Thursday, April 13, 2006

Thoughts on the Piper - UBS Deal

Well it seems like everyone loves this UBS - Piper deal. If you don't remember, Piper announced a few days ago that it would be selling its "private client"(i.e. retail brokerage operation) to UBS for $500 million.

Piper's shares have risen quite a bit, amid analyst upgrades and renewed interest in the investment bank's operations.

It seems that Piper's retail brokerage division was a drag on earnings relative to the high growth capital markets business of equity and debt underwriting and M&A advisory services. Piper also stated that it expects to inject the cash received from UBS back into its capital markets business so it can grow this segment. This seems to make logical sense. You sell a division that isn't performing well and you invest the proceeds from the sale into higher margin, more profitable business.

But think about how middle market investment banking works and where Piper's historical place has been. When I think of middle market investment banking, I think of a pretty even split between fees from underwritings and fees from advisory services. Historically the breakout of fees from capital raising and M&A advice may vary from 50/50, but, for the most part, I think it's about half and half. Now, the primary reason a middle market firm is brought on a deal for capital raising purposes is because the firm selling shares often wants to sell some of the stock to retail customers. If you want to sell your shares insitutionally (to Putnam or Janus portfolio managers), it makes sense to use the wirehouse firms like Goldman or Morgan Stanley. This is where I think Piper will "suffer" post deal. How will they do underwritings? They may still be on a lot of offerings because of relationships, but they won't be viewed as having the ability to distribute shares to people that Lehman or Morgan Stanley can't distribute to.

So Piper will now be like a Jefferies in a lot of ways. But then again, Jefferies has a much more diversified business than Piper. So maybe Piper will be like a Greenhill or Gleacher or Lazard or Houlihan or Blackstone. But then again, Piper doesn't have the reputation or rolodex of those NY firms and those firms concentrate on bigger deals. So maybe Piper is like a Harris Williams, but even Harris Williams has a better "niche."

That's why I think Piper is going to suffer following this deal. While the private client group wasn't profitable on its own, the offerings it allowed them to pursue were themselves lucrative. Piper is going to have a tough time surviving in the already crowded world or pure-play middle-market investment banks. As competition gets tough, its natural to see the Wall Street firms come downstream to fish for middle-market deals as well.

So then the other question is, what will Piper do with the cash they get from the sale? Well first of all, the $500 million number is a little low. SNL stated the following: "The transaction, which SNL Financial values at $875 million, including consideration for the branch network's client margin loan portfolio and contingency payments, is expected to produce after-tax proceeds of about $510 million and an after-tax book gain of approximately $170 million."

The cash is expected to be used to reinvest in the business as well as pay off debt and buy back shares. I think the extinguishment of debt and purchasing of shares are great ways to use capital, as it would improve the company's balance sheet. I'm assuming also that the share repurchase is justifiable because the retail brokerage operation was eating up/tying up a lot of the capital. But with regards to investing money back into the business to try to build out the M&A practice, I'm unsure of the results. You see, investment banking , more so than any other business, is a relationship business and not really scalable. Look at Greenhill or Lazard. They are a finanial services company but capital is not insignificant to them. Their value is their employee relationships, brand, and reputation, and, in my opinion, no reinvestment into an investment banking operation can grow that.

It's yet to be determined what will happen to Piper and it's shares. For now, the ride continues for the Company's shareholders.


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