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Founders' keepers

Buoyant markets mean a welcome recovery for Cazenove, but can chairman David Mayhew preserve the independence of the last of a line of once-proud British securities houses?

FEW COMPANIES GREW FASTER OR MORE AGGRESSIVELY IN THE 1980s AND '90s THAN BTR. THE company went on an acquisition spree that made it the U.K.'s largest industrial conglomerate. To finance its growth, it relied on the expertise of its longtime corporate broker, Cazenove & Co. Most notably, in 1983 the blue-blooded outfit, whose unrivaled relationships with top companies and fund managers made it the most sought-after -- and most closely heeded -- securities firm in London's Square Mile, helped BTR pull off an audacious £700 million ($1.1 billion) bid for rival Thomas Tilling, then the largest hostile takeover in British history. Cazenove financed the bulk of the offer by arranging a £400 million rights issue, also a U.K. record at the time.

So when Invensys, as the overextended BTR is now known, desperately needed to raise capital to remain solvent earlier this year, to whom did CEO Rick Haythornthwaite turn? Deutsche Bank. The big German bank arranged a massive £2.7 billion ($4.9 billion), five-year package, one of the largest corporate refinancings in the U.K. in recent years. Deutsche underwrote a £625 million high-yield bond issue and a £1.6 billion secured loan. The new money allowed Deutsche, along with Cazenove and Morgan Stanley, to underwrite a £450 million rights issue. But Deutsche took the lion's share -- an estimated £60 million -- of the £80 million in bank fees, reflecting the fact that it had put £2 billion of its own capital at risk, bankers involved in the deal say. Cazenove's compensation was less than £10 million.

In today's brutally competitive market for investment banking services, no firm has an ironclad lock on any customer's business, of course. But to have been relegated to a secondary role on such a vital transaction by a longtime client underscores the stark challenge confronting Cazenove, the largest remaining independent securities firm in the U.K. Lacking the capital or product range to compete effectively with increasingly aggressive global powerhouses like Deutsche, the 181-year-old firm faces a critical decision -- whether to fight to retain its independence and in the process risk further erosion of its role as adviser of choice to British corporations.

"Today's more complex financial markets require banks capable of funding multibillion-dollar businesses across every product area around the globe -- Cazenove can't compete with that," says Ranald Michie, a leading British financial historian at the University of Durham. "Cazenove basically needs to up its game, and unless it wants to continue as a niche player, it will probably need to sell to someone who can help take it where it wants to go."

Cazenove ventured a first solution to its existential dilemma three years ago when it dissolved its partnership and placed a 9 percent stake with institutions as a prelude to an initial public offering. Although many observers regarded the IPO as simply a precursor to an eventual sale, the firm insisted that the offering would give it the financial clout to grow and prosper. But Cazenove's legendary market touch and impeccable sense of timing failed miserably; it was forced to abandon its IPO as the investment banking industry suffered massive cutbacks after the global downturn hit. Cazenove was hit particularly hard because it lacked the diversity, most notably in bonds, to offset the bear market in equities. The firm made its first layoffs in more than 50 years and shut foreign operations it once considered vital to its future.

Today markets are heating up once again, and Cazenove is enjoying a welcome rebound in activity and profitability, but the competitive pressure facing the firm is more intense than ever. Bulge-bracket firms are back in expansion mode, banking giants like J.P. Morgan Chase & Co. are jockeying for position, and European contenders like Deutsche and UBS are aggressively building their capacity. As such, Cazenove is left weighing an agonizing choice. Should it strive at all costs to maintain its independence, or will it follow in the footsteps of other legendary names in British finance, such as Kleinwort Benson, Morgan Grenfell, Schroders and S.G. Warburg, and succumb to the charms of a foreign bidder?

Chief executive Robert Pickering acknowledged recently that Cazenove might dust off plans for an IPO if equity markets remain buoyant. The firm's senior executives, led by chairman David Mayhew, also are weighing informal takeover approaches from bigger rivals -- reportedly including one from Lehman Brothers -- that it would have rejected out of hand just a few years ago. As they consider these options, one thing is clear. With scale and capital more important than ever in investment banking, the status quo is not an option if Cazenove wants to thrive. Mayhew and Pickering declined to comment for this article, as did a spokeswoman for Lehman Brothers.

Cazenove's dilemma is heightened by doubts about the eventual succession to Mayhew, 64, whose fabled client relationships have enabled the firm to punch far above its weight against much bigger rivals. Although CEO Pickering, 44, is experienced, he lacks the depth of contacts to replace Mayhew as a rainmaker.

"Cazenove stands apart in the corporate broker community, and this has much to do with David Mayhew, for whom I have always had a high degree of respect," says Michael Bishop, head of pan-European equity at Morley Fund Management, which invested in Cazenove's 2001 private placement. "The problem is, he won't be there for long."

Capital is critical for equity-oriented firms like Cazenove, and the rise of megabanks like Citigroup has made it all the more important. For London's other independent investment bank, Rothschild, capital is less of a problem because it focuses on providing merger advice rather than underwriting equity or debt offerings. But Cazenove is different -- the equities business has always been its lifeblood. The firm's £370 million in capital is less than 1 percent of the capital employed by Goldman, Sachs & Co., however.

Just as important as capital is sheer scale. The bear market took its toll on global rivals like Goldman, Citigroup, UBS and Deutsche, which slashed their staffs. But unlike Cazenove, those firms had booming fixed-income businesses to fall back on when their equities and advisory businesses were struggling.

Cazenove attempted to bulk up three years ago by dissolving its partnership structure and placing £200 million of equity and debt with U.K. institutions as a prelude to an IPO. The firm used the proceeds to expand its international footprint and hoped the promise of equity would help it continue to attract top talent.

The bear market undermined those ambitions, cruelly exposing Cazenove's narrow base. Revenues plunged by a third, to £213 million, in the fiscal year ended April 2003, the firm's most recent published results. Advisory fees dropped 40 percent, to £57 million, and underwriting commissions fell 37 percent, to £25 million. The equities business also suffered from declining trading volumes, with revenue falling 21 percent, to £95 million. Cazenove's fund management arm, which handles $13 billion in assets, including some of Queen Elizabeth II's money, also was hit hard by the market's slide and the loss of investment mandates. Revenue there fell 27 percent, to £36 million.

The sharp slowdown in revenue caused pretax profits to plunge 72 percent, to £14 million, and prompted Cazenove to make sweeping cuts. It closed seven overseas offices and shuttered its Japanese and U.S. equities operations. The cutbacks were the first at the firm since 1947, when the government of then­prime minister Clement Atlee nationalized great swathes of British industry, removing much of Cazenove's client base at a stroke.

The recovery of equity markets over the past year has given Cazenove a welcome lift. The firm led in U.K. equity underwriting in this year's first quarter. But the rising tide hasn't solved Cazenove's deeper dilemma. "We are starting to breathe a sigh of relief," confides one senior Cazenove executive, "but we know it won't get any easier out there. The use of capital is clearly a growing issue, and the ability of the big firms to cross-subsidize -- something we could not offer -- had a big effect on the morale, or spirit, across the firm."

LIKE ROTHSCHILD, CAZENOVE OWES ITS EXISTENCE to European emigrants fleeing persecution. Pierre Cazenove, the great-grandfather of founder Philip Cazenove, was a Huguenot who fled France for Geneva at the end of the 17th century after the revocation of the Edict of Nantes abolished Protestants' rights. One of Pierre's grandsons, James, emigrated to England in the latter half of the next century and set up a merchant banking business. In 1789, James Cazenove opened an account with the Bank of England, according to Cazenove's official history. His son Philip was born nine years later. After attending the prestigious Charterhouse school, Philip was introduced to the London Stock Exchange in 1819 as a clerk for broker J.F. Menet.

Four years later the two founded Menet & Cazenove, which worked hand in glove with merchant banks, most notably that of Nathan Meyer Rothschild. According to an official history of the firm by David Kynaston, a noted City of London historian, the relationship was decisive in putting Cazenove on the map and "assuring the early viability" of the firm. By October of their first year, the partners were conducting a large slug of Rothschild's foreign dealings, including nearly £18,000 of Russian stock trading and, a year later, daily trading in French paper of about £200,000 (worth some £10 million today).

Cazenove moved its headquarters last year from an elegant brick Victorian building at Tokenhouse Yard, in the shadow of the Bank of England, to a modern office block on nearby Moorgate. But behind the sleek marble-and-glass foyer and such contemporary accoutrements as videoconferencing hookups, the weight of tradition lives on. Liveried doormen take visitors' soggy umbrellas and hand them back, properly dried and refitted, upon departure. In the afternoons white-gloved valets slip between meeting rooms serving tea (coffee must be specially requested). To reach those rooms, visitors must pass under the austere stare of Philip Cazenove, whose oil portrait hangs over the entrance to the bank's inner sanctum. The rooms themselves bear the names of such illustrious former partners as Forbes, Henderson and Kemp-Welch, men whose faces continue to gaze down solemnly on today's bankers.

Cazenove has moved on from its humble origins, but it is still a pretty simple business. It offers three main services: advising on mergers and acquisitions, underwriting equity issues and counseling company executives on matters relating to their stock prices. The latter, known as corporate broking, is an activity peculiar to the London market and at the heart of Caze-nove's business model. Companies usually employ one or more brokerages to maintain a dialogue with their biggest shareholders and to satisfy regulators. The Financial Services Authority requires all public companies to employ a so-called sponsor broker to comply with listing rules.

"There just is no analogue to corporate broking in the U.S., Italy or France," says Marcus Agius, the senior U.K. partner for Lazard. "Its origins lie in the old days when the London Stock Exchange was a club. The idea was that people agreed to sponsor securities to ensure that they were not dodgy."

Today brokerages have extended their role to act as sounding boards for companies on a variety of strategic issues, including mergers and acquisitions. Many big U.S. and European investment banks, which acquired U.K. brokerages after the Big Bang deregulation of the London market in 1986, provide corporate broking services for free as a way of enhancing relationships with chief executives and peddling more-lucrative services.

"The biggest change since I started just 15 years ago is that back then brokers were all partnerships without capital, which meant that to get deals done they had to go to merchant banks for their capital, or they would come to us because they had a client that needed money from the market," says Nick Donald, head of U.K. equity capital markets at HSBC in London. "Today not only do brokers not send that kind of business anywhere else, they have big balance sheets that they want to deploy themselves to underwrite entire deals, because brokers are all part of integrated investment banks."

Unlike the brokerages that sold out to foreign rivals, Caze-nove guarded its independence and steadily built upon its corporate broking franchise. By the end of last year, it had more broking mandates, 221, than any other U.K. firm, according to Crawford's Directory of City Connections. It added 32 broking clients alone in the 12 months ended April 2003. The firm, which had often advised clients informally on significant transactions in the past, decided to capitalize on this relationship in the late 1990s by creating a separate M&A department under Pickering, who subsequently became chief executive.

Cazenove's steady expansion has paid some handsome dividends. In the first quarter of this year, the firm edged past Deutsche Bank, Citigroup and UBS to rank No 1 in U.K. equity underwriting rankings and ninth for all of Europe, according to Dealogic. It co-managed the first big European IPO of the year, a E770 million ($960 million) deal for French Internet service provider Iliad. Even during 2002 and much of 2003, when the IPO market was effectively closed, Cazenove ranked as the fifth-largest equity underwriter in the U.K. by arranging a handful of big rights issues for companies desperate to strengthen their balance sheets.

Cazenove also has risen in the rankings of British merger advisers. It stood a respectable eighth -- ahead of Citigroup and J.P. Morgan -- in 2003 and rose to third in the first quarter. Last year Cazenove advised British American Tobacco, a longtime broking customer, on the merger of its U.S. cigarette subsidiary, Brown & Williamson Tobacco Corp., with R.J. Reynolds Tobacco Holdings, and it is currently advising Canary Wharf Group as it weighs competing offers from two investor groups, Silvestor U.K. Properties, a consortium led by Morgan Stanley, and CWG Acquisitions, backed by Canadian conglomerate Brascan Corp. and Canary Wharf chairman Paul Reichmann.

The challenge for Cazenove is to build on its U.K. corporate broking franchise and expand abroad to capture a slice of the European corporate finance market. With that ambition in mind, Cazenove dissolved its partnership and sought fresh capital in April 2001 prior to doing an IPO within two years. Senior executives contended that the move would help the firm recruit bankers who could flesh out the mergers franchise and beef up its ability to underwrite securities. "There was a mismatch between reward and contribution," Mayhew explained at the time. "This new structure gives us the ability to involve every single employee."

The logic was similar, albeit on a smaller scale, to that which had prompted Goldman Sachs to go public two years earlier. Goldman's IPO had also showed the partners at Cazenove how lucrative it could be to capitalize on the goodwill of a partnership built up over generations.

Cazenove sold a 9.2 percent equity stake to some of the U.K.'s most prestigious institutional investors, including Axa's U.K. fund management arm, Standard Life Assurance Co., Aviva's Morley Fund Management, Legal & General, 3i Group and Prudential, for £100 million. The placement valued the firm at £1.2 billion, or a whopping five times book value. The 80 active partners put 14 percent of the equity into an employee trust for staff, sold a further 5 percent to 42 rising stars in the firm's executive ranks and gave a small stake to about two dozen retired partners. That left the partners with roughly 70 percent of the equity, valuing their stakes at an average of £11.7 million apiece. Cazenove raised a further £100 million with a subordinated debt issue.

Unfortunately for a firm with such a reputation for market savvy, the decision to incorporate could hardly have been made at a worse time. The securities industry was going through a wrenching slowdown following the collapse of the technology bubble. Then, four months after Cazenove's incorporation, the September 11 terrorist attacks caused markets to plunge around the world. Equity underwriting dried up, except for rights issues that many troubled companies were forced to make by their banks. And in many of those cases, the investment banking arms of those lenders lapped up the lion's share of underwriting fees.

Instead of focusing on growth, Cazenove was forced to retrench. In February of last year, the firm closed its Tokyo brokerage business, which had been successful in the small-cap arena. It shut down offices in Sydney, Geneva, Bombay and four other cities abroad. Most painfully, Cazenove decided to withdraw from selling U.S. equities to U.K. clients and acting as interlocutor for American companies with British shareholders, a business with roots dating back to the 19th century. In September the 15-strong U.S. equity team led by Christopher Middleton left to form Atlantic Equities.

The harsh new environment caught many of Cazenove's new shareholders by surprise. "At the time we made the investment, it's fair to say we were looking for better times in the markets," says Morley Fund Management's Bishop. "That did not happen, though it's getting better now after two years."

The dramatic deterioration in Cazenove's performance forced the firm to forgo its targeted April 2003 IPO, although the subsequent rally in equity markets could revive those plans. In a recent interview with Reuters, Pickering suggested that the company might reconsider a listing once the "recovery pattern is well established" in the equity markets.

For a firm that has been around for nearly two centuries, waiting a few years for an IPO might not seem like such a big deal. After all, Goldman Sachs shelved its plans for a public offering the first time around after the Russian credit default sparked a bond market rout in 1998. But the wait is a problem for Cazenove because of Mayhew's age. At 64, he must be considering devoting more time to the rare breeds of cattle he husbands at his farm in Hampshire. Mayhew remains arguably the most trusted banker in the U.K., and Cazenove is highly dependent on his personal connections with top British executives. That's why his fellow partners elected him as the first chairman upon incorporation and granted him shares worth about £18 million at the time.

Mayhew went to work in the City shortly after graduating from Eton, and left brokerage Panmure Gordon to join Caze-nove in 1969 with a team led by Michael Richardson. Richardson's wife was a cousin of Mayhew's, highlighting the connections that often characterized City relationships in the days before Big Bang. Indeed, until about 20 years ago, Cazenove partners were encouraged to introduce children to the firm. Two descendants of Philip Cazenove work there today -- Bernard Cazenove is a member of the firm's institutional client services team and heads the firm's charitable trust, and Simon Barnes is European equity capital markets chief.

Mayhew's abilities, not his family ties, propelled him up the ranks and into the boardrooms of the U.K.'s top companies. He started out as an equity salesman and in 1986 was put in charge of the new syndicate desk that Cazenove created to handle equity offerings post­Big Bang. Under his leadership the firm grabbed several big privatization mandates from the British government, including National Power in 1991 and regional water companies, while also assisting FTSE 100 powerhouses like Reuters Group and Pearson to sell new equity.

Mayhew also became embroiled in scandal as broker to brewer Guinness on its hostile £2.6 billion takeover of Distillers Co. in 1986. Shortly after Guinness trumped a competing all-stock offer from supermarkets chain Argyll Group, word leaked out from U.S. regulators interrogating Wall Street financier Ivan Boesky that Guinness had contrived to boost its stock price artificially. In April 1988, Mayhew was one of seven people arrested in connection with the allegations. Although the Guinness affair ended the careers of a handful of men, including the company's chairman and chief executive, Ernest Saunders, and his adviser at Morgan Grenfell, Roger Seelig, in retrospect it did little harm to Mayhew's reputation. On the contrary, it may even have enhanced it. Mayhew was made a senior partner at Cazenove in 1994, two years after Britain's Serious Fraud Office dropped the charges. He emerged as a master tactician who played a leading role in most of the big boardroom dramas of the past decade.

In 1999 he was instrumental in persuading the board of National Westminster Bank to sack CEO Derek Wanless, who had lost the confidence of shareholders, as part of its defense against a hostile bid from Royal Bank of Scotland, according to people involved in the deal. NatWest eventually succumbed, but the move helped to get a larger offer from RBS, which was dueling with Edinburgh rival Bank of Scotland for control of NatWest.

Far from being a ruthless investment banker in the American style, Mayhew exemplifies the genteel and discreet tradition of British banking at its best. A rail-thin chain-smoker, Mayhew rarely gives interviews and is described by clients as circumspect. In between drags on one of his Silk Cuts, he often speaks so softly that one has to lean in closely to hear what he is saying.

But one of Mayhew's traits, according to people who have worked with him, has been his unwillingness to part with some of his long-standing relationships. Rather than hand off major clients to up-and-coming executives, Mayhew has insisted on being "a complete control freak," according to one banker.

Cazenove does have a deep bench of experienced bankers, led by Pickering. A former corporate lawyer at the leading London law firm of Allen & Overy, Pickering joined Cazenove's fledgling corporate finance team in 1985 and moved two years later to the New York office. He was brought back to London in 1989 to spearhead the firm's attempts to offer merger advice and then took charge when Cazenove created a formal M&A division in 1998. He was a clear choice to become chief executive when Cazenove incorporated three years ago. People who have worked with him on deals say that he is a clever tactician with a good understanding of the technical aspects of transactions. He is also said to be good at harnessing the firm's corporate broking expertise on deals, as he did in 2000 when Cazenove helped advise British Gas on its split into two companies, a regulated pipelines operator and an oil and gas exploration and production business. But for all his qualifications, bankers say, Pickering does not have the vast experience that Mayhew does at cultivating relationships with companies, executives and institutional investors to fill his shoes as a chief rainmaker. Pickering's role has been mainly one of managing -- not bringing in -- the business.

The firm demonstrated as much in July 2001 when Mayhew persuaded his longtime friend and sometimes rival David Verey to join the firm. Cazenove executives had high hopes that Verey, then a senior partner at Lazard's London office and ten years younger than Mayhew, would fill the role of senior rainmaker while the younger generation led by Pickering came into its own. That did not prove to be the case. Verey believed he was hired for a management role, according to people familiar with the situation. He left abruptly in August 2002 and later joined Blackstone Group. Verey declined to comment.

The succession issue will only make it harder for Cazenove to revive its IPO ambitions. The small mergers boutique Greenhill & Co., which is going public in May, goes out of its way in its offering prospectus to emphasize that the firm has a broad mix of revenues that aren't dependent on founder Robert Greenhill, the former Morgan Stanley mergers impresario.

Selling out to a larger rival could be the easiest way to solve Cazenove's dilemma. A firm like Lehman, underweight in equities but with a broader array of products in debt markets and structured finance, could exploit Cazenove's corporate relationships. So, too, could a British or European bank looking to bulk up in London. Barclays Capital CEO Bob Diamond has told staff he is interested in beefing up his firm's advisory capabilities. The trend among investment banks to integrate their debt and equity capital markets activities to better serve clients has prompted Barclays Capital to consider a return to equities, which it exited with the sale of BZW to Credit Suisse First Boston in the late 1990s.

But selling out would not suit every-one inside the firm. Traditions run very deep at the independent partnership Philip Cazenove founded when George IV sat on the throne. Until five years ago female employees were discouraged from wearing trousers. Men are still sometimes chided by Mayhew's longtime secretary for wearing loafers to the office (shoes without laces were considered "slippers" in the firm's old dress code) -- though Pickering often wears his own pair to work. American accents are still rare within Cazenove's headquarters. And it was only a few years ago that Cazenove gave up its large partners' room with keyhole desks. But it is not just older staff members who fondly reminisce about the good old days of bowler hats and pinstripe suits and fret over being sold. "We always said we were not religious about independence, but it's key to what makes us different," Pickering told Reuters in January. That difference means being able to provide advice to clients without the conflicts inherent at larger investment banks that have lending, derivatives and proprietary trading business, Cazenove executives maintain.

Some younger executives privately express worries that the value of their stakes will be depressed in the current market, given the poor results of the past two years. The 42 younger executives who acquired a 5 percent stake back in 2001 did it with money borrowed from the firm. Cazenove will not disclose what price they paid except to say that it was "substantially" below the 500 pence a share paid by the institutional investors. The firm holds an internal market for its shares four times a year, and they traded at 250 pence last July. The price has improved with the recovery in equity markets and Caze-nove's business. Sources say the shares traded at 350 pence in March, the most recent session.

Many Cazenove executives believe the firm can still make gains in the equities and mergers league tables, both in the U.K. and in the wider European market, on its own. Indeed, while Cazenove was closing offices in distant markets, it opened them in Paris and Frankfurt and scored some early successes. Cazenove snared the role of joint lead manager of the Iliad IPO through its new Paris office, thanks to its experience in handling the offering of British Internet service provider Freeserve five years earlier. Cazenove also advised Procter & Gamble on last September's E7.6 billion takeover of German hair-care products maker Wella, a relationship that originated with its U.S. equities team and was nurtured by Alexander Klemm, the former UBS banker Cazenove recruited to open its Frankfurt office last year. The firm also boasts profitable equity businesses in South Africa, where it has operated since 1972, and in China, where it is leveraging off a Hong Kong presence established 30 years ago. The latter has been particularly active in China's booming equity capital markets. So far this year Cazenove has co-managed the IPOs of Tom Online, worth HK$1.5 billion ($192 million); China Oriental Group Co., at HK$2.2 billion; and Shanghai Forte Land Co., valued at HK$1.7 billion.

Cazenove bankers have also debated the possibility of expanding in other product areas, such as using the firm's balance sheet more aggressively to underwrite high-yield bonds, according to sources at the firm. And Cazenove Fund Management is beginning to come back after a rough three-year spell in which performance lagged badly and assets plunged by more than 50 percent, to less than £6 billion. In 2002 Cazenove recruited a new chief executive for fund management, Andrew Ross, and a new chief investment manager, Tim Russell, both from HSBC. Last year Cazenove Fund Management won mandates to manage £1.5 billion of new assets, and its flagship UK Growth & Income Fund beat the FTSE all-share index, its benchmark, by 4.3 percent. As a next step, Ross is considering using the firm's strong brand in the U.K. to launch private banking services for wealthy clients.

Add up all of these arguments and it's easy to see why many of Cazenove's executives and bankers want the firm to continue as an independent entity. But as University of Durham's Michie points out, that could be a risky strategy. It is one thing for Cazenove to focus on a niche like U.K. corporate finance. But, says Michie, "firms that can work within the entire corporate capital structures of companies all around the world will get more and more of the business."

That argument isn't lost on Cazenove insiders. As one veteran executive puts it: "We do not wake up every day saying independence is all that matters. It's about adding value for our clients. When we decide that we can no longer give clients what they need or want, then we will have to consider all options."

If deals like the Invensys refinancing are any guide to where Cazenove is headed, it's a good bet the U.K.'s last remaining independent won't remain that way for much longer.