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Lifting the veil

New modeling techniques are beginning to reveal one of Wall Street's biggest secrets - what bankers earn for advising companies on mergers and acquisitions.

New modeling techniques are beginning to reveal one of Wall Street's biggest secrets - what bankers earn for advising companies on mergers and acquisitions.

By Justin Schack
November 2001
Institutional Investor Magazine

Secrecy and discretion are the hallmarks of a good merger adviser. Corporations must entrust M&A bankers with sensitive information when evaluating deals, especially because talks often occur between competing companies in the same industry.

The veil of secrecy also extends to the munificent fees companies pay their M&A advisers. Because they are not required to under most circumstances, roughly four out of five U.S. corporations that retain advisers do not disclose fee arrangements in regulatory filings, says Ernie Osle, head of M&A data at New York research firm Dealogic.

That makes it extremely difficult to measure which investment banks are making the most money on advisory work. The most closely followed league tables, produced by Dealogic and Thomson Financial Securities Data, rank advisers by the dollar volume of deals they handle. But not all transactions are the same. Some, though very large, are not as complex and don't require the expertise or effort as some very small, yet highly nuanced, transactions.

"If an adviser has to work through serious regulatory or antitrust issues or has to structure the transaction carefully for tax reasons, if it's a hostile deal rather than a friendly deal - all these things require more work and can cause fees to rise," says Osle.

Ranking firms according to fees captures such nuances. Recognizing this, Dealogic is developing a mathematical model that estimates undisclosed fees, based on a historical analysis of similar deals where fees were made public.

An early look at these rankings, estimating fees paid to advisers only of U.S. target companies this year, reveals significant differences from traditional volume rankings (see table). Volume leader Morgan Stanley, for instance, collected an average fee of only 20 basis points, while Goldman, Sachs & Co. and Credit Suisse First Boston each received an average fee of 44 basis points.

Some bankers question Dealogic's estimates, noting that the variables determining fees are so numerous that accuracy is difficult. Dealogic admits that its model is a work in progress, but it gains credibility from Morgan Stanley's and Goldman Sachs' public financial reports. These show that Morgan Stanley earned $651 million in total advisory fees during the six months from March to August (it did not previously break this out), far behind Goldman's $959 million.

The debate assumes that companies are indeed willing to pay up for advice. So far this year, the percentage of deals with advisers has dropped to 20 percent, from 24 percent in 2000, according to Dealogic. More companies are turning instead to in-house M&A teams.

Some clients aren't content to keep fees secret. They'd rather not pay at all.

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