1.

STRATEGY

Why Banks Management Team are considering Merger ?

The Environment
 The environment was turbulent and had undergone a lot of changes, it was
now demanding a need for greater scale in order to capture market share
and profits.
 Some of the changes were Globalization, Integrated markets, Contagion
effect and regulatory harmonization across the globe that added uncertainty
to the tumultuous markets.
 New technological innovations put extra demand on the capital bases of the
firms and innovations in financial markets threatened the older market with
low cost substitutes.
 Advanced computing, telecommunications and trading systems were high
costs that could be better absorbed by a larger firm.
 Rising customer expectations lead to higher services but lower loyalty from
consumers. A larger integrated bank would perhaps be better at
 Deregulation within the FSI industry had opened hitherto protected markets
and thus the banks expected high competition.
The Banks
 In 1996, both banks reported losses, reflecting writeoffs in their domestic
loan portfolios due to lack of any real growth in Switzerland due to the real
estate bubble from 1990 to 1997.
The Rationale
 It was considered that consolidation in the swiss market would help realize
economies of scale and would enable the firms to expand beyond the small
Swiss market into the global arena
 Banks were aiming to reposition themselves away from the lower growth
commercial lending market and towards the higher growth segments of
investment banking, brokerage and asset management areas that could
profit from the serious trends in the environment.
 Merging the two companies would create the largest AMC and Private bank
in the world. The Investment banking business would gain the much needed
critical mass and USB AG would inherit a strong base on Ex UBS that would
also helo SBC overcome it shortage of capital.

Is timing right for UBS to enter into Merger ?

I think the timing was right for UBS to enter in the merger due to the following
reasons:
 It was facing a potential unfriendly takeover from by Suisse
 In 1996, firm had suffered an operating loss of Sfr -197 mn as stated
above.

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  The firm was facing serious questions on its strategy due to Martin Ebner, a
swiss active investor who mounted legal challenges to the firms implentaton
of strategy and also opposed the nomination of Robert Studer as Chairman
 UBS was experiencing losses in derivatives positions and it raised questions
about the effectiveness of risk control systems at Ex-UBS. SBC was know
for its risk management expertise.

Is timing right for Swiss Bank to enter into Merger ?

I think the timing was right for Swiss Bank to enter in Merger due to the following
reasons:
 The firm had done a strategic assessment and saw challenges in SBCs
major business lines:
 Commercial Banking: Scale was required to take advantage of innovation
in delivery of retail banking services. A merger permitted more rational
pricing.
 Private Banking: More aggressive program of acquisition and organic
growth would be needed in Europe, North America and Asia to cater to
greater sophistication among customers and higher growth in onshore
private banking
 Investment Banking: SRC wanted to be the most successful investment
bank in Europe and this was threatened by the Amercian banks entering
Europe and drawing off clients and talented staff.
 SBC was in a weak financial position and was facing shortage of capital.
Ospel argued that a merger between SBC and ex-UBS was a “matter of
necessity.”
 In 1996, bank had massive write offs (SFr 3309 mn Extraordinary
expenses) resulting in bank reporting losses of SFr – 1903 mn.

What are the arguments against this merger ?

 This was a merger between the 11th and 12th largest bank in the world. The
Sheer Implementation risk of a transaction of this scale was enormous and
considered a big potential risk. The blending of customer bases and
technology platforms would be quite an effort.
 Cultural fit between the two organisations was also questionable. The fact
that both firms had grown through acquisition and had unique culture raised
questions as to how well their cultures could meet.
 Massive layoffs especially close to home : The merger would entail reducing
the workforce close to home by about 7000 people and this could seriously
disenchant shareholders and gain negative publicity for the company thus
impacting its business.

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Should either bank reconsider any of its other prospective merger
partners ?

 Ex- UBS had evaluated all its potential partners in Credit Suisse, Morgan
Stanley, Merrill Lynch and Deutsche Bank and concluded that SBC would be
the better partner because of greater potential synergies, a closer cultural
match and smaller overlap in investment banking.
 The fact that both firms had Swiss heritage also augured well for the
possible merger in term of cultural and business fit.
 Also both the banks had independently assessed the situation and wanted
to merge together indicating that there was high degree of management
support for the deal and thus this may be one of the better scenarios to
consider.
 As to the alternatives being considered, the other swiss bank was Credit
Suisse which had already made a hostile offer to UBS and was thus not
preferable.

VALUATION

2. Value of contemplated Synergies

The value of contemplated synergies is CHF 20 – 25 bn from three sources CHF

3.5 bn per year from Cost Savings, Accelerated revenue growth and new equity
freed for investments.

My valuation of synergies comes to CHF 37.85 bn as explained in ANNEXURE 1

along with assumptions.

Cost savings potential have been checked by two methods detailed in ANNEXURE
2 and ANNEXURE 3 and seem to be reasonable.

Accelerated revenue growth assumptions have been questioned in the critical

evaluation done in Qn 3 but due to lack of data their plausibility is not
quantifically verifiable.

As for new equity freed the same has been assumed to be reasonable and
critically evaluated in Qn 3.

3. Sources of this value ? Evaluate them critically

There are three primary sources of Value :

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 Cost Savings of CHF 3.5 billion per year. Sources would include the
elimination of duplicate activities in areas such as operations, infrastructure,
trading rooms, Swiss branch networks and corporate staff.

 Critical Evaluation: These savings would be realizable within 3-4 years of

the merger. The savings would represent 22% of the current combined
cost base of Ex-UBS and SBC.

From the analysis two salient points emerge: Higher synergies are coming
from outside Switzerland (41% of people cut in 26% of total number of
facilities) and that personnel expenses contribute to 63 % of the cost
reduction.

The cost reduction is 86% of my estimated cost reduction of SFr 4 bn based

on the headcount reduction plan. The majority is coming from Investment
banking outside Switzerland and from Consumer and corporate within
Switzerland. This seems reasonable considering that both banks are in
Switzerland, hence HO expenses should come down and that Investment
Banking outside Switzerland is where there is overlap.

These gains are not replicable by the shareholders themselves and are
specific to between the two firms in contention and hence seem to be
reasonable.

ANNEXURE 2 and 3 further critically evaluate this cost reduction and show
that it is reasonable to assume the same.

 Accelerated revenue growth of over 10% per year. Sources would include
market growth in private banking, and the realization of benefits from a
bulge bracket position in investment banking.

 Critical Evaluation:

Private Banking and Investment banking form over 70% of the companies
revenues. The company is reducing its investment banking staff by 37%
(7000/19000) indicating significant overlap. Also the companies combined
forecast / Projections indicate the companies revenues will be 28 bn in 2000
compared to 26 bn in 1997, thus growing @ 3% CAGR.

Private Banking Business: SBC already held a leading brand internationally,

but greater sophistication among customers and more rapid growth in
onshore private banking meant that a more aggressive program of
acquisition and organic growth would be needed in Europe, North America

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 and Asia. Joining hands with UBS is a step in the right direction, but initially
the company is more likely to face a lot of issues of platform integration,
technology integration, similar service standard and methodology at all
branches. The combined private banking business would benefit from global
presence, larger pool of talented people, new and innovative products
(SBC’s strength) and efficiency in scale of operatios. Thus over time the
company may achiever this growth but most probably the same would be
difficult in the short run (1/2 years).

Investment Banking Business: SBC was well established in the US through

Warburg Reed and UBS has a significant presence in the UK market with
Phillips & Drew acquisition. The assets seem to be complimentary but the
company is reducing its staff by 37% which is indicating that perhaps both
companies have presence in same geographies. This may have two
implications one that the company gains higher clout in these markets and
two that the company does not necessary expand in its reach. Also a 10%
increase in this business is likely considering that once the company is in
bulge bracket position it would be able to execute large billion dollars deals.
However this will take a bit long and perhaps the gains would not be
realized immediately.

In summary I feel that the 10% increase may be slightly optimistic,

achievable perhaps over a longer period of time and not immediately.

 Redeployment of excess capital of CHF 11- 13 billion. Capital would be

released by closing and sale of redundant facilities and operations. This
capital would be reinvested to earn a targeted return on equity between 15
and 20 %.

Two major sources of capital redeployment are New equity from profit
retention (CHF 8 – 9 bn) and Release of Equity of CHF 3-4 bn thus giving a
total of CHF 11- 13 bn for redeployment. A back of the envelope computation
of asset value of office closed is about SFr 3.75 bn as shown in Exhibit 1.

A 3.5 % ROI on 11 – 13 bn would give the company additional return of .42 Bn

which is an additional 0.05% ROI (.42 / 922 bn of assets)for the company.

The other sources being new equity from profit retention and release of equity
seem to be reasonable since they are company estimates of future profitability
and possible retention due to the same. Other than that the other amounts
seem to be marginal at best.

 Provision : In addition to the above the company has kept a provision of SFr
7 bn towards merger restructuring charges. This indicates company lack of

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 confidence to achieve the merger or just the fact that the management
wants some room to play around with in case things don’t go right.

4. Exhibit 17 suggests SBC will be sold at a discount. Why would SBC

sell for less than market value
Exhibit 17 shows that SBC has been given shares at an implied discount of 0.82
% which is very marginal considering that share prices keep fluctuating day on
day.

The basis on which the value is divided is decided based on negotiation and the
fact that who brings more value to the table. The gains that would be realized
here are two fold
 Cost Synergies
 Higher Growth
 Redeployment of capital

Many of these gains are accruing from the side of UBS, UBS is the less efficient
of the two firms (ROE 16% Vs 19%) and hence maximum value accretion shall
take place in the value of UBS. As a result higher value should be appropriated
towards UBS.

Apart form this Value is being appropriated here in the ratio of 40% to SBC
and 60% to UBS as show in Exhibit 2.

Another reason is that UBS had registered shareholders who did not have
voting rights. This reduced the decision power of UBS shareholders in the
merged entity. Hence to adjust for the voting power a higher value was given
to UBS shareholders.

In conclusion it may be stated that deal is a merger of equals and it shall

take place as a “Merger of Equals” with exchange ratios based on market values.
Thus the key here is the valuation of equity the fairness of which shall be
confirmed by Morgan Stanley and Wasserstein Parella.

5. As UBS management, Terms you seek for the merger ? What if you are
swiss management ? Discuss issues, financial or not

Terms I would seek as UBS Management

Board Seats: Being the larger bank UBS would seek the chairmanship position in
the Board and preferably with Veto Power.

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Layoffs: UBS would like lesser number of people fired from their staff especially
closer to home or atleast that the same be done based on % of staff employed by
each firm in the geographies.

Loan Losses : UBS would like that SBC shareholders bear any unexpected losses
arising from loans given in the previous years.

Registered Shareholders: UBS would like the registered shareholders to get

voting power in the new firm as this would enhance their power in the firm

Have clear financial and non financial targets : The merger is being done to
achieve certain targets and improve the ROE of UBS. This portion should be
emphasized upon and clear targets relating to the same should be set.

Price : I would like to seek a higher price than the 60% being offered today as
most of the synergies shall be realized based on improvement of UBS operations
and hence UBS is the source of synergy

Terms I would Seek as Swiss Managment

Board Seats: SBC should seek equal number of votes and seats in the Board
considering that this is a merger of equals.

Lay offs: SBC would like to protect its employees saying they are more talented
and special. Considering this it would like lesser number of people fired from its
ranks as compared to UBS.

Risk Controls: SBC would like Ex- UBS shareholders to handle any part of the
lawsuits or liabilites due to discovery of any major risk control issues found at
UBS.

Price: I would like to seek higher price than the current 40% being offered as
SBC has the skills and management expertise by which it shall be able to
turnaround the company. I would argue that anyways merging at market prices
or lower than that seems to be very low valuation of SBCs potential.

EXECUTION

6. Risks associated with this deal

The following are the major risks associated with the deal:

 Execution risk: You are combining the 12th and 13th largest banks in the
world in terms of market cap and this by itself would be a challenge.

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  Layoffs: Laying off 7000 people in the home country forming 18% of your
company staff is a big challenge. There could be severe outburst from the
public and even shareholders. This move will not be easy and is perhaps the
biggest challenge in the deal.
 Realizing Synergies : Cost reductions, growth in revenues and freeing up
capital base is not going to be easy. Especially cost reductions is going to be
tough considering that it is higher service that you are willing to offer. There
is high possibility that instead of replacing the current system you add on to
it both in terms of costs and process. Growth in investment banking
revenues will be a big challenge considering that US is a very competitive
market and that your home base is also under attack from US firms.
 Management Risk: It is very much possible that some of the senior
management and staff may leave the firm voluntarily as they donot get the
same position in the combined firm. Example the CFO is from SBC, this may
not be acceptable to the CFO of UBS and he may decide to leave the
combined entity.
 Cultural Differences: Although both firms may have swiss heritage they
have different styles of functioning. SBC is a far more aggressive bank and
believes in revolutionizing and innovating. UBS is a larger bank
comparatively. Cultural differences may lead to issues post merger in
functioning and realizing synergies.
 Anti-trust Issues : The two banks are the largest and third largest in
Switzerland and also are 13th and 14th in the world. It is highly possible that
the merger may face anti-trust issues in different markets especially in
Europe and much more so in Switzerland where it would have almost
monopolistic presence after the merger.
 Risk Practices at Ex-UBS: Weak risk control systems at Ex-UBS is a
source of potential risk for the firm and it could throw up some surprises
and dampen any cost reductions.
 Share holders Approval: Many shareholders may not agree to this deal as
they may not share the companies vision or its ability to achieve it.
 Competition Risk: There is a high degree of likelihood that competitiors
would try to create problems for this deal as it would seriously threaten
their competitive position.
 Environment: Continued turbulence in the capital market might challenge
the realization of synergies and aimed purpose of merger might be
defeated.

7. How will Senior Management and BoD be composed from the ranks
of the two firms

This is a merger of equals hence the following would be method of composition

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  Chairman should be from the firm that is contributing more to the company
– 60% of merged firm is from UBS hence from them. The chairman should
have VETO power to resolve disputes / differences in opinion.
 Equal number of people should be from both banks in the board
representing the “merger of equals” philosophy.(Exhibit 22)
 Current Members & Skills: Decision should also be taken based on who in
the current boards would be retiring and who would add most value to the
combined firm. It may not make sense to have two board members with
similar competencies. Its better to have one with better competency and
retire the other one.
 Past and current relationship: Any prior or current familiarity between
members may be positive for the member as it would signify possibly better
working relationship in the board.

Senior Management Composition

The senior management composition shall be based on the compentencies and

abilities of the various members and current management in the two firms. For
Example the risk management and control of SBC is very strong, hence it is
more likely that the person heading that division is from SBC. The CEO in the
form of M. Ospel makes sense as he is viewed as innovative and person able to
make a change as he did at SBC. Another determining factor would be whether
both division are getting merged and if so it is more possible tha the
management of the larger sized division get the leadership subject to merit.
Negotiations would be playing a major role in determining who should head the
division. As per Exhibit 22 6 positions in top management has gone to sBC and
4 to UBS (including one Chairman) indicating that SBC is perhaps able to get
its people to head the divisions possibly based on past track records and merit.

8. How would you characterize the merger – negotiation process?

The merger would be characterized as one where both the parties were interested
in going ahead with the merger as it was considered best for each party albeit for
different reasons. Also the counter party was the best available alternative to the,

In term of the negotiation process, the formal negotiations started on March 3

1997 after Ospel and Cabiallavetta had discussed mandates and leadership of the
new firm.

Only July 7, the committees of both the boards met. There were disagreements
over several key issues, notably regarding the management structure and the
valuation of loan loss provisions made by the two firms over previous years.

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 Following this meeting both sides independently decided to discontinue
negotiations.

Later, after a strategy seminar in UBS that concluded that SBC was best partner,
and after certain environment events such as change in tax laws in UK and
collapse of Japanese bank stocks, that called into question the risk control
systems at UBS, considerable pressure was built up on UBS to go for the deal.
The changes in environment and its impact on the banks derivatives management
business had a huge impact on UBS. Negotiations resumed in October 1997,
between the CEOs of both companies and a term sheet was drawn up by late
November.

In this sense, in the second round of negotiations SBC had much higher
bargaining power than UBS and hence was able to gain key positions in the new
organisation and perhaps good value too.

One would have to comment that the negotiators at UBS did not have the
complete understanding of the gravity of their situation and thus gave away their
power by not negotiating effectively the first time around.

9. How would you determine whether the stock market is giving the bank full
credit for its cost reduction and revenue growth initiatives ?

Compute the market capitalization of both the banks prior to the merger
announcement ( I would prefer an average market capitalization of say over 15
days). (V1) – Approximately CHF 85,094 Mn (Dec 4, 1997)

Compute the market capitalization of the combined UBS AG or the combined market
cap of both the firms after the announcement.

The difference in the combined market cap before and after announcement shows
the market estimate of the value of synergies realizable by the two firms as a result
of merger.

In the given case, estimated synergy value is CHF 20 – 25 bn, hence the value
should be approximately CHF 105,094 bn. However this is a stated value and
perhaps should be evaluated after some time of completion of merger to assess how
th market is truly viewing the merger.

Hence if the value is greater than 105,094 then the market is giving the banks full
credit for synergies.

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