Emerging markets are the place for investment bankers to wheel and deal during the next couple of years, as bankers in Asia, the Middle East and Latin America earn an increasing share of investment banking revenue.
Emerging markets' share of investment banking revenue has increased both in percentage share and total value over the past few years. In 2005, investment-banking revenue from emerging markets accounted for almost $40 billion, or 16% of the global investment-banking revenue total. Those figures increased to just over $78 billion, a 21% share of the total in 2007.
Emerging markets’ share of investment banking revenue will soar to 28%-30% by 2010, according to McKinsey Quarterly. And depending on how quickly the global financial markets recover, emerging markets will see investment banking revenue growth from $40 billion to somewhere between $90 billion and $115 billion in the five-year period of 2005-2010.
McKinsey’s overall thesis - that emerging markets are coming to represent an increasingly important source of investment banking revenues - appears correct. Emerging market economies are generally growing economically much faster than the West, so opportunities for companies are greater and an increasing proportion of the merger business is happening there.
With high Asian savings rates, current account surpluses, and the piling up of petrodollars, emerging markets represent much of the world’s savings pool. So, it’s not surprising that emerging market investment banking business is growing rapidly, both in absolute terms and as a percentage of the global total.
So we should all rush out and buy Goldman Sachs Group Inc. (NYSE:GS), right?
Not so fast.
First, Goldman Sachs has had huge successes in a number of emerging markets, notably China, but its main business remains with U.S. and European Union companies, and that’s not going to change. Even if its emerging markets business were to expand, it could never be big enough to provide more than a modest uplift over the gloomy prospects for investment banking business domestically.
Second, Goldman Sachs and the rest of Wall Street are hopelessly uncompetitive in terms of costs and fees. They can be undercut, and fairly easily.
Wall Street firms have a habit of relying on superb connections to get the mandates and a dedicated team of top quality salesmen to sell the paper. But with emerging markets being largely separate from the United States and EU, the big Wall Street houses don’t necessarily have the local connections they need. And paper issued by emerging markets often sells to investors such as the sovereign wealth funds, which are again outside the normal Wall Street speed-dial.
Moreover, Wall Street bankers are hopelessly overpaid - recent graduates from the top business schools can start at around $200,000 a year. That makes a lot of emerging market deals off-limits, because they are too small to cover U.S. investment banks' costs.
A merger deal that might make a $250,000 fee just isn’t worth their while - by the time they’ve put analysts onto it, found a buyer and done the legal work, they’re out of pocket. A $250,000 fee is small change to a U.S. or Western Europe investment bank, but in many emerging markets it represents a decent piece of business. What’s more, there are a far greater number of $250,000 deals around in those emerging markets then there are $2.5 million pieces of business.
Local traders and analysts, even with some years of experience, make a fraction of $200,000 Wall Street salaries. That means, for most business in emerging markets, local houses are likely to be much more competitive than their Wall Street brethren.
How to Play Emerging Markets' Growing Share of Investment Banking Revenue
If you want to buy into the dynamic growth business of emerging markets investment banking, you need to invest in emerging markets investment banks. Here are three prime examples (the third of which is primarily a fund manager):
- The Nomura Securities unit of Nomura Holdings Inc. (NYSE:NMR): Japan might not be an emerging market, but its top investment bankers are paid a fraction of Wall Street’s head honchos, even though living standards are similar to the United States. The bad news first: It was horribly battered by the subprime fiasco, but has since exited that business. The worse news: Its top management is obsessed with competing in London and New York, and liable to waste yet more shareholder money attempting to do so. The good news: Nomura has a truly wonderful franchise, as the largest investment bank and brokerage house in the second-largest market in the world. It’s selling at an infinite Price/Earnings ratio, due to its U.S. losses, but only at about 1.2 times net asset value, a very reasonable rating indeed, and about eight times its peak earnings in the last cycle. It doesn’t pay a dividend currently, but I still like the franchise.
- Sun Hung Kai & Co. Ltd. (OTC:SHGKY): This is Hong Kong’s largest independent investment bank and brokerage house, with operations in China and the Middle East. Its shares trade at a prospective P/E ratio of 4.6, and feature a dividend yield of 6.1%. It’s illiquid in the U.S. market, so if your broker deals through Hong Kong, you may want to buy there. Still, you have to like the rating, and it’s particularly attractive for income investors.
- Fondos Provida SA (Chile) (NYSE:PVD): Primarily a funds manager of the privatized Chilean social security funds, the business has diversified to hold investments in fund administrators in the emerging markets of Peru, Ecuador, Mexico and the Dominican Republic. It is majority owned by the Banco Bilbao Vizcaya Argentaria SA (BBV). Its shares are trading at nine times trailing earnings, and feature a dividend yield of 7.6% - again, especially alluring for income investors.