State-related investment banks take big hit

For dealmakers, the third quarter went as well as they could have expected -- which was not well at all.

Amid the global credit crisis, investment banks with strong ties to Minnesota assisted in only four initial public offerings, the same number as the previous quarter, according to the Star Tribune Quarterly Deals Report. So far this year, the firms helped underwrite 15 IPOs compared with 35 in the same period in 2007.

Minnesota-related investment banks advised on 50 mergers and acquisitions, only slightly down from the second quarter but far fewer than the 63 deals done in the third quarter of 2007.

The grim numbers underscore the collapse of Wall Street's once mighty financial titans who underwrote hundreds of billions of dollars in deals with the help of easy credit and overconfident investors. The previous three months alone saw the bankruptcy of Lehman Brothers, followed by the panic-driven sale of Merrill Lynch and the conversion of Goldman Sachs and Morgan Stanley into bank holding companies.

"The investment bank [business model] in the United States is pretty much dead," said Peter de Vos, head of investment banking for RBC Capital Markets in New York. Lehman's bankruptcy, in particular, "led to a dramatic downdraft in the market. I don't think there were many people in investment banking [who] saw how quickly things evolved after Lehman. It was on a scale that has not been witnessed since the Great Depression."

Gone are the days when large investment banks can leverage themselves to boost returns, De Vos said. Smaller, niche-focused firms will drive the dealmaking now, he said.

Stock offerings dry up

What little of it remains. IPO activity has essentially ground to a halt as companies are either pulling or postponing stock offerings, preferring to wait out the downturn or seeking private financing. Nationally, there were only eight IPOs in the third quarter and 49 for the year so far, compared with 190 in the same period in 2007, according to New York-based Dealogic, which tracks equity offerings.

"The crisis in the credit markets and prolonged volatility in the equity markets are deterring companies from pursuing IPOs," said Scott Gehsmann, a capital markets partner in PricewaterhouseCoopers' Transaction Services Group. "Issuers will continue to defer equity offerings until some stability is restored and investors regain confidence in the U.S. financial system."

'This is a buyer's market'

By contrast, mergers and acquisitions in the third quarter soared to 2,254 from 1,818 during the previous quarter. However, sellers are accepting lower prices than they would have commanded in previous years, said Scott Richardson, managing director of Houlihan Lokey Howard & Zukin's office in Minneapolis. Still, the sellers probably got far more for their companies selling in the third quarter than if they had waited until after the Wall Street meltdown in October, he said.

"This is a buyers' market, no doubt about it," he said.

Notable local deals included Craig-Hallum Capital Group's $64 million private placement for Dolan Media Co.; Piper Jaffray's participation in a $61.3 million IPO for Beijing-based China Distance Education Holdings and St. Jude Medical's $81.3 million acquisition of EP Medsystems Inc., a New Jersey-based medical instruments maker. Piper Jaffray & Co. advised EP Medsystems.

Investment bankers say recent moves by the Federal Reserve and Treasury Department, including a $700 billion bailout package for banks, are starting to thaw credit markets but investors are unlikely to see a big turnaround for 2009.

In the meantime, firms such as RBC Capital Markets and Minneapolis-based Piper Jaffray & Companies are offering services like restructuring advice to their clients. RBC's De Vos said the company has also been able to hire top talent from Lehman and Bear Sterns, which was rescued from bankruptcy and sold to J.P Morgan Chase in March. He admits the Wall Street fallout allowed RBC to hire people it never would have been able to lure away during the boom years.

The real question is how surviving investment banks will respond to the new competitive landscape.

"The turmoil in the credit markets has changed the business model of our larger competitors," said Jon Salveson, head of investment banking for Piper Jaffray. "We're not sure how these companies will look [in the future.] So how should we change? Our core business is in pretty good shape. But how do we gain share? We definitely have to be able to do that. There is a lot of capacity that has been taken out of the industry. We've got to get our share."

Thomas Lee • 612-673-7744