International -- European Cover Story
Deal Mania! (int'l edition)
Suddenly, Europe is awash in mergers and acquisitions. The scale is American, and so is the style: Hostile deals, huge debt, fat fees for bankers. And this is just the start
Milanese investment banker Ruggiero Magnoni has a daily schedule that seems impossible to cram into 24 hours. On one morning in late March, the head of European mergers and acquisitions for Lehman Brothers Inc. is in Munich, closing a deal that will bring Italy's Silvio Berlusconi and Saudi investor Prince Alwaleed bin Talal into the tightly held German media empire of Leo Kirch. Next, Magnoni jets to Milan to strategize on Olivetti's $58.5 billion hostile bid for giant phone company Telecom Italia. Finally, he rushes to London to line up the $24.5 billion financing Olivetti needs. Between meetings, Magnoni, 48, puts the finishing touches on juicy contracts for the team of London-based bankers Lehman has just snatched away from rival Deutsche Bank.
As Magnoni's breakneck schedule shows, merger frenzy is hitting Europe big-time. On Mar. 19, French conglomerateur Francois Pinault launched a bidding war for Italy's Gucci in a direct challenge to luxury-goods baron Bernard Arnault. A few days later, four of the biggest Italian banks announced they would merge into two, creating Italy's first megabanks and leaving former heavyweight Mediobanca in the cold. Meanwhile, the fight in France as Banque Nationale de Paris (BNP) tries to gain control of two rivals rages on. "This is only the beginning," says Magnoni of the dealmaking. "It's going to go on for the next five years."
Europe is seeing a burst of mergers and acquisitions that seems likely to put it on a par with the U.S. in the $1 trillion-per-year league. But just as formidable as the pace and size of deal mania in Europe is its new, cutthroat style. In place of quiet agreements among members of a clubby business elite are ferocious, drawn-out battles over corporate control that leave egos tattered. Newspaper readers are following the sagas like soap operas.CHEAP MONEY. Hostile deals have been standard operating procedure in Britain for years, but until recently they were considered declasse on the Continent. Now, three hostile bids--Gucci, Telecom Italia, and BNP--are playing out at once. At $110 billion, their potential value is more than all the Continental hostile deals in this decade, according to Paul Gibbs, who analyzes deal trends for J.P. Morgan & Co. in London. Wry bankers have dubbed the battle between French tycoons Arnault and Pinault over Gucci "the handbag wars." They are far more impressed by the France's BNP, which is defying the wishes of the Finance Ministry to bid for rivals Societe Generale and Paribas. "Over the past three years, all the taboos have been broken," says Edouard de Rothschild, general partner at Paris-based investment bank Rothschild & Cie.
Like many other changes rocking Europe, the explosion in deals is due largely to the launch of the euro. The single market is intensifying pressure on companies to consolidate and build a Europe-wide presence. Also in part because of the new currency, which brought interest rates down, the Continent is awash in cheap money. High stock prices, too, make stock-swap acquisitions easier to execute."TEN YEARS BEHIND." Hostile deals are dying out in the U.S. Europe, however, is likely to see bitter fighting over the next few years. For one thing, corporate founding families and proud CEOs hate giving up control. At the same time, other bosses see a once-in-a-lifetime opportunity to build empires. Until it becomes clearer who the winners and losers are, bankers say, much of the reshuffling will be done through uninvited moves.
All the instability makes Europe a dealmaker's heaven. For years, investment bankers have been making the rounds of chief executives, telling them they need to strip down to core businesses, then bulk them up to survive the competition unleashed by globalization and the launch of the single currency. Now, that careful cultivation of clients is paying off, and Europe has a shot at becoming the world's deal capital. The reason: "Europe is 10 years behind the U.S." in consolidation, says J.P. Morgan's Gibbs.
Indeed, in France, panicked managers are rushing to restructure before a hostile raider and his clever banker do it for them. In 1998, France ranked No. 2 in Europe behind Britain with $86 billion in mergers and acquisitions, up 31% over the previous year. But during the past eight weeks, the action has taken a quantum leap, with a flurry of deals worth more than $50 billion, including BNP's dual bid and the Gucci fracas. "The French are finally adjusting their clock to the time of the rest of the world," says de Rothschild.
American-style dealmaking, considered dirty business in tradition-bound France as little as five years ago, is seeping into corporate practice. Recently privatized companies have begun to adopt the financial tools of the Anglo-Saxon world to raise capital. And advising on issues such as the sale of assets or a stock-market listing gives U.S. investment banks entree with top management. "The dialogue has grown over the past five years to be more intimate and to include not only financing issues but strategy," says Sylvain Hefes, head of European investment banking at Goldman, Sachs & Co. in Paris.BITTER PILL. That's one reason European companies are increasingly using techniques familiar in the U.S. from the 1980s, both to execute takeovers and to protect themselves. Gucci, for example, lined up Morgan Stanley Dean Witter early on to help defend itself. Last June, when Milan-based Prada snapped up 9.5% of Gucci's shares, CEO Domenico De Sole realized he had to do more. Over the summer, he called Skadden, Arps, Slate, Meagher & Flom senior partner Joseph H. Flom, with whom he sits on the board of Harvard Law School. Could Skadden work out a poison pill to deter raiders? The law firm created an employee stock ownership plan that could be triggered to dilute a raider's stake. That helped in mid-February after Arnault bought out Prada's shares and signaled he would try to control Gucci with just a 34% stake. De Sole says his ESOP defense took Arnault by surprise.
The Americans have brought another innovation to European dealmaking: debt. Olivetti's audacious bid for Telecom Italia will include a staggering $24.5 billion in bank borrowing--making it one of the largest leveraged buyouts ever. Even Pinault's proposed $2.9 billion offer for 40% of Gucci is to be debt-financed. Such monster borrowings are possible because European investors are hungry for higher yields than the 4% or so they can earn from government bonds. For example, the Olivetti debt, which is nevertheless likely to get an investment-grade rating, will likely yield around 7%. The appetite for such bonds makes previously unthinkable deals now possible.
All the capital is like a gun held to the heads of the CEOs of European corporations, particularly former state-owned companies. Until recently, such companies as Telecom Italia or the struggling Dutch electronics maker Philips were virtually immune from raiders. But the lesson of the Olivetti bid is any underperforming company may be takeover bait. "If industries don't restructure themselves, it will be done for them by entrepreneurs or private equity firms," says John K. Hepburn, vice-chairman of Morgan Stanley International Inc. in London.
Smelling blood, American buyout firms such as Kohlberg Kravis Roberts, Clayton Dubilier & Rice, and Hicks Muse Tate & Furst are all either opening offices in London or beefing up existing operations. So far, they have stuck to modest-size deals. But buyout specialists say they are hunting for bigger targets in basic manufacturing, financial services, retail, and media. They may also go after smaller companies scorned by today's European stock investors, who are obsessed with big-cap companies. Alan Jones, head of leveraged finance at Morgan Stanley in London, reckons that there is $30 billion in buyout money alone aimed at Europe. If that money is put to use at a conservative 3-to-1 debt-to-equity ratio, it could fuel $120 billion in buyouts.
Leveraged buyouts and other complex deals can earn bankers far fatter fees than plain-vanilla mergers. On a typical $1 billion LBO, for instance, the merger portion of the fee would be about $4 million. But the bank would be in line for financing fees of up to $18 million, says one insider. If successful, Olivetti's bid for Telecom Italia could produce a stratospheric payday for the banks. The four banks representing Olivetti, for example, may take in as much as $425 million for arranging the $24 billion financing. Of course, they will pay out a good chunk of this as they bring in other banks. Various other fees could bring the total well over $500 million. "It is one big Christmas tree," says a London banker.TALENT RAIDS. No wonder the scramble for goodies is so competitive. Banks are beefing up their merger teams and looking for specialists in hot industries such as telecommunications and leveraged finance. Lehman Brothers, not a big factor in Europe until recently, has been particularly aggressive--for example, in poaching talent from Deutsche Bank. Donaldson, Lufkin & Jenrette, which is leading the Olivetti deal with Lehman, recently grabbed the heads of Salomon Smith Barney's financial services team. "This is one of the biggest investment banking opportunities in a long time," says DLJ Europe chief Martin Smith.
Even a perennial market leader such as Goldman Sachs is hunting for scarce European talent. An executive at one U.S. bank recounts spending the morning making calls to established merger pros in an effort to persuade them to jump ship. Good people, especially Continental Europeans, don't come cheaply. One executive says total compensation of $2.5 million to $5 million per year is the going rate for a seasoned merger specialist.BORDER JUMPERS? A market crash or other shock could temporarily stall the activity, but bankers think that Europe's merger run has a long way to go. For one thing, although the European economy is slightly larger than that of the U.S., Europe has seen far fewer deals. European companies remain substantially smaller than their U.S. counterparts. The average market cap of the top 100 European companies is just $37 billion, compared with $66 billion in the U.S.
What industries will see the next big deals? Telecommunications is a good bet. The industry has seen a wave of mergers this year, but it is still organized largely on a national basis. Cross-border consolidation could produce enormous combinations similar to the Baby Bell mergers in the U.S.
Financial services is another hot area. So far, bank deals have been largely of the in-country variety because the resulting cost savings are easier to sell to the market. Terence C. Eccles, bank merger specialist at J.P. Morgan, notes that in most European countries, only a few domestic bank deals are possible. That accounts for the pace of activity in France and Italy, where chief executives are playing musical chairs in an effort not to be left out. Once this round of deals has been completed, Eccles says, CEOs may turn to bigger, cross-border deals.
With much of Europe using the same currency, such international linkups seem inevitable. "This is the shadow of the euro," say Felix G. Rohatyn, former Lazard Freres & Co. partner and the current U.S. ambassador to France, of the merger wave. "It has inspired a more active and muscular capitalism." The new currency and the competition it has spawned have lit a fire under Europe's companies and their bankers that is likely to burn for many more years.By Stanley Reed in London, John Rossant in Rome, and Gail Edmondson in Paris, with Thane Peterson in FrankfurtReturn to top