Operating Beneath the Bulge

Big Wall Street and European investment banks are enduring the worst period in years for mandates in Latin America. The multi-billion dollar privatizations, mergers and acquisitions, and bond deals that sustained the banks for the last five years have vanished.

But smaller banks and boutiques, with deals too small to interest the bulge bracket investment banks, are busy. Modestly sized, family-run firms in the region are still looking to make acquisitions and Central American economies are still issuing debt both locally and internationally.

Scot Fischer, head of Latin American investment banking at Tampa-based Communications Equity Association (CEA), says he is seeing a steady flow of business. Since 1990 the firm has booked $20 billion-worth of transactions in Latin America. CEA, which employs 220 people, is now managing its third financing deal for Metronet, the Mexico City-based cable company, aiming to raise between $12 to $15 million in private equity.

“Our revenues are dwarfed by the major houses,” says Fischer. “But we are growing and doing good business.” CEA, which specializes in advisory services for merger and acquisition deals for technology and media companies, bought UK-based investment bank Regent Association at the end of 1999 to focus further on deals in the information technology sector.

Even in Buenos Aires, things are ticking over for Merchant Bankers Asociados, which has just under 90 employees. The firm’s recent deals include working as financial advisor to the Italian insurance company Assicurazoni Generali in its $50 million purchase of a 30% stake in Caja de Ahorro y Seguros, which is owned by the Argentine government. Late last year, Merchant Bankers acted as financial advisor to the shareholders of Embotelladoras del Interior in the 100% sale of the company to Cervecería y Maltería Quilmes for $49 million. In the past five years, the size of the firm’s deals have ranged from $50 million to around $300 million. “The point is that our business has not dropped off in the downturn,” says Pablo Taussig, managing director of Merchant Bankers.

Bob Chandler, a partner at Mexico’s Sánchez-DeVanny Eseverri, a business advisory firm, says, “We’re not making lots of money, but we are making a living. Business would be brisker if a wave of foreign multinationals moved into Mexico. That would be a home run for us.” Sánchez-DeVanny has 50 employees split between its offices in Monterrey and Mexico City.

Others are more upbeat. According to Todd Huckaby of Santiago-based IB Partners, his bank, with its 13 staff, has done $5 billion-worth of deals since its creation three years ago. In late October, IB closed the $129 million purchase of an 18.3% stake in Chilean company Soquimich representing Potash Corporation of Saskatchewan, the world’s largest fertilizer producer.

IB Partners began focusing on deals worth about $50 million and has progressed steadily. At the end of 1999, it worked as the advisor in the sale of 67% of the equity of Parque del Sendero, the largest Chilean cemetery operator, to US private equity investors Latin American Enterprise Fund, for $75 million. IB Partners is currently working on transactions with a cumulative value of more than $200 million for both US and Chilean companies.

Controlling the Top
The bulge bracket firms like Goldman Sachs, JP Morgan, Morgan Stanley and Salomon Smith Barney hold undisputed sway in big-ticket mergers and acquisitions and sovereign debt issues. The 10 largest houses have overseen 90% of debt deals in the last five years. These firms have offices in the region’s business capitals, staffed with highly trained local and international bankers. Furthermore, the bulge bracket firms are the only ones able to combine understanding of local and global market trends, a crucial asset these days as industries such as power, telecommunications and manufacturing become increasingly globalized. And only these big firms have the capacity to manage distribution in all the world’s main financial centers and ensure liquidity in major bond and equity offerings.

However, investment banking is an expensive, capital-intensive business. “This is not a boutique business,” says Francisco Pujol, head of the emerging markets debt team at Morgan Stanley in New York. “You have got to have large amounts of capital to bring a buyer to market or to make a market.”

Still, within the sovereign market investors have discovered a penchant for smaller, less volatile credits. In November, Morgan Stanley advised Guatemala on a 10-year $325 million bond issue. Also in November, Deutsche Bank and Merrill Lynch managed a $250 million sale of 10-year bonds for Uruguay.

The focus on smaller credits is where boutiques make most of their money. Standard New York Securities, an affiliate of the UK merchant bank Standard Bank London, has carved out a niche in Costa Rica, Guatemala and El Salvador. It specializes in depositary receipts, bond deals and commercial paper issues. It also handles smaller but interesting deals. For example, Standard issued $5 million in dollar-denominated trust certificates for the Costa Rican government in early October, following a $45 million issue of dollar denominated treasury bills for the El Salvador government in May.

Boutiques say they offer clients a personal touch that their larger rivals lack. “The big banks fly their people in and fly them out again,” says Fischer, of Communications Equity. “A managing director might be there to get the business, but he most likely won’t be there for later meetings.”

Says IB’s Huckaby, “You’ve got to be on the ground. You cannot be like the big banks and do it all from New York. Local companies need a lot more handholding. I get rung up every morning by one elderly chairman to have coffee and talk about his deal.” Bob Chandler says he goes to “clients’ weddings, their friends’ funerals and their children’s baptisms to get the business. It is the only way to be privy to what is going on in business circles.”

The boutiques claim that their size allows them to be faster and more flexible than the competition. Peter Wallin, senior vice president of Standard New York Securities, claims, “Our smaller size means we can offer a quicker service. And we can adapt to market conditions well. In the current climate, we have redirected our resources to the solid, smaller debtors. That is where the business is.”

Executives at smaller banks say that even though they lack scale, they don’t skimp on service or use structures that are less sophisticated than those designed by the big firms. Many bankers come from the major houses and brought their skills and contacts with them. Huckaby left Goldman Sachs to form IB partners, Chandler spent much of his career at Chase and Mexico’s Banorte. Fischer worked at Chase from 1982 to 1992 and at Citigroup from 1995 until earlier this year.

As well as employing highly trained professionals, niche investment banks sometimes team up with larger partners. Merchant Bankers in Buenos Aires was associated with Salomon Smith Barney for almost a decade and is now associated with Bank of America. “That way we can provide full investment banking services in Argentina,” says Taussig.

Gerardo Sepúlveda, a partner at the Latin American Enterprise Fund, says IB Partners provided top-notch service to the fund. “They offered us local knowledge with training garnered from the big institutions,” he says. “They were fully devoted to us in a way that a big bank may not have been because of the small size of the deal. When you are not doing a deal with worldwide implications, it pays to use a boutique such as IB.”

But how much money do the smaller deals bring? Proportionately more than the big banks make out of much larger deals, the boutiques say. Smaller houses typically charge fees of 3% to 5% of the transaction value, compared with a maximum 1.5% to 2% charged by the major houses. In cash terms, this is much less than 2% of a $2 billion deal. But when big deals are scarce, the bulge bracket firms are hunting for business wherever they can find it.

“There is no rule to say big investment banks won’t go for a $300 million deal, but we face the same amount of work for a small deal as for a big deal,” says Carlos Guimarães, head of Latin American investment banking at Salomon Smith Barney. “The large deals are more profitable for us.”

The battle between big banks for deals to gain league table representation has also brought fees down dramatically. In July, Salomon agreed to underwrite a $710.7 million secondary equity offering of Petrobras shares for the Brazilian government’s BNDES development bank for a fee of .19%.

Lower Operating Costs
The investment banks have high overheads because they are based in New York, must commit capital to ensure secondary market liquidity and because they have expensive payrolls. Although headcount and bonuses have declined on Wall Street, the boutiques still have much lower operating costs. “The salary of an equity research analyst at a major bank can be up to $1 million a year,” says Fischer. “While we do hire researchers for deals, we have access to the industry research of the big banks too.”

According to Huckaby of IB Partners, smaller banks have fewer layers of managment and can charge lower retainers during a deal. “A New York bank charges $50,000 a month plus another $10,000 in travel costs. We charge $25,000 all in,” Huckaby says.

Smaller banks may yet become a victim of their own success. “The progress that the pioneers have made will most likely be copied and followed by others,” says Wallin. “Those who have developed a niche presence may sense more competition in emerging markets.” And that competition may be coming from the giant Wall Street houses, hungry for deals to tide them over a famine of big-ticket deals in Latin America.