THE BIG 6 : PART FIVE
UBS
Squeaky
Clean?
Firm Wants to Bolster its Image to Restore Investor Confidence. But Will Record Profits and Growing
M&A Market Share do the Trick?
BY BEN MATTLIN
In
April 2003, the investment bank then called UBS Warburg (it dropped the "Warburg" in June) raised the bar on warding off potential
conflicts of interest. It pulled some analysts from its global fixed-income research department to work exclusively on "capital-formation"
-- i.e., to do due diligence on potential investment-banking clients and help originate deals. Remaining analysts were then
free to publish reports and issue investment recommendations without the distractions and temptations of corporate finance.
"This change wasn't mandated by a regulatory authority," Robert Wolf, UBS' global head of fixed income, explained recently.
"We simply felt making a clear separation was the right thing to do."
This January, investment banking CEO and chairman John P. Costas reiterated
the importance of doing the right thing. In a speech to financial professionals, he said, "We are working hard everywhere
we can to try to restore the investor optimism and confidence."
No doubt everyone shares that laudable goal, but since when has doing the
right thing become UBS' mantra and marching orders? What's prodded the London-headquartered investment-banking arm of Zürich's
UBS AG (annual revenue: $31 billion) to don the mantle of righteousness? Is it merely a façade, or does it signify deeper
stirrings within the century-and-a-half-old financial institution? And perhaps most importantly, how will UBS' new direction
impact institutional investors?
A FULL-SERVICE POWERHOUSE
To be sure, the publicly-held UBS group stems from multifarious traditions.
Now Switzerland's largest bank, with a footprint in 50 countries, a staff of some 69,000 people worldwide and invested assets
worth more than $1 trillion, UBS AG came together from the 1998 merger of Swiss Bank Corp. (SBC) and Union Bank of Switzerland.
The former was launched in 1872 and had already opened a branch in London by the end of 1898. The latter was created in 1912
by the merger of two other Swiss banks, Bank of Winterthur and Toggenburger Bank.
The development of UBS Investment Bank was similarly via acquisition. In
1992, SBC gobbled up Chicago's O'Connor & Associates, a leading options and futures brokerage. Then SBC gained the institutional
asset management skills of Brinson Partners, also of Chicago, and the investment banking business of London's 61-year-old
S.G. Warburg Group, both in 1995. In 1997 it acquired Dillon, Read & Co., a New York-based corporate-finance expert dating
back to 1832. Most recently, the combined firm purchased PaineWebber in 2000, giving it a foothold into private client asset
management in the U.S.
The parent organization is still trying to jell into a single entity under
the brand name UBS -- and not surprisingly, it's crucial to link that name with reliability and integrity. This mission extends
not only outward, to the firm's reputation, but also inward. One current employee who spoke on condition of anonymity describes
in-office posters and flyers that tout mentoring programs for local children and other ways to get involved in the community.
"It's very visible," he says. "We want to be cleaner than clean."
BAD PRESS AND GOOD PRESS
Certainly UBS could use some good PR. It was one of the 10 brokerage houses
involved in last April's $1.4 billion legal settlement with New York Attorney General Eliot Spitzer and the U.S. Securities
and Exchange Commission to clean up allegedly tainted research. UBS' portion of the settlement: an undisclosed amount between
$80 million and $125 million. (UBS was contacted for this piece but failed to respond by deadline.)
Its analysts have also been implicated in the fraudulent accounting scandal
that's plagued HealthSouth Corp., a leading provider of rehabilitative medicine and onetime UBS banking client. They've come
under fire in an unrelated class-action lawsuit that alleges analyst bias in recommendinag chipmaker Atmel Corp. through most
of 2000 and 2001. In addition, UBS has been charged in the ongoing crackdown on mutual-fund sales practices. Earlier, it became
the first major international bank to disclose significant losses amounting to some $700 million related to its stake in the
speculative hedge fund Long-Term Capital Management. And in the late-1990s, the UBS name was further tarnished when it was
accused of hoarding assets that belonged to Holocaust survivors and their heirs -- a scandal that went on for years. It was
finally resolved in 2000, after a thorough review of the facts and a $1.25 billion settlement involving several financial
institutions.
A lot of bad press to live down, but the investment bank's accomplishments
of late are perhaps the surest tonic. With some 16,000 professionals spread across 30 countries, the department racked up
underwriting fees for stock and bond offerings worldwide of $816.1 million in 2003, a 29% jump from the prior year. This is
especially noteworthy because most other firms saw underwriting fees decline in 2003, in part because low interest rates spurred
bond sales, which pay lower fees to underwriters than stock issues. UBS ranked seventh in underwriting fees collected, as
measured by Thomson Financial and reported in The Wall Street Journal.
Among its recent corporate-finance clients: Denver-based Newmont Mining
Corp., the world's largest gold producer. In November 2003, when it wanted to raise money with a follow-on offering of 24
million shares of common stock, it chose UBS to co-lead the $1.1 billion offering as joint bookrunning underwriter. At the
same time, UBS was joint bookrunning underwriter of a seven-year $1.4 billion convertible bond for Petróleos Mexicanos (also
known as "Pemex"), the Mexican state-owned oil monopoly. The notes are convertible to European stock, and the deal benefited
from UBS' broad-based international expertise.
In global underwriting of initial public offerings (IPOs) of stock, UBS
slipped a notch to No. 9 among U.S. underwriters ranked by total proceeds earned in 2003. Its total proceeds fell to $500
million from $600 million in 2002. Nevertheless, UBS' share of the lucrative global IPO market jumped to 3.5% in 2003 from
just 2.6% the previous year.
What's more, in the final quarter of 2003, UBS was the top underwriter
among U.S. competitors in the housing finance sector. Its municipal securities group ranked second in lead-managed negotiated
underwriting volume and achieved an 11.7% market share, up from 9.3% a year earlier. The group's revenue surged 11% for the
year to a record $373 million.
IMPROVEMENTS IN M&A ACTIVITY
While setting no records, UBS Investment Bank is also active in financial
advisory, including mergers and acquisitions (M&As). In 2003, it leapfrogged three tiers from the year before to finish
eighth among M&A advisers worldwide (whether representing buyers or sellers), when ranked by transaction values as announced
and taking into account the net debt of target companies, as measured by Thomson First Call. In all, UBS boasted involvement
in 257 deals globally, representing an aggregate value of $152.1 billion -- a significant increase from 2002's 188 M&A
deals worth a total of $131.1 billion. In fact, the value of UBS-advised M&A transactions in 2003 amounts to a 28.25%
year-over-year advance, outstripping the annual increase for the industry as a whole by 17.8 percentage points.
One highlight: UBS was co-advisor of the second-largest U.S.-based M&A
deal announced in 2003 -- the $16.4 billion merger of WellPoint Health Networks, a managed-care provider, and Anthem, which
supplies healthcare benefits. The marriage, announced in October 2003, hasn't been consummated as of this writing.
Admittedly, UBS has never enjoyed a very large market share of M&A
or underwriting transactions. Although it's gaining ground, it's never been among the elite at the top of the so-called League
Tables. The strength of its investment banking tends to lie in niche areas such as housing finance and municipal securities.
In 2000, it reportedly spent some $650 million hiring talent in financial advisory, leveraged loans, real estate, structured
credits, credit derivatives, currency exchange and other highly specialized businesses -- an effort that has apparently paid
off.
STRONGER IN RESEARCH
Some observers point to the strength of its sell-side research team, which
comprises 1,300 professionals in 20 locations who track some 3,400 companies globally. The bulk of the analyst pool is spread
between London and New York. "The research department is generally better than the corporate-finance department, based on
the rankings," allows a former UBS corporate-finance director, who spoke on condition of anonymity.
Indeed, UBS analysts are near the top of their game. As a group they were
No. 1 in Institutional Investor magazine's 2003 and 2004 All-Europe equity rankings. They also finished first in the
global survey. In the 2003 All-America equity roster, UBS surfaced at fifth, a significant improvement from eighth place in
2002. Individually, they held 32 positions on the Institutional Investor "team," up from 20 the year before. And in
that magazine's U.S. fixed-income competition, UBS researchers moved up a notch to seize the fifth rung. They didn't, however,
fare quite as well in the 2003 Wall Street Journal Best on the Street tabulations, landing in sixth place.
Have occasional allegations of biased stock research fazed the group? The
former UBS corporate-finance manager notes that interaction between bankers and equity analysts was "pretty standard," at
least before he left in August 2002. Though most of UBS' equity research department was in a separate building from corporate
finance, the former corporate-finance director recalls, the physical divide did little to reinforce the "Chinese wall" between
the two activities. "It was common practice to use the analysts as part of our investment-banking pitches," he says. "We would
tell potential underwriting clients that we had world-class research and could provide an award-winning analyst.... Sometimes
we'd even bring an analyst along for our pitches, to show that we knew the particular industry, we knew how to position the
company in the marketplace."
None of this guaranteed underwriting clients a Buy rating. "We couldn't
say anything about the kind of research we were going to give," adds the ex-banker. But then a "sort of drumbeat to be careful
about research" grew louder. Eventually, bankers could no longer even be on the phone with an analyst and a banking client
at the same time, unless a compliance officer was patched in too.
Of course, no harm was ever intended. Most of the investment bank's investor
clients were seasoned institutions, he says, and there was "a certain understanding about research and investment banking.
Most sophisticated investors understood how things worked."
That might have been reasonable before November 2000, when UBS bought PaineWebber
for some $11 billion and gained 2.7 million new clients, many of who were retail investors who likely didn't share the understanding
about how things worked.
How much has UBS research changed? Last August, David Shulman, then UBS'
global head of fixed-income distribution, acknowledged that before the reorganization which separated pure credit research
from banking research, the fixed-income research squad spent at least a quarter of its time on corporate finance. As for the
equity side, Chuck Hill, research director at Thomson First Call, the independent market data cruncher, gives UBS a mixed
review. Before the legal settlements and new regulations, he says, most brokerages pinned Sell ratings on fewer than two percent
of their stocks under coverage. "That's hard to justify, even in a bull market," insists Hill. Once sell-side researchers
started having to report their ratings distribution, however, many increased their Sells to 15% of their universe, which Hill
dubs "quite reasonable." UBS weighs in with 10% of its stock calls at Sell. "It appears to have changed somewhat from the
policies of the past," concludes Hill, "but not as much as most of the other major brokerages."
COSTAS' COST-CUTTING PAYS DIVIDENDS
Breaking from the past is something investment-banking chief John Costas
knows quite well. While building UBS' presence in the U.S. by attracting local talent, he's also proved a skilled cost-cutter.
A graduate of the University of Delaware who earned his MBA from the Tuck School at Dartmouth University, Costas joined Union
Bank of Switzerland in 1996 and soon was made head of its fixed-income and derivatives operations. Two years later he was
global head of fixed income at Warburg Dillon Read, as the investment-banking operations were known then. He became CEO in
December 2001 and chairman the following September.
His efforts are considered at least partly responsible for UBS AG's staggering
81% year-over-year increase in profits in 2003 to $5.15 billion, on basic earnings-per-share growth of 96% to $4.61 a share.
(Excluding unusual short-term items and goodwill amortization, net profit rose 33%.) It was the parent company's second most
profitable year ever. All business areas reported stronger than expected results despite the sluggish macroeconomic environment.
UBS' global asset management operations reported total invested assets in separately managed accounts catapulted 102% to $3.7
billion by year-end. The net inflow from private clients surged more than 40% from the prior year to $41 billion. In trading
volumes, UBS maintained market shares of 10.2% and 5.4% on the New York Stock Exchange and Nasdaq, respectively, in the fourth
quarter last year. (Globally, UBS is a member of 87 different exchanges in 31 countries.)
Not surprisingly, UBS shares in the U.S. (they're also traded on the Swiss
and Tokyo stock exchanges) advanced 41% in 2003, beating the Standard & Poor's 500 index by 15 percentage points. Investors,
it seems, already have confidence in it.
ENSURING QUALITY
Nevertheless, the efforts to bolster the integrity and honesty of UBS research
-- and in turn, to protect the firm from further litigation or penalty -- continue full force. In November 2003 the investment
bank contracted with independent research consultant Michael Dritz of Dritz Enterprises, a business management firm, to oversee
negotiations for third-party research, as required by the legal settlements. Earlier last year, UBS hired San Francisco-based
StarMine, a high-technology company that tracks and analyzes Wall Street data, to monitor its analysts' investment recommendations
and earnings estimates. (StarMine will be featured in June 2004 Buyside.) "The goal is to come out with objective and
fair measures of how well they're doing," says StarMine representative David Lichtblau, who explains that UBS requested its
investment ratings be measured "on an absolute scale." That is, a stock rated Buy should gain value, a Sell should fall, and
so forth. "Some of UBS' competitors have put their recommendations on a market-relative scale," he elaborates. "When their
analysts say 'Outperform,' they mean the stock is expected to fare better than its peers but not necessarily go up."
Naturally, the goal is to help management build and maintain quality research
-- at least in terms of analysts' forecasting abilities. For professional investors who rely not on sell-side recommendations
and earnings estimates so much as on the give-and-take with analysts, the exchange of ideas, information, impressions and
even opposing views, this objective data may be useless. Yet for firms trying to calculate the worth of their analysts --
for figuring incentive-based compensation and attracting new investor clients -- now that they can no longer judge by contributions
to investment banking, StarMine's scoring techniques could prove invaluable. "We're not an official standard," says Lichtblau,
"but it helps to have an independent appraisal."
Hill of Thomson First Call would agree. "This
implies the analysts are trying to be more honest," he says.
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