Nomura: The Global Powerhouse

Every Saturday evening, Kenichi Watanabe leaves his Tokyo home and heads to a Buddhist temple in the hills outside the city, where he practices zazen, or Zen Buddhist meditation, from midnight to 5:00 a.m. The practice helps Watanabe, the chief executive of Nomura Holdings, to clarify his thoughts and stay sharply focused. ―It calms my mind, he says.



Watanabe needs all the calm and clearheadedness he can get. One year ago, during some of the darkest hours of the worldwide financial panic, he rolled the dice in the biggest gamble of his 34-year career by acquiring the European and Asian operations of the failed Lehman Brothers Holdings after Britain's Barclays snapped up its U.S. assets. The price was modest — $225 million for the Asian business and a token $2 for the European unit — but the deal carried enormous risks.



Nomura increased its head count by nearly 50 percent at a stroke and committed to paying ¥140 billion ($1.5 billion) in bonuses to the former Lehman employees to keep them on board. Such largesse risked a backlash from Nomura's existing staff, most of whom work for much lower pay than their new colleagues in return for the near guarantee of lifetime employment, but didn't guarantee that Lehman staff wouldn't bolt after final bonus payments are made this month. Moreover, there was no immediate prospect that Nomura could earn a decent return on its investment, given the depressed state of markets in the aftermath of Lehman's collapse.



Watanabe, however, is convinced that the Lehman assets represents a once-in-a-lifetime opportunity to build a global platform. With his daring move he aims to transform Nomura — a powerhouse in Japan but a perennial weakling in foreign markets — into a titan to rival the likes of Goldman, Sachs & Co., JPMorgan Chase & Co. and Deutsche Bank around the world.



"My vision is to create an Asia-based global investment bank that is within the ranks of the global top five," a broadly smiling Watanabe, 56, told Institutional Investor in an interview in the 12th-floor boardroom of Nomura's headquarters in Tokyo's Otemachi financial district. "I have no doubt I will succeed."



The CEO will need more than confidence to win over Nomura's many skeptics. Over the years the firm has tried several times, unsuccessfully, to parlay its dominance of Japan's securities markets into global leadership, without success. Nomura built a top-five position in the eurobond market in the 1980s by underwriting equity-linked bonds, only to retreat after Tokyo's stock market bubble burst after 1989. More recently, Nomura expanded aggressively into the U.S. mortgage market earlier this decade but pulled out with big losses after the subprime crisis erupted; the firm took ¥126 billion in subprime write-downs in the financial year ended March 31, 2008, prompting a shakeup that elevated Watanabe to the CEO post in April 2008 in place of Nobuyuki Koga, who was demoted to chairman of Nomura's securities subsidiary.



With the Lehman acquisition, Watanabe hoped to achieve global scale in one fell swoop. So far, however, the CEO has had to acknowledge far bigger losses than his predecessor did. After taking write-offs of ¥120 billion for expenses related to the Lehman acquisition and ¥415 billion for everything from exposure to Bernard Madoff's hedge fund, U.S. monoline insurers and failed Icelandic banks, Nomura in April reported a loss of ¥708 billion for the year ended March 31, then a record for a Japanese company. That performance, and doubts about the Lehman deal, have depressed the firm's share price; at ¥573 late last month, the stock was down 61.5 percent from a year earlier, compared with a 13.7 percent decline in the Nikkei 225 index over the same period. (The drop also reflects two share issues, one in March and one this month that will dilute existing shareholders by about 45 percent.)



Some analysts believe the bloodletting is far from over. "We think they might have more problematic assets and more losses in the coming year, and we're not sure they can downsize expenses to an appropriate level or when the domestic equities market might recover," says Yuri Yoshida, director of financial institutions ratings at Standard & Poor's in Japan, which downgraded Nomura by one notch, to BBB+, in January. Watanabe has ordered his managers to cut the group's annual operating expenses by 10 percent, or ¥100 billion yen, to restore profitability. Nomura reduced its head count by nearly 600, to 25,730 employees, in the first half of 2009.



Yet for all the doubts and the tremendous costs involved in the Lehman bet, Nomura is showing signs of attaining some of Watanabe's goals. The firm has made significant market share gains in equities and mergers and acquisition advisory in Asia outside of Japan so far this year. According to data provider Dealogic, Nomura ranked third in equities in the Asia-Pacific region this year as of September 9, acting as book runner on $13.2 billion of deals, up from No. 8 in 2007, the last full year prior to the merger. In M&A, Nomura rose to No. 8 in the region from No. 17 in 2007, advising on $33.3 billion of deals. Watanabe's team has made slower progress in Europe, but even there Nomura has succeeded in retaining Lehman's leading position on the London Stock Exchange, with a market share of about 6 percent, up from a lowly rank of 82nd before the acquisition.



Such gains helped Nomura return to the black in the quarter ended June 30. The firm posted net income of ¥11.4 billion in the period, compared with a loss of ¥76.6 billion a year earlier. Revenue was up 41 percent, at ¥363.6 billion; crucially, revenue from the firm's global markets division, bulked up by the Lehman acquisition, exceeded domestic revenue for the first time in Nomura's 84-year history. The results, which beat most analysts' expectations, put Nomura on track to meet or exceed Watanabe's targets for the financial year ending March 31, 2010, which analysts say aim for revenue of ¥1.0 trillion to ¥1.1 trillion and pretax profits of ¥100 billion to ¥200 billion.



"The Lehman integration seems pretty stable, and Nomura is leading in a number of areas,"says Neil Katkov, a Tokyo-based analyst with the financial research firm Celent. "I'm a lot less skeptical now than I was a few months ago about Nomura's chance of success."



Watanabe has also managed to bolster Nomura's capital, raising ¥278 billion with a share offering in March that boosted the firm's tier-1 capital ratio to 11.7 percent. The company plans to raise a further ¥511 billion with another share offering this month. Nomura's difficulties over the past year stand in sharp contrast to the smooth absorption of Lehman's U.S. operations by Barclays. The British bank paid $1.75 billion for the business and Lehman's New York headquarters, which gave it a serious presence in equities and M&A to go with its global debt franchise. Barclays Capital, the investment banking unit, slipped one place, to ninth, in global investment banking in the first three quarters of this year, with $1.39 billion in revenue, according to Dealogic. Nomura edged up two places, to 12th, with revenue of $741 million. The firm lacks a meaningful presence in the U.S., still the largest market for investment banking fees, but has been hiring there aggressively in recent months.



Nomura is not the only Japanese financial institution seeking to exploit the weakness of global giants to raise its profile. One year ago, Mitsubishi UFJ Group, the country's largest bank by assets, bought a 20 percent stake in Morgan Stanley for $9 billion, giving the U.S. firm a critical capital injection. In May, Sumitomo Mitsui Financial Group took advantage of Citigroup's distress and bought Citi's share of Nikko Citigroup, a retail brokerage joint venture with Nikko Securities, for $5.2 billion. The deals appear to put an end to nearly two decades of retreat by Japanese financial institutions since the collapse of Japan's equity and property bubbles in the late 1980s.



Turning Nomura into a global bulge bracket player is a daunting challenge. The history of cross-border acquisitions in investment banking is checkered at best. UBS and Deutsche Bank struggled to make headway in the U.S. market despite spending billions to buy PaineWebber and Bankers Trust Corp., respectively, while Credit Suisse splashed out $11.5 billion for Donaldson, Lufkin & Jenrette, only to watch many of DLJ's top bankers walk out the door.



Nomura's recent history also offers plenty of grounds for skepticism. The firm rode Tokyo's rampant bull market of the 1980s to become the world's largest securities company by capital, with more than $10 billion in 1986, exceeding the combined capital at the time of Merrill Lynch & Co., Salomon Brothers and Shearson Lehman. After the equity bubble burst, however, underwriting business dried up, and Nomura's profits and share price tumbled. ―The lost decade, the moniker given to Japan's stagnant, debt-plagued economy in the 1990s, applied qually well to the country's biggest brokerage.



Watanabe, however, believes Nomura has no choice but to go international and reduce its reliance on the slow-growth Japanese economy if it wants to thrive. He sums up his approach with the motto ―Create change, be world-class, and act with speed. In some respects, Watanabe is an unlikely change agent. He joined Nomura as a trainee in 1975 after getting a B.A. in economics from Kobe University. He distinguished himself in the 1980s as a senior executive in domestic retail sales, the core of the firm, and won promotion to general manager of international planning and administration. He never served overseas, though.



Far from being insular, Watanabe has repeatedly sought to shake up the status quo. After being promoted to the board of Nomura Securities Co., the group's main operating arm, in 1998, he successfully pushed to split off asset management into a separate unit and list Nomura's shares on the New York Stock Exchange. Later, as head of domestic retail and deputy president of Nomura Securities, Watanabe was the driver behind Nomura's $1.2 billion acquisition of Instinet, a New York–based agency brokerage whose Chi-X unit operates leading alternative exchanges in the U.S., Europe and Asia.



Shortly after taking over as CEO, Watanabe gathered the firm's top executives at a picturesque Karuizawa resort in the mountains of Nagano prefecture in August 2008, a month before Lehman's collapse. He told his team that Nomura needed to move aggressively to bring in international talent and that the best way to do that was through an acquisition rather than an organic approach. "When we were presented with the Lehman opportunity, we immediately knew that it would give us an opportunity to create change as well as change ourselves," he tells II.



The contrast between Nomura's hierarchical Japanese culture, which emphasizes loyalty and seniority, and Lehman's brash American culture, which encourages risk-taking with big rewards, is especially stark. Consider the compensation gap. Although Nomura declines to comment on pay levels, a senior Tokyo recruiter says the head of a trading desk at Nomura could expect to earn as much as ¥65 million a year, including a base salary of ¥15 million and a bonus of as much as ¥50 million. A comparable person at Lehman would typically make as much as ¥350 million, including a salary of ¥50 million and a bonus of as much as ¥300 million.



To retain talent, Nomura guaranteed to pay ex-Lehman employees bonuses equivalent to what they received in 2007, the peak of the bull market. The bonuses for the more than 8,000 former Lehman staffers averaged $190,000 a piece, 70 percent of which was paid in March and the remaining 30 percent due to be paid this month. Ninety-five percent of the Lehman employees who were offered jobs at Nomura accepted. The key question is whether those bankers will depart once final bonus payments are made. Already Jasjit Bhattal, the former CEO of Lehman's Asian operations who was made chairman of Nomura Asia, announced in August that he would leave at the end of the year.



The revival of industry fortunes this year and an increase in poaching are likely to lead to more defections, but many former Lehman staffers say they are happy. "There's a lot of gratitude among ex-Lehman people to be given an opportunity to work at Nomura," says Paul Schulte, Nomura's Hong Kong–based Asian equity strategist, who held a similar post at Lehman. "Many feel, Let's work as hard as we always worked.' It's too early to know, but there is a sense the Japanese senior managers are giving us a great deal of freedom to run each operation."



Paul Norris, head of European equity research, is also upbeat. "Lehman built a large operation over 15 years in Europe, and we were proud of what we accomplished," he says. "When our American parent swept $8 billion out of Europe and put us into receivership the next morning, we were bitter and disappointed. Nomura has given us the opportunity to [rebuild]. It is very exciting."



If anything, Nomura employees grumble that the firm is favoring ex-Lehmanites for jobs, especially in Europe, where it took on 2,650 staff from the failed U.S. investment bank. (Nomura also absorbed 5,500 former Lehman employees in Asia, including 2,900 workers and information technology specialists in Mumbai, India.) Top executives dismiss any suggestion of favoritism but acknowledge that they aim to use the integration to instill a global, performance-based culture at Nomura.



"The new boss of a unit must be the [person] who can do it," says Hiromasa Yamazaki, the Tokyo-based deputy chief executive officer of global markets, who oversaw the acquisition of Lehman's Asia unit. "Japanese or non-Japanese doesn't matter, ex-Nomura or ex-Lehman doesn't matter." Watanabe has appointed four non-Japanese executives to the 15-member board of senior managing directors, the executive committee that runs the company. They are Sadeq Sayeed, head of Europe, a Pakistan-born banker who joined Nomura in 2000 after a decade at Credit Suisse First Boston; David Farrant, global head of human resources, who joined Nomura in 1991 from Ford Motor Co.; David Benson, Nomura's former European COO who rejoined the firm as global chief risk officer in October 2008 after a one-year stint at Man Group; and Paul Spanswick, the co-chief administrative officer for Europe, the Middle East and Africa, a ten-year Nomura veteran who previously worked in a variety of finance and risk management roles at UBS and Citigroup. Benson, Farrant and Spanswick are British.



After the Lehman deal, Watanabe also dispatched some of his top executives overseas, a major departure for a firm in which divisional bosses have traditionally been rooted at corporate headquarters in Tokyo. The global head of investment banking, Hiromi Yamaji, moved to London, and the global head of equities, Naoki Matsuba, shifted to New York.



"Unless you have a very strong operation in Europe or the U.S., you can't be competitive enough," Yamaji says in an interview in his office on the 30th floor of the old Lehman building in London's Canary Wharf financial district. "Many large U.S. or European investment banks are globalized. Many are offering products and services to Japanese clients. Integrating the Lehman operations and building a truly global firm won't be easy, though," Yamaji acknowledges. "What is a challenge is to manage thousands of new bankers, traders and staff," he explains. "The challenge is creating a new Nomura."



Some industry observers say they are impressed with the steps Nomura has taken so far, even if it is too early to judge the success of the Lehman deal. They have been successful in securing a large body of Lehman professionals in Europe and Asia. That's quite a bold move, says David Hatt, president of Deutsche Bank Japan.



"This deal will mean very big, fundamental changes to Nomura, as it involves bringing on thousands of non-Japanese onto the staff," says Kenneth Courtis, a veteran Japan-watcher and former vice chairman of Goldman Sachs Asia. "The Nomura people are fully aware of this challenge and are prepared. They aren't going into this blindly."



Watanabe's global vision is clear. Whether he can make it a reality remains to be seen, but so far there have been some encouraging signs.



In Asia, the addition of bankers from Lehman have helped Nomura win advisory mandates on ten deals worth a total of more than $12 billion since December. The firm was sole adviser to Chinese oil giant Sinopec Corp. on its $1.9 billion takeover of Tanganyika Oil in December. It also acted as lead adviser to Japan's Kirin Holdings in its $1.2 billion acquisition of the Philippines' San Miguel Brewery in February and Kirin's concurrent sale of a 19.9 percent stake in the brewer's parent company, San Miguel Corp., to Q-Tech Alliance for $831 million. Unfortunately, the biggest deal was one that got away: Nomura was lead adviser on Aluminum Corp. of China's $19.5 billion bid for a strategic stake in Rio Tinto Group before the Australian mining giant's shareholders rejected that offer in June.



"In banking we absolutely hit the ground running here at Nomura," says Glenn Schiffman, the Hong Kong–based head of investment banking for Asia, ex-Japan. Schiffman was an 18-year Lehman veteran who was the lead negotiator for Lehman employees during the Nomura takeover talks. Nomura ranked eighth in Asia-Pacific M&A this year as of early September, advising on 97 deals worth a total of $33.3 billion; in 2007, the last full year before the Lehman deal, the firm was in 17th place. In Asia-Pacific equities, Nomura rose to No. 3, working on $13.2 billion of issues, up from eighth place in 2007.



The acquisition has even given Nomura a boost at home in Japan, where the firm's share of trading on the Tokyo Stock Exchange has risen from 7 percent in September 2008 to 8 percent in recent months, according to data from the Japan Securities Dealers Association. "Nomura was very strong with long-only investors, whereas Lehman was very strong with hedge fund–oriented, high-trading investors," Watanabe says. "The combination of the two has allowed us to capture more market share."



In Europe, Nomura has quickly rebuilt much of Lehman's equity market presence under the leadership of Rachid Bouzouba, who was also one of the key Lehman negotiators on the takeover. Bouzouba has kept the overwhelming bulk of his 750-strong team of traders, salespeople and analysts intact and says the group has managed to retain most of its clients through the transition. He is aiming to generate secondary equity trading revenues of $1 billion in the year ending next March 31. "We are back to probably 2004 in terms of the size of the market, and at that time we were making less than $1 billion," he says. Longer term, the firm aims to become the No. 1 player in global equities by 2011. "That is achievable under Nomura," he says.



Bouzouba, 39, a Moroccan national and naturalized Frenchman who began his career at Société Générale and Crédit Lyonnais in Paris before joining Lehman in 2003, says talk of a culture clash at Nomura is overblown. "I grew up in Morocco, I went to France to work and I am very open to cultures," he says. Bouzouba says he was constantly second-guessed by "guys in New York" at Lehman but has been given a free hand by his new bosses in Tokyo. "In fact, I have more autonomy at Nomura than I did at Lehman."



Bouzouba has been focusing on shoring up the firm's equity research to drive growth. Lehman ranked sixth in Institutional Investor's All-Europe Research Team in 2008, but the team, now as part of Nomura, slipped two places, to eighth, in this year's ranking. In May, the firm recruited 15 analysts from rival firms, including Alastair Syme from Bank of America–Merrill Lynch, who was part of the first-ranked team in oil and gas in this year's II survey; Marc Van't Sant from Citigroup, whose team ranked No. 2 in business and employment services; and Mark McVicar from Dresdner Kleinwort, whose team came in third place in transport. European research head Norris, a 19-year Lehman veteran, says the recruits have boosted his team to 126 analysts covering 540 companies. "Our pitch is the opportunity to build the business and be part of a transformation," he says.



The U.S. represents an even bigger challenge for Nomura. The firm has never succeeded in establishing a serious long-term presence there, despite having pioneered the commercial-mortgage-backed securities market in the 1990s. Watanabe and his team have begun to fill the gap, though. The firm has hired some 300 people so far this year to build up its equity and fixed-income teams, raising its overall U.S. head count to about 900. The recruits include Ciaran O'Kelly, former global head of equities at Bank of America Corp., who joined as head of U.S. equities in July. Also that month, Nomura buttressed its fixed-income ambitions by winning Federal Reserve Board approval to become a primary dealer in U.S. Treasuries.



Still, the U.S. remains a clear No. 3 behind Asia and Europe among Watanabe's priorities. "The emerging markets have been less affected than developed markets by the crisis," Watanabe says. "Asia, and especially China, is looking good, with low leverage thanks to smaller borrowings, not to mention the substantial scale of the fiscal stimulus measures announced by China. The environment for financial institutions will also shift from one concentrated on the U.S. to a truly multipolar one as Asia increasingly grows in importance."



The CEO believes his newly enlarged Nomura should be capable of generating consistent pretax profits of ¥500 billion a year, compared with about ¥300 billion previously, when it wasn't racking up big losses.



Analysts say he may not have much time to deliver. "He has to show results in a few years' time, or his head is on the block," says Terrie Lloyd, president of Japan Inc. Holdings, a Tokyo-based consulting firm that specializes in M&A advisory. "You can't take losses like what he took this year."



Natsumu Tsujino, a financial sector analyst at JPMorgan Securities Japan Co. in Tokyo, who has a "neutral" rating on Nomura's stock, says Watanabe's gamble will ultimately depend on the health of financial markets. "His assumption is that further valuation losses [on Nomura's investments] will be zero," she says. "If his assumption holds true, he can make this company profitable by the end of this year." That would be a welcome start. But Watanabe must deliver much more to quiet the skeptics and prove that the daring Lehman purchase was the right move. The Zen practitioner will need all of his powers of concentration to succeed.



(Source: Institutional Investor, Oct 2009)