Goodbody staff are waiting for a decision from Fexco, the company’s 51 per cent owner, over who is to be their new parent company. The decision is believed to be down to Davy and Bank of China, with Irish Life a distant third.

A lot is at stake. Davy and Bank of China are very different companies with very different plans for Goodbody.

Bank of China is the fourth biggest bank in the world by assets ($3 trillion if you’re wondering). But for its size, it’s not very global. 92.5 per cent of its assets are in China, Hong Kong, Macau and Taiwan. Goodbody would help build its position in Europe. 

Davy wants to consolidate its position as the biggest broker  and wealth manager in Ireland. It wants to bring in Goodbody’s clients and boost margins by cutting duplicated costs. A euphemism for firing staff.

The Killorglin-based international payments company Fexco will get the final say. Fexco bought 75 per cent of Goodbody at the bottom of the market in 2010 for €24 million (Goodbody staff were able to boost their ownership to 49 per cent later, under an incentive scheme). Now it’s mulling its options.

Goodbody is expected to go for as much as €150 million. Davy is offering a mixture of cash and shares, though its expected Davy would need to offer a premium to compensate Fexco — and the 49 per cent — for the rough business of integrating the two companies. 

Bank of China is following its clients to Europe

Bank of China is owned by the Chinese state. Its motivations for coming to Ireland are part part commercial, and part geopolitical.

The commercial motivation is straightforward: it’s following its clients. It used to be that investment flowed from the developed world into China. Now, the flow is reversing. Speaking in the South China Morning Post, Alfred Shang of Bitrock Partners said of Chinese banks, “In recent years, we see them follow another type of wealthy clients – the high net worth individuals who look for opportunities to invest globally, especially against local capital market volatility”. So Bank of China wants to connect Chinese investors with Irish and European assets. Liu Xinyi, president of Shanghai Pudong Development Bank, said “China is transferring from capital inflow to outflow and financial institutions should move in tandem with those corporate clients to go abroad”.

The Chinese state has an interest in pushing Bank of China into foreign markets. China has spent years trying to get foreigners to use its currency, the yuan, without much success. Even in China’s Belt and Road program, which lavishes spending on its central Asian neighbours, Citigroup economists have estimated lenders and contractors prefer to use dollars. Increasing financial flows between the west and China is an important step in building faith in the yuan, which is a strategic goal of the Chinese state.

A mark against Bank of China could be the collapse of another Chinese deal to buy Goodbody last year. In July Zhongze, a Chinese consortium, had a €150 million offer for Goodbody accepted. The deal was announced to the market in June 2018, and Goodbody seemed happy. Managing director Roy Barrett said at the time that the deal “facilitates the creation of a bridge from east to west and vice-versa for institutional capital seeking opportunities in both regions”. 

But the deal fell apart in January when, late in the day, the makeup of the Zhongze consortium changed. Sources indicate the Central Bank was unwilling to sign off amid questions about the ownership of the Chinese group. 

Bank of China helped finance the Zhongze group. Now it’s back for another try. One would expect Bank of China learned something from the first experience. It will have learned the Central Bank doesn’t have a problem, in principle, with Chinese ownership of Irish firms, because it blessed the deal in its first iteration. And it will have learned the Central Bank needs to see clarity over ownership of Irish financial institutions.

In that respect the Central Bank is in step with the rest of Official Ireland. This year the minister for State for Financial Services and Insurance, Michael D’Arcy, said the Government would “maximise… opportunities” for foreign financial firms like Bank of China after Brexit. The business minister Heather Humphreys has said “The Irish Government places huge importance on Ireland’s close, friendly, and mutually beneficial relationship with China”. Humpheys cited Bank of China as an example of beneficial direct investment in Ireland by Chinese companies.

Direct investment in Ireland by Bank of China should help assuage the Central Bank. Bank of China set up its Dublin base in 2017 and the Dublin branch of its aviation finance arm, BOC Aviation, is well established with $350 million of revenue last year.

Bigger business, bigger margins

Bank of China’s iconic headquarters.

Bank of China and Davy are coming at this deal from very different angles. For Bank of China, the Goodbody acquisition would be a tiny piece of its global expansion strategy. For Davy, it would cement its dominance in Ireland.

There are three reasons why buying Goodbody makes a lot of sense for Davy.

The first is the generic argument for combining two players in the same industry. Davy is the biggest player in the Irish wealth management and broking business. Goodbody is number two. Combining the businesses would unlock synergies. Davy, which has invested heavily in its technology platform in recent years, would be able to take on Goodbody clients without much increasing its costs. Headcount at the combined business could go down.  

The second reason the acquisition makes sense for Davy is that regulation is increasing across the industry. Regulation and compliance costs, which are largely fixed in nature, punish small firms and help big ones. How? Big firms like Davy can spread fixed costs over a greater number of users than small firms can. Some small firms, like Campbell O’Connor or Merrion for example, can’t make the numbers work. And they go out of business. The Davys of this world gobble up their market share, which further decreases their fixed costs per user. 

The big regulatory change here is MiFID II. MiFID II is a set of rules, established by the EU, aimed at protecting investors and making the financial industry more transparent. For example, it forces firms to specify exactly what it charges in fees, with an itemised breakdown on request, delivered “in good time”. This kind of transparency costs money.

MiFID II has played havoc with the stockbroking business. In the FT, broker Andrew Monk has said “It’s not much fun any more, we’re not earning as much as we used to . . . Mifid has made it really difficult and tiring. We’re all in our mid-50s, owning these businesses. The question now is how to get out.” The activist investor Richard Bernstein has said “Unless a firm has got a niche in this environment and can set out why it should remain independent, it should be part of industry consolidation so that clients can benefit from the resultant reduction in regulatory and other fixed costs.” UK brokers Cenkos, Arden Partners and WH Ireland are down 79 per cent,  66 per cent and 67 per cent respectively since MiFID II was approved in 2014.

A Goodbody deal then would help Davy navigate MiFID II by growing market share, and offer a chance to cut costs through reducing overall headcount and boosting Goodbody’s flat margins. In stockbroking, as in other industries facing regulation, bigger is better. 

What about competition? Market sources indicate the CCPC, Ireland’s competition authority, wouldn’t block a Davy deal at a time of heavy consolidation in the financial industry. Davy would be left as the biggest player, yes, with 50 per cent of the wealth management industry. But the market would still be split between the myriad of bankers, insurance companies, brokers and asset managers chasing the business of well-to-do investors.

Institutional investors are reportedly more worried about market concentration than the CCPC. Institutional investors have up to now been lessening counterparty risk by splitting their business between Goodbody and Davy. And there are the potential conflicts of interest that arise from merging Goodbody and Davy’s capital markets businesses, where Davy and Goodbody will have advised on opposing sides of M&A deals.  

A third justification for the deal relates to Goodbody’s low margins. Goodbody’s most recent financials from 2017 show a business struggling to deal with costs. It made just €3 million operating profit on trading income (ie revenue) of €68.9 million, for a 4.3 per cent operating margin. According to an analysis by Casey Quirk, a consultant, average operating margins in the industry globally were 29 per cent in 2019.

We don’t have equivalent financials for Davy. But it’s likely it could do better than 4.3 per cent. €68.9 million of additional revenue for Davy would be expected to generate a lot more than €3 million profit. 

A 4.3 per cent operating margin indicates Goodbody alone is too small to bear the increased costs that come with MiFID and other regulations.

On the balance sheet, Goodbody had €1.1 million in debt with €12 million cash at hand. Davy, by comparison, is flush. Boosted by its stake in the ISEQ sale, in 2018 it recorded €171 million in cash, and no debt.

Goodbody’s wealth management business is its most valuable asset. According to industry sources, a wealth manager would expect to charge a fee of around 60 basis points (or 0.6 per cent) per year. Goodbody has €7 billion of assets under management, so the wealth management business alone would be about €42 million in top line revenue to its new owner. 

Previous Irish deals hint at what the wealth management business might be worth. In February St James’s Place paid €12 million for Harvest Financial Services, which had €1 billion of assets under management, and in May Brewin Dolphin bought Investec’s €2.9 billion wealth management business for €44 million. That’s a range of €12-15 million paid for every billion of assets under management. These deals would value Goodbody’s wealth management business at €84-105 million.

Moving parts

It’s a complicated decision. Two bidders and four big stakeholders. 

Goodbody staff, with their 49 per cent ownership, know which bid they prefer. Bank of China offers a route to the Chinese market, help paying for investments in technology and compliance – and it won’t immediately sack lots of them. It would be a secure home. The Bank of China bid is also more straightforward than the Davy one because it’s likely to be all in cash, with earn outs to ensure key staff stay in place. 

Davy is offering a 20 per cent stake in the combined entity, plus cash. Based on a €150 million valuation for Goodbody, the combined entity could be worth anything from €450-700 million, which would value a 20 per cent stake at anywhere between €90-140 million. Plus whatever cash Davy throws on top. The Davy offer, then, promises less cash up front,  with a potentially valuable dividend stream. The value of that dividend stream depends, as we’ve seen, on Davy successfully integrating Goodbody and making the most of its dominant market position.

The third important factor is uncertainty over the Bank of China bid. Goodbody and Fexco got burned last year when the Zhongze bid collapsed, after 18 months of negotiations. To manage this risk, Fexco is believed to be seeking a termination fee from Bank of China which would obligate it to pay a fixed amount should the deal fall through. 

Fexco needs to decide the value of a 20 per cent combined Davy stake; how much it values the immediacy of up front cash; whether it thinks the Bank of China will follow through; and whether it’s worth angering the 49 per cent owners and staff, who could make a merger very difficult. 

For Fexco, these are good problems to have. For Goodbody, not so much.