July 10, 2019

Breakingviews: Wall Street minnows pitch merger nirvana

by Breakingviews.

A couple of Wall Street’s relative minnows are pitching merger nirvana. Chad Abraham, chief executive of Minneapolis-based Piper Jaffray, reckons a $485 million purchase of Sandler O’Neill will double his investment bank’s margins – all without cost cuts or new revenue. That’s a mouth-watering prospect, and potentially powerful marketing for a firm which, when combined, will generate more than half its revenue from advising clients on deals. In reality, though, the tie-up’s returns will just be middling.

That’s not to dismiss the appeal of the acquisition for the $1 billion Piper Jaffray. Sandler O’Neill is one of the top consiglieres to the financial-services sector. By number of deals, it has been the top M&A adviser to the industry since 2012, helped in large part by the fairly frequent unions between small players. Goldman Sachs and other bulge-bracket players tend to focus on larger transactions, which have been more sporadic. It’s likely to be a long-running source of business as the almost 6,000 U.S. banks continue to consolidate.

The target also has a fixed-income business that rarely takes positions to get clients’ trades done. Being so light on capital use is a rarity for this type of operation and will help boost its new owner’s return on equity.

So far so good. But Piper Jaffray needs the help. Last year it only managed an 8.3% return on equity. And its pre-tax margin was a lowly 9%. Compensation and benefits account for a large chunk of that, coming in at 65% of revenue. The same metric at larger rival Jefferies is around 55%, while the likes of Goldman and Morgan Stanley are even lower.

Increasing the pre-tax margin to as much as 19%, as Abraham plans, would put the renamed Piper Sandler in decent territory: well ahead of the 11% posted last year by Cowen but shy of the 26% or more margin that Evercore and Lazard routinely crank out. The merger makes sense for Piper Jaffray, but it’s not enough to transcend its peer group’s performance.


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