Monday, 22 February 2010

When is too much, too much ?

How do you price services which are very exclusive and for which there is no possibility of a real market ? Is there some such thing as a “fair price” or is that concept an oxymoron ? Does public opinion on what constitutes “excessive” have any role to play ? Should pricing have any relation to cost at all ? Not easy questions to answer. Welcome to the world of investment banking.

The case that triggers this post is a legal suit filed by JP Morgan on Consolidated Minerals (ignore who they are for the purpose of this issue), in an Australian court. The case relates to the acquisition of Consolidated Minerals, a mining company, by Palmary for A$ 1.3 bn. JP Morgan was Consolidated Minerals' advisor in the acquisition. But the new owner, Palmary has a dispute on what fees must be paid by them to JP Morgan. Palmary believes that JP Morgan’s fees should be A$ 7m. JP Morgan believes it should be A$ 50m. Hence the dispute.

Its extremely rare for investment banking fees to be brought to court. It’s a rarified and secretive world, which usually settles its fees in cosy chats. The amounts involved are huge. In big M&A transactions, fees would routinely be in hundreds of millions of dollars. The fees are usually a percentage of the size of the transaction and since acquisitions are routinely in many billions of dollars, the adviser’s fees are also massive.

But there is growing criticism that the fees are “excessive”. Herein lies the rub – who, if anyone, is to determine what is excessive ? In a normal free market, you would say its none of anybody’s business. But as I observed before, its not a free market – in fact its not a market at all. Its all cloaked in secrecy. Does just that fact justify intervention by anybody ?

One thing is certain – the fees bear no relation to costs. But then in a million other products and services, the price bears no relation to cost. In the case of M&A adviser’s fees the costs are probably less than 5% of the fee amount. That, by itself, is no argument for saying the fees are excessive. The difficulty is that fees of many millions of dollars does seem usurious; there’s just no way it will not attract attention. Especially since it usually one of the most profitable lines of a bank leading to large bonuses, which the public and governments seem to be very agitated about.

Defenders say that as long as a company is willing to pay the fee, it’s a matter between the company and the adviser and everybody else should keep their noses out of the matter. There is a lot of merit in this position. If at all anybody should object, it should be the shareholders of the company - they are the ones with the power to restrain Boards from paying excessive amounts. And they should exercise that power, and not merely keep quiet.

But the socialist bleeding heart that I am, I have some qualms. I have had some insight into this business in a previous avatar. With a few shining exceptions, the “advice” the many investment banks dole out is often trash. That they should be paid many hundreds of millions for this, doesn’t sit easily, even though the economic rationale for it may be somewhat strong.

I have some difficulty swallowing the pricing of different services in the banking world. It does look a bit too much. But then, when is too much, too much ? And who is to say so ?

14 comments:

  1. /It does look a bit too much. But then, when is too much, too much ? And who is to say so ? /


    Depends on who is getting the money and who is giving it :D :D :D

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  2. xchactly as "gils" says, it depends on the buyer and seller.IMHO it is applicable to all business, not just banking. My Mom finds it difficult to swallow the prices of saravanabhavan hotel. I am also sure that even any other hotelier at a non-metro would feel the same!

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  3. Payments for services are always a hard one and I think the payers succumb because the transaction is big for them and they would rather stick with the "experts". Case in point - why do I have to pay 5% as broker's fee when I sell my house? That is clearly too much but the alternative "sale by owner" is suicide in this market.

    But back to the banks. Another interesting question is why IPO auctions, with a minimal role (and fees) for the investment banks never took off (Google was the only real high-profile IPO auction). Especially since the bookbuilding process, where investment banks build demand for the IPO in return for fat fees, is seen as basically flawed and not fair to all investors. But there is still some apparently valuable service that the banks are providing and doing an auction without too much hand-holding by the banks is risky for all parties. Does it justify the fees? I don't think so. But companies are caught in their grip and maybe the current mood is right to question them.

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  4. Interesting!!! Wouldn't there be a clause in the legalese between JPM and Consolidated Minerals when the folks start the negotiations for the upward merger. x% would be the charges for consultancy provided the business is sold for m million, and range it accordingly from there for a higher or lower price of sale. All said, it seems to me like a 2 parties involved control and negotiate what they want to offer and what they want to get.

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  5. @gils - Very true - But still the millions .....

    @zeno - Very apt observations. It is indeed true of all businesses. Its just that the scale in investment banking is so huge that it starts to jar. And there really isn;t a free competition - its all a cartel.

    @J - you echo my sentiments. I can't put a logical argument to it, but somehow the fees in the banking industry seem "excessive".

    @RamMmm- Well typically in engaging an adviser you never do the paperwork until well after the deal is over ! Its all wink and nod and its considered indecent to talk fees up front. In this case, the wink and nod was between JP Morgan and the Consolidated Board, who at that time had the mandate to increase the value for their shareholders. Once the acquisition is complete, the acquirer actually has had his interests acted against by JP Morgan. The acquirere sees no reason to honour the wink and the nod. Hence the legal case.

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  6. Interesting point. It is easy to say "Caveat Emptor" etc but that is just a nostrum. My own fairly recent experience is that firms and boutiques dispensing "advice" do not be fair and upfront with respect to costs. For entrepreneurs like myself, this is hugely unfair. We have been hit very hard by a European firm with whom we worked on the basis of an assurance. However the size of the fee is not the issue - it is how much to do you want to pay a soldier of fortune to stand by your side and reveal the Smith & Wesson tucked into his size 52 waistband when predators come calling. Also known as "hafta" in Mumbai, "protection money" in Mafialand.

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  7. when my grandfather was young, he used to get jackfruit from his friend's farm in kerala. He used assume a cost (not necessarily linked to the market value of the Jackfruit) and do a money order to his friend. It did have a premium to it more so a variable of my grandfather's affordability and his affinity to the quality of the jackfruits. Neither my grandfather nor his friend ever thought whether the price was right or wrong nor did they have a basis to it. But i am sure if the jackfruit was not psycologically not as satisfying as it was, both of them could have found reasons on why there was premium or a discount to the price.

    as far as the response to the socialist behind this post, i would want to awake the capitalist in you and would probably recommend that prices are best left to the buyer and seller and if there is a premium or a discount, it is because both of them feel there should be one.

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  8. Well, when is too much? I guess when the buyer runs out of the budget. There is a black box called budget which sometimes decides prices which are exorbitant and superfluous. Even in few high-profile companies, such kind of inefficiencies still exist. Take the case of media markets.

    What is too much and when is too much? well, as long as urns are full of greens, nothing is too much! Hard but true!

    P.S. - While reading this one, I thought this time around you would defend the case as a capitalist but not this time again! :-)

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  9. @Dada - Very true. These firms somehow radiate the feeling that its very "uncool" to discuss fees beforehand. And then later charge a bomb and continue radiating the air that if you don't pay, you are a neandrathal.

    @Sandhya - Have a problem with being purely capitalisit on this issue. Take this case. Cons Min had engaged them - their shareholders one getting a high price. What prevents the Board from agreeing to crazy fees and the acquirer is left holding the tab even though the "service provided" was against the acquirer's interests ?

    @Vishal - Somehow not able to reconcile to the "nothing is too much" as long as the buyer and seller agree. In that case anti trust law should not exist. Regulatory watchdogs should not exist. The investment banking market, as I have observed, is not a market - its very hush hush, clearly there's a cartel and the buyer does not have the usual safequards - for example you can't go through the normal three quotations principle.

    Btw - am a capitalist in the head and a socialist at heart copying the philosophy of Narayana Murthy, to whom this quote is ascribed to.

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  10. Completely agree with your insights!

    I was actually coming from viewpoint of inefficiencies that exist in this grey area. True, we need regulators. However, there are certain transactions within the framwork where propriety can be questioned many more times and in many instances, shareowners do not tend to exercise powers to prevent such transactions. I wonder how these could be dealt with?

    I completely relate to your socialist heart. :-)

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  11. groundbreaking insights! I too often thing abt the price thats been put upon certain products / services, and sometimes the prices defines the brand, thier high style and next to god nature!

    Sometimes I think its the sheer greediness in different forms!

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  12. @Sri - Only some humble opinion Sri -n thanks for the compliments. Yes there is a lot of greed in all this.

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  13. I know the window is closed here! But let me add something here. I had seen one interview with Ritu Beri once! And she was asked, doesn't she think that her creations are way way too costly, even compared to other big designers in the market? And she said, I am charging for the cost + profit on the dress, I am charging for the 'art'. Those who appreciate art, pay for it! Now Investment Banking may not be as artistic as above, but who is to say? I personally, very strongly feel, my profession is an art too (nobody is willing to pay a bomb for it, is another story! :D)!

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  14. @Deepa - The window is never never closed; especially for you ! Well, it would stretch the imagination to consider investment banking as art, but still . Its all an issue of scale. Any such justification would be tough to justify amounts like $500 m.

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