Next time an investment bank is asked to provide a private equity client with some bridge equity, they should think very seriously about saying no.
This is the stand Merrill Lynch took on KKR’s £11.1bn buy-out of Alliance Boots. The bank had both an advisory and a debt finance role, but was the only one out of seven not to participate in the bridge.
With the private equity crowd threatening to pull other lucrative mandates from those banks reluctant to underwrite the equity, no wonder their nerves are shot.
True, at one time or another, all investment banks have to provide clients with competitive, low-margin products to keep them sweet.
Two years ago, many rushed into block trades, whereby the banks sold large chunks of shares on behalf of governments and large companies.
The banks would buy the stock themselves at the outset and take it on to their books. If all went well, they could make a profit. If it didn’t, they were left holding a large slug of stock.
But bridge equity may be one product innovation too far and it is dangerous for private equity to brand those banks that choose not to participate as cowards.
Indeed, the bigger and more complex the deal, the more banking firepower is needed, so in the end, it is unlikely that those banks that refuse to provide one product will be frozen out of future deals.
It is all beginning to look like the Russian roulette scene in The Deer Hunter in which the Vietcong forced their American captives to play the “one shot kill” for their amusement and made bets on who would die first.
Instead of risking their lives with a lethal bullet, the investment banks are being forced to wager their balance sheets — and all for a paltry 1 per cent underwriting fee.
Other banks might try to argue that they can easily place the equity, even if it is the private equity client that dictates who to sell to first. But in a market as frenzied as this, there will eventually be one difficult private equity deal where the bank is left holding the equity and trying to plug the hole blown through its books.
lina.saigol@ft.com
