Outlook: Why the real value is in fund management
Thursday 20 November 1997
What was largely ignored when SBC bailed out Warburg's was that the British investment bank's shareholders were left with the good bit, its 75 per cent stake in Mercury Asset Management. That company was yesterday knocked out to Merrill Lynch for a cool pounds 3.1bn, or nearly four times the amount of the original investment bank. Thus does the child outgrow the parent. In round terms, then, Warburg shareholders eventually secured some pounds 3.2bn of value from their investment, or more than half what Travellers is paying for the mighty Salomon Brothers. Not so bad after all, Mr Warburg.
The really interesting thing about the MAM deal, however, is what it says about the relative values of investment banking and fund management. Merrill Lynch is setting a new valuation benchmark for active fund management by paying 3 per cent of MAM's funds under management. Few deals, in Europe at least, have exceeded 2.5 per cent before. MAM was always going to command a premium. It is by far the biggest independent fund management company in London, and its investment performance, until quite recently, has been outstanding.
However, there is a quite separate theme running through this heady valuation. By Merrill's own admission, there is less and less money to be made out of straight securities trading these days. There could scarcely be a more logical strategy, then, than to buy the customer. Unlike the securities houses through which they buy and sell shares and bonds, fund management companies like MAM are able to deliver a stable stream of high- quality, fee-based income.
In achieving this, the fund manager is in large measure behaving like a parasite on the belly of the investment bank, using its capital and stealing the bank's best research to improve performance. The most successful investment banks these days are the ones, like Goldman Sachs, with their own proprietary trading operations and the ability to charge top dollar for their services. You only have to look at the experience of BZW, NatWest Markets and UBS to know that in general nobody makes much money buying and selling stock on behalf of the fund managers. The value is thus shifting from the trading of securities into the management of the funds.
Merrill's acquisition of MAM raises the old concern about the way control of the City is slipping into foreign hands. In fund management, however, it is genuinely possible to make the argument that what matters is less who owns the business than where it is run from. Merrill is making it plain that the whole of its institutional portfolio management operation will in future fall within MAM's orbit, and that this company will be run on an arms-length basis from London. This deal is therefore more of a gain for the City than a loss.
Furthermore, the barriers of entry in fund management have always been low and the whole business is filled with entrepreneurial opportunity. Look at the way the hedge fund operators have come from nothing over the past 15 years. MAM's disappearance within the belly of Merrill Lynch should create more openings for British-owned independents than it closes. From every perspective, then, it is hard to see who loses from this deal.
A new issue comes unstuck
The market can be a harsh master and its judgement yesterday on Ionica, the upstart rival to British Telecom, has been blunt and uncompromising. Yesterday's 40 per cent plunge in Ionica's share price leaves the company trading at around net asset value. When a company is only worth what its assets can be sold for, that usually implies it is bust. This is a quite breathtaking fall from grace for a company which was floated as recently as July. Forget the fine words and fabulous forecasts of the prospectus. What SBC Warburg must have meant to say was that Ionica would be a basket case within four months.
To be fair, yesterday's markdown in the shares was almost certainly an overreaction and was accompanied by little in the way of volume. The company has pounds 230m in cash, a debt facility of pounds 300m which remains untouched and a bunch of key shareholders who, for now, are locked in still supportive of the chief executive and founding father, Nigel Playford.
Unfortunately, Ionica also has a mountain to climb to restore City confidence and an equally long way to go to demonstrate that the freeze on signing new customers is the result of a temporary, technological glitch and is not symptomatic of more deep rooted managerial and marketing problems. The prospectus in the summer was full to the brim with health warnings, but no-one suspected Ionica would come out in spots quite this quickly. Still less could anyone have anticipated the nature of the illness. The ailment Ionica has gone down with is a computer virus - in this case the inability of its main supplier, Nortel, to develop on time a key piece of software which allows Ionica to increase the capacity of its network.
This will not be sorted out until May which is an achingly long time in the development of a start up business. How many customers will be happy to wait until May as BT nibbles away at prices, is anyone's guess. The more interesting question is how many of the founding shareholders will stick around as the lock-up begins to unravel two months later. Unless Mr Playford is fast on his feet, Ionica's number may be up as an independent force in telecoms.
It's right to give P&O a green light
Fresh from living up to her moniker by stopping Freemans and Littlewoods in their tracks, Mrs Blockit has performed a nifty U-turn in the Channel and allowed P&O and Stena to lash their short-sea ferry operations together. But in doing so she has still managed to disagree with both her Director General of Fair Trading, who recommended outright prohibition, and the Monopolies and Mergers Commission, which recommended a set of behavioural undertakings which Mrs Beckett did not think went far enough.
The decision to permit the ferry merger to proceed, subject to a price cap once the prop of duty free disappears in 1999, is probably correct. The damage to jobs, service and competition would have been worse had Lord Sterling and the Swedes been forced to slug it out to the death with the Channel Tunnel. What the decision says about mergers policy is less clear cut. What is plain is that as long as Mrs Beckett is in the driving seat, the consumer will always be king. The pursuit by Barclays of NatWest looks ever more hopeless.
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