fails to do this, it will be saddled with impossibly high costs. Mr Murdoch may have the last laugh.

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