As the investment-banking subsidiary of one of Canada’s “Big 5” retail banks, CIBC World Markets earns revenue the same way as all investment banks: by earning fees on mergers & acquisitions and debt & equity financings provided to corporate clients.1 The investment banking competitive landscape ranges from the other 4 major Canadian banks (RBC, Scotiabank, TD, BMO), to branches of American “bulge brackets”, to small specialized boutiques. In practice, the Big 5 are typically thought of as the “go to” option for any large deal focusing on the Canadian capital markets, due to the boutiques’ lack of scale and the bulge brackets’ limited Canadian expertise.2
In theory, competitive advantage in this environment could come from having superior knowledge of the markets, broader scale to facilitate deals, and/or better analytic talent. In reality, strict regulatory controls limit banks to using only publicly-available information, the Big 5 are all of similar size due to their relationships with their parent banks, and they all recruit talent in equal measure from top universities. Senior executives have been known to say “I see the same deal proposals coming out of every bank – the only difference to me is the colour of the pitch book.”2
Under this oligopolistic structure, real success in attracting deals rests on two key factors:
- Building relationships – senior executives in target companies must prefer to work with your firm when there is a deal to be done
- Retaining talent – while acquisition of junior talent may be the same across across banks, retaining analysts and associates once they have become more experienced can make a large difference in the firm’s efficiency and analysis quality
Three key aspects of CIBC World Markets’ operating model are misaligned with its business model (and the two key success factors above):
Given the emphasis on fee revenue, CIBC implemented a process designed to drive deal flow, similar to the examples we saw for pharmaceutical companies seeking blockbuster drugs. Managing directors are compensated in part by hitting a target number of meetings held and deal pitches delivered to each client.3 Unlike the pharmaceutical targets, the issue with this metric is that proposal quantity is not correlated with proposal acceptance. Managing directors frequently invest time developing pitches that they (and the analysts working for them) are well aware are not suitable for client management, just to ensure that a meeting occurs.3 This may adversely affect both client relationships, if the client feels as though CIBC is frequently proposing suboptimal deals and wasting their time, and talent retention, when the analysts & associates get tired of spending late nights and weekends developing pitches that do not result in business.
Iterative valuation process
Pitching for M&A business or equity issuances typically includes CIBC’s “suggested price” for an company or asset, and managing directors understand a price outside a client’s expectations likely will not win the deal.3 The valuation process includes an analyst putting together a model and initial value, which is put through several rounds of review for “reasonableness”, during which assumptions are tweaked. The risk is that assumptions (which are highly subjective) are changed until the valuation is in the range to win the business, but in doing so the bank may have misjudged actual market conditions (e.g. the firm’s shares drop immediately post-IPO). In this case, processes designed to win short-term can cause severe damage to the bank’s relationship with that client.2
Analysts and associates are expected to be in the office working through normal business hours (8 am onwards) plus any time required in the weekday evenings and on weekends.3 However, these junior employees are often sitting idle during the weekdays as executive directors and managing directors are out of the office in client meetings, generating work which does not get passed to the analysts until the end of the client day, for completion the next morning. Therefore, client work risks being completed in a rushed fashion by employees who are already tired from a full day, increasing potential for error and negatively impacting junior employee morale. A night shift or rotating shift model might be better aligned to the quick turnarounds required by the industry.
…the vicious cycle continues
Client relationships suffer from low-value meetings and potentially inflated valuations leading to real financial impacts. Fee revenues dwindle from lack of deal flow, and the bank has to spend more time pitching for business. More pitches mean more late nights and weekends for analysts, who grow disengaged from working hard on prospective deals that rarely materialize, and they leave for other banks with more deals and therefore bigger bonuses. CIBC must spend more time hiring and training; in the meantime, lack of analytical horsepower causes deal flow to dwindle further. Is this a business model designed for success?
1 Bloomberg BusinessWeek: “Company Overview of CIBC World Markets, Inc.” accessible at: http://www.bloomberg.com/research/stocks/private/snapshot.asp?privcapId=10963881
2 Senior VP interview, major Canadian oil & gas company.
3 Employee interviews and personal experience.