Will Nomura get indigestion from its Lehman purchase

By Terrie Lloyd

Japan’s biggest investment bank, Nomura, is buying out the operations and staff of Lehman Brothers’ European, Middle Eastern and Asia-Pacific operations. On the face of it, Nomura has got itself a good deal, especially the highly-publicized $2 purchase of the European and Middle East investment banking and equities operations business. But of course, the price is low for a reason…

Specifically, because Lehman has very little assets of value left on its books that haven’t already been earmarked to sell to pay out its creditors. So what Nomura is really paying for with their $2 is the rather hefty salaries of the many staff that Lehman employs in those parts of the world, as well as in the Asia-Pacific region.

Indeed, even Nomura is saying that what they are buying is really just the Lehman staff and some sundry Asia-based IT assets. According to a recent Nikkei interview with Nomura President Kenichi Watanabe, the Nikkei concludes that Nomura has “steered clear of Lehman’s risk-laden balance sheet and focused instead on the company’s healthy assets—namely, its personnel.”

Well that’s good, because there are 5,500 of them, 1,300 of whom are in Tokyo. Nomura wants them badly enough that it has issued assurances that everyone will have a job after the handover, and in particular has guaranteed the various Lehman managing directors that their compensation packages will stay as they are. Unfortunately for Nomura, it appears that the assurances are not being given much credibility, and already a number of high-profile managers in the most desirable segment, equities, have jumped ship.

According to the Nikkei, and this is only hearsay at this point, about a quarter of the 170-person Tokyo equities team have either left already or are in the process of leaving, and apparently there are a number of others in investment banking and fixed income who have declined to sign on with Nomura. Since these teams are supposedly THE major reason Nomura is buying the Lehman business, I wonder if the Japanese firm isn’t taking too long to staunch the bleeding?

The current goings on have also made me wonder how will the Lehman acquisition go long-term for Nomura. Will the Japanese firm emerge as a resurgent world force in investment banking, thanks to its canny purchase and Lehman’s unfortunate accident, or will the Japanese-ness of Nomura serve to disincentivize the Lehman staff and lead to their gradual and steady hemeorraging to other firms?

Although I am not an insider at either firm, by listening to the recruiting markets and media, our understanding of the general atmosphere and incentive schemes of both companies leads us to make the following general characterizations of each:

1. Lehman Brothers in Japan and around the world has been a high-flying, highly innovative company, attracting top-level performers to execute deals and create businesses that reward those performers outstandingly and the rest of the operations team on a more moderate level.

Some would say that this kind of environment epitomizes the creed of greed that is being bashed by politicians in the U.S. at present, but no one could deny that Lehman’s innovations and risk taking have led to some major coups here in Japan. Uppermost in my mind was their funding of 80 billion yen of debt for Horie-mon of Livedoor back in his heyday. The structuring of this debt was such that Lehman wound up with huge profits at the expense of the markets. OK, so they lost it all again with the Marubeni scandal in March of this year, but a pending lawsuit may still see them get it back.

It is my understanding, too, that Lehman pays “above market” in Japan for almost all categories of employees. In some cases, as much as 30% above market. And remember that the “market” we’re talking about is the employment universe for foreign securities firms, which of course pay at least 30% more and sometimes up to double what their less-flashy Japanese counterparts do. As a result, Lehman has a good slice of talented bilinguals and a particularly high number of bilingual, risk-taking foreigners, who have led some of the best deals for the company.

Contrast this type of environment, then, with Nomura, a company which just 10 years ago was regarded with the same disdain as politicians in the LDP. By far the largest player in the Japanese investment banking field, it was generally regarded as the repository for home-team deals and corporate egoism. Although it wasn’t a place anyone really wanted to work, it was a fantastic place to make connections that would pay off in the next job. So many senior finance industry players have had a stint at Nomura somewhere early on in their careers, especially players in Private Equity, REITs, and general banking.

To Nomura’s credit, things appear to have changed for the better over the last 10 years, and the company has cleaned up its act significantly—particularly after several scandals in the late 1990s. Its operations in Europe, in particular, have helped create a new international image, while steady profits here in Japan have reinforced its market leadership position. Further, its February 2007, $1.2 billion acquisition of market data supplier Instinet seems to be going well, which means that the company has figured out how to buy and maintain an international operations business. Nonetheless, it appears difficult for Nomura to completely evolve into a full-blown securities firm with all the risks and leveraging that that kind of business entails. The corporate culture just doesn’t seem
to support that kind of activity.

Instead, Nomura has come to be viewed as more of a Steady-Eddy type of firm. Its worker-bee atmosphere has meant that it is relatively conservative and doesn’t seem to mind sacrificing potentially huge profits and bonuses in return for stability and predictability. Of course, in retrospect this may not be a bad thing and is perhaps the future of investment banking itself for the next 3-5 years.

So will Nomura be able to successfully merge the Lehman staff into its business or not?

My sense is that Nomura is going to wind up paying more than it thinks for less human assets than it can use. I think that the dilution process will occur in two phases. Firstly, the Wunderkind of Lehman are highly mobile and from Day One have viewed Nomura as an environment that would restrict their activities and ambitions. As they have started to leave, the ability for the remaining front office team members to pull down big and innovative deals will start to disappear—leaving Nomura with some sharp but very expensive back-office and middle-office teams and not enough people to provide the front-end income.

Thus, the second phase will start, and this will be slower and more drawn out. I imagine that as income drops, Nomura will inevitably have to use its own sales and deal teams to create revenue and thus the inherent lower performance of those home-grown teams will accentuate the expense of keeping the remaining Lehman staff.

It would only be rational under such circumstances for Nomura to start pressuring the remaining higher-paid staff to either take on more responsibility or to accept a cut in wages. The image of “working like a dog” comes to mind. This scenario is particularly likely as the global economy contracts, as it surely will once the U.S. money markets start to realize that government’s $700 billion is only the down payment on unwinding the financial mire ahead of it. Indeed, some commentators are estimating the U.S. clean-up to be in excess of $6 trillion, and that’s not counting the tsunami of debt that a global depression would cause.

So would Lehman Brothers staff be better off jumping ship now? It’s hard to say. In the investment banking world, usually it’s a case of last-in, first-off, and for those people jumping to companies which might still not have come clean on their full subprime or CDO liabilities, the ex-Lehman staff could wind up facing redundancy sooner than they think. On the other hand, those people who stay in Lehman will be able to parry Nomura’s cost-cutting efforts for some time, possibly several years, giving them time to look for a better and more stable position and for the current fear-based employment environment to become more rational again.

Either way, I don’t see the deal being so good for Nomura. President Watanabe says that he expects a hit to the Nomura P&L for the coming year as the acquisition is absorbed. However, I think he is being optimistic. Instead, he may be required to take personal responsibility for draining the company’s treasury to buy into a dream whose time has already passed.

Terrie Lloyd writes a weekly newsletter for entrepreneurs and business people about business and political opportunities in Japan.

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9 Comments

faulkmore at 02:45 PM JST - 7th October

I think the argument is that $2 is over valued. Whatever happened to $1 or a nickel or a dime? Luckily for Nomura the last few days have seen the yen strengthening against the dollar. That $2 became more affordable for Nomura. Just a little honey to sweeten the deal.

Besides the staff, it seems the article is downplaying the value of the overseas office and what is left of Lehman's businesses.

As long as there is a patch of dirt without a house on it, Lehman can earn money by ravaging the environment. Fear not...

So long as there is a house on a patch of land that can be torn down and made into several units. Politicians will support the banking and real estate industry.

My question is when will they destroy houses and return the area to forest in order to increase the value of the houses that remain? That should be an industry that competes with real estate. We should give that industry a short catchy name, so everyone can easily remember it. Or how about this. Lets call it "war"!!
rjdsr at 11:51 PM JST - 7th October

This looks like Nomura's first step towards being the biggest and most influential investment bank in the world. Westerners hate this, because they can't accept the thought that the Japanese are winning out in "their" realm. Tables have been turned, lads!
rjdsr at 12:25 AM JST - 8th October

You think Nomura will ahve the influenec of HSBC for instance, me thinks not!!

So you don't think Nomura is going bankrupt, like HSBC.
MrDickMorris at 12:27 AM JST - 8th October

HSBC has heslthier assets, and a broader worlwide portfolio than Nomura is ever likely to have.

The big guns, HSBC, Lloyds etc are giants compared to Nomura.

you post constantly, without any knowledge of what you are posting.
usaexpat at 06:36 AM JST - 8th October

If Nomura has the money to take this on for the long haul it will be a good buy.
frontandcentre at 01:33 PM JST - 8th October

rjdsr - HSBC and Lloyds are primarily retail and corporate banks. Nomura is an investment bank - there's a big difference. Nomura's past headline successes have come from recruiting foreign talent - e.g. Guy Hands - and paying them substantial rewards to do deals their way, without too much interference. Unless they let the parts of Lehman that they acquired continue on much the same course (bear in mind that Barclays had first bite, and bought the US operations) then I think Terrie Lloyd's prediction about the outcome may be correct.

The feeling is that if something's going to give it won't be Nomura's current corporate style, it'll be Lehman's. The irony in Japan being that Lehman Brothers Japan had nothing to do with the downfall of the company - that was due to bad decisions elsewhere.
slappayuki at 02:14 AM JST - 11th October

Lehman Brothers Japan had nothing to do with the downfall of the company - that was due to bad decisions elsewhere.

I'd like to see some documented proof of that.
ozellis at 07:30 AM JST - 11th October

Terry, I would like to know where the employees would be going. It would seem to me that the financial employment pie is a lot, lot smaller these days. I would suggest that 1/4 of the workforce is leaving or planning to leave is no longer hearsay, just simply not true.
slappayuki at 03:01 AM JST - 12th October

I've heard that a lot are going back to eikaiwa, or else headhunting.

Expect a lot of divorces as Japanese wives realize the foreign dream boy husband really wasn't a long term proposition.