It takes guts to sacrifice $100bn of league table credit and a sack of financing fees in this anxious market, yet Merrill Lynch is right to have done so. The bank refused to lend the Brazilian mining group Vale money to fund a possible bid for Xstrata and as a result, has been fired as its lead adviser.
Here’s what happened: Merrill’s M&A team originated the idea of the takeover and took it to Vale’s chief executive late last year. The bank pledged to provide some of the financing and was formally engaged, along with Lehman Brothers, to advise on the process. But Vale then demanded commitments from Merrill on multiple financing structures for the cash and shares bid which the bank believed were unreasonable. Merrill advised its client – as it was paid to do – that these structures would be bad for Vale shareholders.
And the risk-rated return on the financing made no sense for Merrill shareholders, who are just coming to grips with the bank’s credit crunch writedown. Investment banks are damned if they do and damned if they don’t. They are criticised by shareholders for lending their balance sheets too quickly to buy league table credit, in spite of the risk. But when they try to behave as advisers with the sole interest of best servicing clients and their own shareholders, they are sacked.
The more relevant question is: are Citi, Credit Suisse and Lehman Brothers – Vale’s other lending banks – doing the right thing by betting their balance sheets on one big deal at a time when the extent of unpriced risk for banks is still not known?
Xstrata is not going to sell out cheaply and Vale needs at least $90bn in cash to attract the attention of Glencore, with a 35 per cent stake in the Anglo-Swiss miner. That’s a tall order at a time when banks do not have the capacity to finance more than one large bid and most are tied up with BHP Billiton’s increasingly desperate bid for Rio Tinto.
Merrill is showing its mettle at a key point. No one knows where the market is heading and how much risk has yet to be priced. There’s no shame in being conservative in such circumstances. That’s a lesson Vale should consider before pressing ahead with an offer for Xstrata.
