CIBC World Markets: Serving clients or serving selves?
How one investment bank falls short of “beating the Street”
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):
Management incentives
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
Staffing structure
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?
Sources:
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.
Images:
http://www.huffingtonpost.ca/2011/11/01/cibc-world-markets-provinces-condition-populace-austerity_n_1069642.html
Interesting analysis of CIBC’s investment banking operations. The model described worked successfully a few decades ago, when labor market and regulatory environment allowed banks to impose some of these measures without a significant impact in talent recruiting and retention (which in the end is their main asset). Since then, generational, technological and industry changes have taken place. The millennial generation values work/life balance more than prior generations. In addition, there is today a wider range of sectors competing for the same pool of talent targeted by investment banks (e.g. consulting and tech companies). So in brief, this is a good example of an operating model that has not successfully adapted to a change in conditions.
Thank you Andrea, this is a very interesting piece and pretty accurate picture of the investment banking landscape, especially in Canada. Despite an apparent misalignment in the operating and business models of firms serving this industry, it is interesting to note that firms such as CIBC, RBC Capital Markets, BMO Capital Markets etc continue to be very profitable. Inherently the investment banking business is a human capital business which provides huge margins for firms and hence I wonder whether firms in this industry are reluctant to change an age-old model that ensures profitability, despite the issues highlighted above.
Given the fact that there is limited differentiation between the big banks, do you think misalignment in the business and operating models is especially apparent at CIBC or whether this is a systemic industry issue and CIBC merely follows the norm? I ask that because the recruiting and staffing structures and pay at junior levels is pretty much the same at all the banks and hence is it really in CIBC’s interest to be the one bank shifting away from industry norms and risk being noncompetitive if other companies in the industry do not follow its move?
Given the uncertain work schedules, many banks have now resorted to increasing compensation at the analyst and associate level rather than having a shift schedule – do you think CIBC would be able to recruit talent away from these firms if they offer lower compensation in return for reduced hours? This is especially a difficult issue to tackle as many individuals at the analyst level view the investment banking program as a 2-year stint to gain experience and have a high salary right after graduation, and then move out to other buy-side finance or corporate opportunities.