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The Sun Also Rises

Nomura is back and building in London. What, again?

Few investment banks seeking to build a European business have experienced the ups and downs of Nomura. The giant Japanese brokerage was one of the leading Eurobond underwriters in the late 1980s but faded when Japan’s bubble economy burst. The firm enjoyed a resurgence of sorts in the ’90s, when the principal finance business, run by Guy Hands, pulled off a string of blockbuster deals, but the bank parted company with the British financier after a hotel investment turned sour.

Now Nomura is hoping it’s third time lucky. It is making a big play to build up its European capital markets business and become the “Asian house of choice” for European companies. Nomura executives want it to be the first firm that European CEOs think of when seeking access to Asian markets for capital or acquisitions.

“From the point of view of a European CEO, Europe and the U.S. can be covered by bulge-bracket banks, but who can cover Asia?” asks Yugo Ishida, CEO of Nomura International, the firm’s London-based European arm.

Nomura wants to be much more than just a conduit for Japanese capital. Executives want to build a capacity and a reputation as a trusted adviser able to do purely European deals.

A beaming Hideaki Sunaga, former co-head of investment banking in Europe (who relocated to Tokyo this month to develop the firm’s Asian merchant banking business as chief of business and planning for Nomura Holdings), proclaims Nomura’s ambitions to be part of a broader Japanese economic resurgence. “We’re reviving the dream we had in the 1980s of becoming a truly global securities house,” he says. “After this long deflationary period, it’s our turn in the sun.”

Adds Barry Nix, the ex–Bear, Stearns & Co. bond salesman who co-heads Nomura’s European trading operation: “There’s no other investment bank left in the world that is an undisputed leader in its home country yet hasn’t built its nondomestic business to a credible size. What we have here is a fantastic opportunity.”

Nomura’s logic in targeting Europe — and eventually the U.S. — is hard to fault, and certainly the timing looks favorable. Japan is making a robust recovery from its lost decade of deflationary stagnation, and signs point to newly confident Japanese investors putting a larger proportion of their ¥12 trillion ($103 billion) of savings into stocks than the current modest 11 percent. “If that share would only double, it would create enormous earnings potential,” says Christian Thun-Höhenstein, 46, Nomura’s co-head of investment banking in Europe.

What’s more, there has been a wave of cross-border M&A deals between Asia and Europe. Japanese firms’ overseas acquisitions hit a 15-year high in 2005. Starting in 2007, a new corporate law will allow foreign acquirers to buy Japanese companies using stock rather than cash. New provisions will also allow acquirers to squeeze out minority holders more easily, facilitating the M&A process. “Industries like steel, cars and pharma are crying out for consolidation,” observes Kohei Yuki, head of global banking, Japan, at Deutsche Securities in Tokyo.

Nor is the recent volatility in global markets likely to hurt Nomura’s long-term strategy. In fact, it could help by making stable Japanese investors that much more appealing to CEOs, compared with, say, restless hedge funds. “Our strength to European corporates is that the most-active shareholders are now American and European hedge funds,” says Nomura Holdings business chief Sunaga. “European corporates would like some long-term silent shareholders, which is a very common characteristic of Japanese and Asian investors.”

Still, Nomura has done the European tour before, only to beat a retreat when times got tough. After arriving in the City of London in 1986, the firm quickly built a top-five Eurobond underwriting business, arranging convertible and warrant-attached bonds. After the Japanese bubble burst, the firm’s commitment to Europe occasionally waxed but mostly waned.

That history helps to explain why many observers are dubious about Nomura’s latest bid to build a genuinely global franchise, with Europe as a central foundation block.

“Nomura really has to prove that it has the character to compete globally with firms that have traditionally been more dynamic and flexible,” warns Mark Headley, lead portfolio manager of the $450 million-in-assets, San Francisco–based Matthews Japan Fund, which holds a significant position in Nomura. Tokyo, he says, is really where the upside is: “I don’t own Nomura for their global potential — I own them for their domestic strength.”

But another investor in Nomura, Robert McKillop, who heads the £3 billion ($5.5 billion) Japanese equities desk at Standard Life Investments in Edinburgh, gives more credence to the firm’s international assault. “The bank has excess capital, and there’s no reason why Japan, as the world’s second-largest economy, shouldn’t have global investment banking capability,” the money manager argues. Noting that Nomura’s current management has a good track record of allocating capital to businesses with high returns, McKillop concludes, “That’s why I’m watching closely rather than running for the door.”

Nomura’s executives aren’t daunted by the firm’s checkered past, but they promise to learn from it. They are plotting a deliberate strategy for returning the firm to its glory days, rather than a mad dash for growth, as in the 1980s. Executives say they are not contemplating any investment or hiring binges, although they insist the firm will dedicate enough resources to the effort, without specifying how much.

“We’re less likely to be caught up in waves of excess,” contends European investment bank co-chief Thun-Höhenstein, who joined the firm last year from Deutsche Bank, where he presided over global media banking.

Chief operating officer David Benson, who was head of interest-rate derivatives at UBS before Nomura hired him as a risk consultant in 1997, notes that this time around there is a “much clearer understanding of the need to play to the firm’s strengths” in its three core areas: investment banking, trading and merchant banking. “There’s no point trying to compete with Credit Suisse or Deutsche Bank in fixed income, for example,” says Benson, 55. “We simply need to focus on the delivery of coherently packaged Asian products to European clients — products that can be seen as equivalent in quality to the Japanese products we already deliver.”

Nomura’s ambitions are noble, but the firm has a long way to go to fulfill them. Nomura International has been a drag on group earnings for years. It posted a loss of £141 million in the fiscal year ended March 31, 2005, and followed that up with a £114 million loss in the year ended this March. The well-traveled Ishida, 49, an equity salesman by training who has done tours of duty in Bahrain, Hong Kong and Milan, says he wants the unit to break even by the end of March 2007.

The firm also remains a distinctly second-division player in the European league tables, ranking in the low 20s in both debt and equity underwriting. In the more volatile M&A category, Nomura was 16th in 2005 but slipped back to 50th in the first half of 2006.

Yet there is anecdotal evidence of progress. In a deal that Thun-Höhenstein is especially proud of, Nomura in January 2005 helped German development bank KfW become the first non-Japanese issuer to offer a nonyen bond in the Japanese retail market. The bank doubled the size of the deal to E1.1 billion ($1.4 billion) after investors snapped up the bonds, which were exchangeable into Deutsche Post shares.

“We have been working with Nomura for two decades,” says Frank Czichowski, treasurer of state-owned KfW. “Nomura’s growing strength is equally appreciated when it comes to selling our loans — be they benchmark issues in euros or U.S. dollars — in the global capital markets.”

Nomura controls a not-inconsiderable chunk of Japanese liquidity. It is by far the biggest of Japan’s securities firms, with a market cap of $34 billion, more than twice that of No. 2 Daiwa Securities. Nomura has a roughly one-quarter share of Japan’s retail brokerage market and handles more than one fifth of domestic bond underwriting. It is also No.1 in equity and equity-related deals, global and Euroyen bonds and Japan-related M&A deals.

The firm’s revenues rose 43 percent in the fiscal year ended March 31, 2006, to ¥1.15 trillion; earnings more than tripled, to a record ¥304 billion. Return on equity was 16 percent, up from 5 percent in fiscal 2005. Bond underwriting and proprietary trading drove the earnings surge along with some chunky M&A business: Nomura featured in about ¥15 trillion of deals last year, up from ¥11 trillion in 2004.

By rights, a firm with a home base like that ought to be a formidable competitor in Europe and the rest of the world. Where did Nomura go wrong?

COO and strategist Benson admits that the firm’s foreign expansion has been held back at times by its greatest domestic strength: a strong broker culture, handed down from Tokyo. “There are very clear lines of demarcation. You know where the commission is, you know which salesman talks to each client,” he says. But that kind of rigid approach doesn’t wash with today’s corporate executives and portfolio managers, says Benson. “They want capital, they want capital introductions, they want credit lines, they want cross-product netting, they want valuation services,” he observes.

Even during Japan’s economic heyday, in the 1980s, Nomura was never able to take full advantage of its size — at one time, its market cap was almost 20 times larger than Merrill Lynch & Co.’s. The firm’s emphasis was on bond underwriting and secondary trading, mostly in Japanese equities. It never really penetrated that rarefied inner circle of firms that are trusted by CEOs for M&A and corporate finance advice.

When Japan’s economic crisis hit in 1990, Nomura’s top management turned in panic to shoring up domestic operations. The firm’s gaijin-run outposts in New York and London built up niche businesses in areas like mezzanine finance and distressed debt, but none of those activities enhanced Nomura’s wider franchise.

By far the most notorious of these niche businesses was the principal finance operation run by Hands. The banker joined Nomura in 1994 at age 34 after 12 years at Goldman, Sachs & Co., latterly as head of global asset structuring. Hands was given virtual carte blanche to invest billions of the firm’s capital in 15 businesses, from AT&T Capital to Thorn to William Hill.

Many of his deals were successes — Hands’s returns averaged about 60 percent — but in 2001 his luck ran out with the loss of the entire £213 million that Nomura had sunk into Le Méridien, the hotel group. By then, recalls COO Benson, some of Nomura’s corporate clients were expressing concerns over conflicts of interest. In March 2002, Hands spun out his principal financial group into Terra Firma Capital Partners; the London-based firm has since invested around E6.5 billion in such companies as cinema chains Odeon and United Cinemas International; and Awas, an aircraft-leasing operation.

Unfortunately for Nomura, when British and European CEOs think of the Japanese firm, the first name that comes to mind is often that of the flamboyant Hands. “We have a calling card that is generally not well understood by European issuers,” concedes New Zealander Marcus Le Grice, 41, head of equity capital markets and another Deutsche alum. “People scratch their heads and think of Guy Hands, but they don’t think of Asian dominance and why it might work for them.”

Apart from its headlong plunge into principal finance, Nomura International spent more than a decade adrift. It was kept afloat, barely, by its bread-and-butter business of Japanese cash equities, a reasonably successful fixed-income syndicate team, a few profitable niches such as health care and derivatives and its role as an exporter to Tokyo of cutting-edge techniques like principal finance and synthetic collateralized debt obligations.

Parent Nomura tacitly acknowledged that its stratified structure and bloated bureaucracy were stifling deal makers’ entrepreneurial instincts when in April it pared down its board of executive officers from 32 to 11. As important, an all-new group management council now sits just below the executive board, with 17 members focusing exclusively on overseeing their respective divisional and regional operations. (Ishida survived the cull of the main board, reflecting Nomura’s new level of commitment to international operations.)

“It’s a different business model today,” says Sunaga. “Franchise-building is my mission.”

Sunaga’s key recruit was Deutsche Bank’s Thun-Höhenstein, a tall German with an aristocratic bearing. The banker ought to know about building on a firm’s strengths: At Deutsche, which he joined in 1996 after six years as an investment banker at Merrill Lynch, Thun-Höhenstein spent his first few years developing the investment banking franchise from Germany outward under Maurice Thompson and Michael Cohrs.

Thun-Höhenstein helped to pull in other Deutsche bankers. Robert Koenig, who was co-head of European telecom corporate finance for the German bank, arrived in August 2005 to look after TMT clients, and Klaus Pflum, head of Deutsche’s automotive banking effort, joined Nomura in April to head auto and industrial. For the financial institutions beat, the firm recruited the head of Italian and Austrian FIG at UBS, Fabio Massimo Genovese, who arrived in March. Health care, meanwhile, remains the domain of Code Securities, a London-based biotech boutique that Nomura bought last September, following the departure of its own, high-profile health care team to Piper Jaffray & Co. in London.

Indeed, not all the traffic in talent has been inbound. Last month Nomura parted company with Joachim Willnow, head of equity derivatives in Europe, and Stefano Ghersi, European head of debt capital markets, replacing them with co-heads who were promoted from within. According to a spokeswoman, both were casualties of a drive for profitability within the global markets division headed by Barry Nix.

Thun-Höhenstein, meanwhile, has encouraged his bankers to pursue an aggressive sales regime, comparing Nomura’s situation to that of the U.S. investment banks that piled into the U.K. in the 1990s. “You have to actually go out and get business and think cross-border,” he says.

Many of those borders happen to be in Central and Eastern Europe. Nomura’s banking drive is channeled in large part toward CEE, where the fees may be smaller than in Western Europe but where competition is also less intense. Europe Nomura aims to do for companies in Slovenia, Poland, the Czech Republic and Russia what Tokyo Nomura has been doing for enterprises in emerging Asia. For instance, the firm introduced South Korean department store Lotte on the Seoul and London stock markets in February, in the largest-ever IPO by a private-sector Asian company outside of Japan.

The CEE strategy makes a lot of sense: Despite Nomura’s to-ing and fro-ing in London over the past two decades, it has maintained a steady presence in Eastern Europe. One loyal client is Lukas Julinek, group treasurer of Asfinag, an Austrian road-financing company that hired Nomura last summer to comanage a $1 billion, five-year bond to refinance debt that matured in January.

“We see Nomura as an Asian and Japanese house with local distribution capacities and long-term commitment to their natural home market,” says Julinek. “But they’ve also had a long history of serving clients in this region and have always shown strong commitment to them.”

Yet another ex-Deutsche banker, Philip Staveley, who ran the German bank’s emerging-markets cash equity sales, is heading up Nomura’s new team of CEE-geared emerging-markets analysts, traders and salespeople. Their activities should support the firm’s bankers in the region.

Nomura’s global markets division, in London, has more than doubled its head count since 2003, to 350. Among Nomura’s notable additions are 46 equity derivatives specialists, mostly from Merrill Lynch. Global markets co-head Nix says the department’s thrust is no longer proprietary trading but origination and sales focused squarely on clients.

“We don’t have a strategy like Deutsche’s, which is to be all things to all men,” he says. “We have to scale our opportunities and ambitions to ensure that we deliver on our underlying mission — bringing capital flows to our product origination capabilities and marrying the two.”

Nix vows that further expansion will be orderly and disciplined. Last fall Nomura even conducted a cull in fixed-income sales and trading, laying off 25. Ishida blames “overcapacity” and “underperformance.” Still, for some skeptics, the episode recalled Nomura’s old pattern of boom-bust ambivalence.

“Scalability is key,” says Nix, looking sleek and tanned. “Over the past couple of years, we’ve added quite a few business units but haven’t pulled out of any, either. If we need to add people, it’ll be in areas where we see growing opportunities.”

For all of Nomura’s effort to build up internally, it continues to see alliances with other firms as a workable strategy, despite experience to the contrary. In February 2005 the firm entered into a partnership with venerable London merger house Rothschild to get a leg up in cross-border M&A.

The arrangement was similar to those Nomura struck in 2001 with Thomas Weisel Partners, a San Francisco–based TMT and health care boutique investment bank, and with New York blue-ribbon deal-making shop Wasserstein Perella in 1988. Neither venture delivered much, if anything, in the way of deal flow: Weisel has since courted other partners in pursuit of wider geographic coverage; the alliance with Wasserstein was dissolved in 2000, with Tokyo officials stiffly explaining that both sides had “traded sufficient levels of know-how.”

Nomura and Rothschild were hoping to tap into each other’s origination and execution capabilities, but almost 18 months later the venture’s output is pretty feeble: just two modest deals, both sourced by Nomura. One was Japanese car-accessory retailer Autobacs Seven Co.’s purchase of a 5 percent stake in a kindred enterprise, Halfords of the U.K., in December; and the other was Japanese ball-bearing maker NTN’s purchase of a 25 percent stake in German driveshaft manufacturer IFA-Antriebstechnik in April.

Nomura higher-ups are growing impatient. “When Baron David de Rothschild paid a recent visit to Tokyo, every board member asked him, ‘When can we see a ticket from Rothschild?’” recalls Sunaga ruefully.

Unlike the Weisel and Wasserstein tie-ups, which involved Nomura’s injecting large amounts of cash to acquire an equity stake, the Rothschild pact entails no capital commitment. Either side can call it quits with 30 days’ notice.

Ishida is prepared to wait a little longer. “How the relationship develops is the main thing,” says the Nomura International CEO. “It takes time to get to know each other.”

Which could also be said of Nomura’s relationship with European CEOs. To one former corporate boss, Colin Marshall, Lord Marshall of Knightsbridge, who ran British Airways for a decade before becoming chairman of Nomura International in 2004, the Japanese firm is a sleeping giant.

“Since I came on board,” Lord Marshall says, “I’ve found that people are familiar with the Nomura name. It may be that in recent years they haven’t had much contact, but they’re aware of its existence and strength out East.” Ishida’s task is to translate that into strength in the West.