COLUMBIA BUSINESS SCHOOL

Asian Corporate Finance and Business Strategy

Joining Forces and Turning Heads: The Nikko Salomon Smith Barney Joint Venture

Eric Tiénou MBA ’03

© 2003 by The Trustees of Columbia University in the City of . All rights reserved.

CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS SPRING 2003 www.gsb.columbia.edu/chazenjournal

Nikko Securities began in 1920 as the securities division of the Industrial Bank of Japan and was incorporated in 1944 as the result of a merger of Kawashimaya Securities Co., Ltd. and Nikko Securities Co., Ltd. As a member of the Mitsubishi keiretsu, Nikko Securities enjoyed strong business linkages with a number of Japan’s blue-chip manufacturing firms during the period of rapid postwar growth.1 These linkages in combination with overall growth in the market enabled Nikko to establish itself as the number three securities firm in Japan.2 Nikko, like other leading Japanese securities firms, suffered losses in the 1990s because of underlying economic weakness in Japan along with the sokaiya payoff and corporate racketeering scandals.3 By early 1998, Nikko was reeling from the impact of its tarnished reputation and sanctions imposed on it by the Ministry of Finance. There were a number of options available to the chief executive officer of Nikko Securities, Masashi Kaneko, including sale of the company to a competitor or ceasing operations altogether. As the Japanese financial market lay in turmoil, there was a round of consolidation in the industry in the . One of the most active participants in this arena was the Travelers Group under the leadership of the acquisitive Sanford “Sandy” Weil. This firm had purchased in 1997 and merged it with its Smith Barney unit to form Salomon Smith Barney investment bank. The Travelers Group acquisitions were not limited to the United States as it sought out opportunities globally. The mature status of securities markets in the United States and Europe led Travelers to seek opportunities in Asia and Latin America. Just as regulatory liberalization was fueling the consolidation of the financial services industry in the United States, it was anticipated that the Big Bang would have a similar impact in Japan.4 The Big Bang also was intended to accelerate corporate restructuring in Japan, and this in turn would have increased the demand among Japanese companies for equity financing and M&A transactions, including complicated cross-border . The relatively small scale of this activity in Japan prior to the Big Bang meant that the ability of domestic securities firms to structure and finance these sophisticated deals was limited—but European and American firms had spent decades honing their skills in this area. All these factors combined to make Japan the last great financial frontier within the developed world for U.S. securities firms. Keen to take advantage of these opportunities, Travelers Group management sought to enter the Japanese market. There were a number of options available to them, including establishing Salomon Smith Barney operations in Japan from the ground up, acquiring an existing Japanese securities firm or entering into a joint venture.5 To Travelers’s management, a joint venture with an incumbent Japanese securities firm presented the best . The importance of personal relationships in the Japanese business world and the entrenched nature of Japanese incumbents constituted a formidable barrier to entry. By linking up with a Japanese firm, Travelers would be able to take

1 Keiretsu is a generic term for a corporate group in postwar Japan. The Mitsubishi keiretsu was one of Japan’s largest corporate groups, with many of the principle enterprises having been founded prior to World War II. 2 This information comes from manager interview and various issues of Nikko Securities annual reports. 3 The sokaiya were corporate extortionists, often allied with the Japanese underworld, who threatened to disrupt shareholder meetings and embarrass corporate management by revealing damaging information unless they were paid off by corporate funds. Nikko Securities was among a large number of firms convicted of paying off these extortionists, in violation of Japanese law. 4 The Gramm-Leach-Bliley Act repealed a number of regulatory barriers in the U.S. financial services industry, prompting a wave of industry restructuring. 5 Salomon Brothers had long maintained a presence in Japan, but the scope of their operations was narrower than the potential scope of operations of SSB, particularly once it became part of .

SPRING 2003 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 1 advantage of the relational capital of an incumbent while bringing technical capabilities into the market that none of the incumbents currently possessed. In Nikko Securities, Travelers Group saw a good opportunity to enter the market via a joint venture. On June 1, 1998, it was announced that Travelers Group and Nikko Securities would form a joint venture called Nikko Salomon Smith Barney. It would be 51 percent controlled by Nikko Securities and 49 percent controlled by Travelers Group. Additionally, Travelers Group would take a 20 percent stake in Nikko Securities by investing $100 million, and Nikko would invest $220 million in Travelers Group by buying shares on the open market. Exhibit 1 provides a timeline of major events in the formation of the Nikko SSB joint venture. The venture would be limited to /wholesale operations, while the retail networks would remain separate. Additionally, as Travelers was entering into this arrangement, it also announced plans to merge with Citicorp. Citicorp had established a significant presence in Japan in the 10 years prior to 1998; it had pioneered the loan syndication market in Japan and was active in cross-border trade financing. Regulatory constraints that were only lifted in 1998 had prevented Citicorp from also building a business in other aspects of wholesale banking, such as debt and equity issuance as well as mergers and acquisitions. The articulated strategy would be to use Nikko’s local knowledge and linkages in conjunction with Salomon Smith Barney’s global presence and financial expertise to take advantage of the perceived opportunities presented by the Big Bang. As stated in the 1998 Nikko Securities annual report, As the Big Bang got underway, Nikko has studied strategic capital participation with global players as a means of enhancing profits and offering the highest level of services to customers. In June 1998, the company announced a comprehensive alliance with the U.S. Travelers Group, with the objective of completing each other’s customer bases in the global markets, including Japan’s. Through Nikko’s branch network, it will be possible for Travelers to fully participate in the Japanese retail financial markets. Nikko’s internationalization will be boosted by Travelers network’s pipelines to European and U.S. institutional investors. Nikko can also hone its technology in underwriting and derivatives.6 Unlike the Merrill Lynch–Yamaichi tie-up, the Nikko Securities–Citigroup/Salomon Smith Barney joint venture was met with skepticism. The primary reason for this skepticism was the gap in corporate culture that existed between Japanese and Western firms. This had troubled other U.S.-Japan joint ventures and acquisitions, particularly in the financial services field, and few observers thought that Nikko SSB would be immune from the pressures. As stated in an article, A lot of questions surround the joint venture. Nikko’s foreign branches will be merged into Travelers’ investment bank, Salomon Smith Barney—a firm with an entirely different corporate culture. Already there are grumbles within Salomon Smith Barney about how the two will mesh. It is not clear that Travelers will be in the driving seat. . . . Travelers’s boss, Sanford Weill, has built a well-deserved reputation from assembling a collection of second- tier financial firms into a money machine, but in Japan he may yet meet his match (Economist 1998). While concerns remained about the viability of this venture, the principals in the deal clearly believed in its potential. Nikko needed to partner with another firm in order to survive, while

6 See Nikko Securities 1998 Annual Report, 11.

SPRING 2003 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 2 Travelers needed a Japanese partner to take advantage of the changes brought forth by the Big Bang. Managers at both Nikko Securities and Citigroup/SSB were aware of the cultural gaps that had negatively affected Japan-U.S. ventures in the past, and given the necessity of the arrangement, they were determined to bridge this gap. From the outset a management structure was devised to deal with the cultural gap. By agreement the CEO of the joint venture would be a Citigroup person, but all divisions, groups and desks would be co-headed by Citigroup and Nikko personnel.7 While this management structure did start to address some of the cultural issues it did not eliminate strain within the organization. As indicated in the Financial Times (1999), Some bankers insist that these mergers and alliances provide an easy way to achieve a distribution system and corporate client network. Salomon Smith Barney claims that its coverage in the wholesale banking sector is now unrivalled by any western firm, and is forecasting profits in its first year of operation. But these alliances face at least two problems. One is the fiendish management challenge of combining Japanese and non- Japanese corporate cultures. Although the NSSB [Nikko SSB] venture has tried to tackle this by appointing “coheads” of every department and introducing a single pay scale, this has not been achieved without considerable friction. While Nikko SSB struggled to overcome the cultural gap in order to complete the integration of the joint venture, financial results that were better than anticipated helped solidify the venture. At the outset, it was projected that it would take three years to become profitable. However, the Big Bang proved to have a bigger impact on firms than on individuals as major Japanese firms sought to raise capital on international capital markets and engage in cross-border acquisitions. The Nikko SSB venture was ideally positioned to take advantage of this shift. Nikko’s linkages to many of Japan’s premiere companies proved extremely useful in obtaining work from firms such as Japan Tobacco, Nippon Telephone & Telegraph and the Long Term Credit Bank. This, in combination with Citigroup/SSB’s technical expertise and global distribution network, gave Nikko SSB the ability to compete effectively with established Japanese securities firms as well as international entrants into the Japanese securities industry. Even though Citigroup was a recently created entity, it was able to rapidly gain prominence in the global securities industry. Through its connections to the various components of the Citigroup empire, Nikko SSB had a degree of access to institutional investors in Europe and North America that its domestic competitors simply did not have. This proved to be useful in an environment in which foreigners were large net purchasers of Japanese securities. Just as Nikko SSB started operations in the spring of 1999, Japanese industry was in the process of reshaping itself to take advantage of the opportunities afforded by the Big Bang. In 1999, there were more than 1,800 mergers and acquisitions, with a total value of over $85 billion—a dramatic increase over the 885 transactions worth a total of $40 billion in 1998. Additionally, in 1999, in excess of $65 billion in equities and convertible bonds were issued by more than 60 companies. In this environment of expanding deal flow, Nikko SSB had two advantages: superior expertise in

7 The effectiveness of this management structure was increased by the fact that many of the senior “foreign” employees from the Salomon Smith Barney side were long-term residents of Japan with years – even decades – of experience working in the Japanese securities industry. For example, John Nicolis, the co-head of the equities division and a managing director, had been working in Japan since the mid-1980s. Furthermore, not all of the senior managers from Salomon were foreign. The handpicked CEO of the joint venture from the Citigroup side, Mr. Kojima, was himself Japanese, but had years of experience working for Salomon.

SPRING 2003 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 3 complex financial transactions and strong ties to international institutional investors. These advantages quickly revealed their worth. In its first year of operation, Nikko SSB underwrote such high profile projects as the of Oracle Japan—a deal which led to a secondary offering of $9 billion in 2000. In addition, Nikko SSB worked on Ripplewoods’s purchase of Long- Term Credit Bank and the initial public offering of Nippon Telephone & Telegraph (NTT). However, the hallmark deal for the fledgling venture was its role in structuring Japan Tobacco’s purchase of R. J. Reynolds’ non-U.S. tobacco brands—a complicated cross-border transaction that demonstrated to the market the full range of Nikko SSB’s expertise. This translated into financial success as Nikko Salomon Smith Barney became profitable in 10 months versus the projected three years.8 This success was by no means temporary. In the fiscal year ending in March 2000, Nikko SSB had a 60 percent market share of equity issuances in Japan and as well as a dominant position in debt issuance. By May of 2000, the venture was being called “highly successful” (Financial Times 2001). The momentum continued through the end of 2001. For the 12 months ending in December 2001, Nikko SSB maintained leading positions in equity and equity-related issuances as well as mergers and acquisitions. Exhibit 2 and Exhibit 3 illustrate the level of Nikko SSB’s success. It is clear that this early financial success helped it to overcome challenges in the form of the cultural gap as individuals from both sides of the joint venture were able to recognize the merits in teaming up these complementary firms and leveraging each of these companies’ strengths. It was clear that the fusion of Nikko’s client relationships and large, well-connected domestic equity research team with SSB’s cutting-edge financial technology and strong access to foreign institutional investors had produced a winning combination. By 2001, other U.S. investment banks were rumored to be considering such ventures. As the Financial Times put it, “Imitation is the sincerest form of flattery, even in investment banking (Financial Times 2001). It is a testament to the impact that Nikko Salomon Smith Barney, the hybrid U.S./Japanese investment bank, has had on the local market that rumors regularly surface about similar tie-ups between overseas houses and Japanese counterparts.” Successful imitation was a potential threat to Nikko SSB’s business model. Despite the Big Bang, deal flow remained comparatively modest in Japan, and the entry of a similarly equipped competitor could eat into Nikko SSB’s bottom line. Even if no similar joint venture was formed, gradual diffusion of the technology of complicated financial transactions to domestic competitors could limit the scope of Nikko SSB’s competitive advantage. The other pillar of Nikko SSB’s competitive advantage—its superior access to foreign institutional investors—was only useful to the extent that foreigners remained willing to increase their holdings of Japanese securities. If foreign interest in the Japanese market faded, so, potentially, could this source of competitive advantage. Another factor weighing on the future of Nikko SSB was its joint venture structure. As indicated by one Nikko SSB insider, “Joint ventures don’t last forever; they have to end sometime.” Given that reality, what will become of this venture? The obvious step would be for one of the partners to buy out the other. However, such a transaction would have pitfalls. If Nikko were to buy out the venture, it could lose the international distribution network and, possibly, the technical capabilities

8 The 10th month of operation was the first full accounting period. However, the joint venture’s operations had actually been profitable from inception.

SPRING 2003 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 4 that Citigroup/SSB brings to the table. If Citigroup/SSB were to buy out the venture, it could lose the client roster and research capabilities that Nikko brings to the venture. As the employees of Nikko SSB looked back over the first four years of operation in early 2003, they had much to celebrate and much of which they could be just as proud. On the other hand, as American investment prospectuses warn clients, “past performance is no guarantee of future profits.” What would the future hold for this venture and for the still-troubled economy in which it had enjoyed such success?

SPRING 2003 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 5 References

The Economist. 1998. Japanese finance: Out of joint. 6 June, 71.

Financial Times. 2001. Survey. 12 April, 4.

———. 1999. Survey—Japanese financial markets. 21 June, 3.

SPRING 2003 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 6 EXHIBIT 1. Timeline of Significant Events in the History of Nikko Salomon Smith Barney

1987 Primerica purchases Smith, Barney, Harris Upham & Co.

1988 Commercial Credit purchases Primerica.

1993 July—Primerica acquires retail brokerage and asset management operations of Shearson from American Express, combined with Smith Barney. Dec.—Primerica acquires Travelers; Smith Barney becomes wholly owned subsidiary of Travelers Group.

1996 Primerica operations consolidated and renamed Travelers Property Casualty, taken public. Nov. 11—“Big Bang” announced.

1997 Travelers purchases Salomon Inc. (formerly Salomon Brothers) and forms Salomon Smith Barney investment bank.

1998 April 1—“Big Bang” changes go into effect. June 1—Nikko announces JV with Travelers Group to serve corporate and institutional clients, with services to include , corporate finance, capital markets transactions and research. Aug. 28—Based on agreement, Travelers Group provides capital of ¥217.3 billion (¥67.2 billion: 9.5 percent of Nikko’s outstanding common plus ¥15.1 in convertible bonds which could be transferred into an additional 15.5 percent of common stock), Nikko Securities would purchase between ¥10 billion and ¥50 billion of Travelers’ shares on the open market. Oct. 8—Travelers mergers with Citicorp to from Citigroup, SSB becomes the investment banking arm (precipitated by Gramm-Leach-Bliley Act).

1999 Feb. 26—Nikko SSB incorporated. March 1—Nikko SSB starts operations. March 28—Citigroup increases stake in Nikko Securities to 20.7 percent.

2000 May 1—Citigroup’s SSB acquires Schroders PLC. PLC establishes foothold in European market.

2001 Dec.—NikkoCiti Trust and Banking incorporated by transfer of 50 percent outstanding shares of the Nikko Trust and Banking Corporation to Citigroup Inc.

Source: Citigroup Inc., Nikko Securities Ltd. and Bloomberg LLP.

SPRING 2003 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 7 EXHIBIT 2. 2001 League Tables for Japanese, U.S. and Global Markets U.S. Debt and Equity Offerings (Jan. 1–Dec. 31, 2001)

Rank Managers Vol.($ mil) Share (%) 1 Salomon Smith Barney 394,513.50 13.7

2 Merrill Lynch 346,960.70 12.2

3 CS 278,730.70 9.7

4 J. P. Morgan Chase 247,978.00 8.6

5 Goldman Sachs 244,148.80 8.5

Source: Investment Dealer’s Digest.

Japan Common Stock and Equity Linked (Jan. 1–Dec. 31, 2001)

Rank Managers Vol.($ mil) Share (%) 1 Nikko Salomon Smith Barney 10,223.40 36

2 Nomura 5,972.10 21.1

3 Daiwa SMBC 3,803.90 13.4

4 Goldman Sachs 2,728.50 9.6

5 Merrill Lynch 1,940.40 6.8

Source: Thomson Financial.

Global Debt, Equity and Equity Related (Jan. 1–Dec. 31, 2001)

Rank Bookrunners Vol.($ mil) Share (%) 1 Citigroup/Salomon Smith Barney 486,920.70 10.9

2 Merrill Lynch 432,696.50 10.6

3 CS First Boston 346,942.10 8.5

4 J. P. Morgan 315,087.50 7.7

5 Goldman Sachs 302,458.20 7.4

Source: Thomson Financial.

SPRING 2003 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 8 EXHIBIT 3. League Tables for Japanese, U.S. and Global Markets, 2002 U.S. Debt and Equity Offerings (Jan. 1–June 30, 2002)

Rank Managers Vol.($ mil) Share (%) 1 Salomon Smith Barney 195,838.30 12.7

2 Merrill Lynch 169,051.30 11

3 J. P. Morgan Chase 148,481.50 9.7

4 CS First Boston 145,017.30 9.4

5 Lehman Brother 126,834.50 8.3

Source: Investment Dealer’s Digest.

Japan Common Stock and Equity Linked (Jan. 1–Dec. 31, 2002)

Rank Managers Vol.($ mil) Share (%) 1 Nikko Salomon Smith Barney 6,106.90 30.4

2 Nomura 5,541.00 27.6

3 Daiwa SMBC 2,850.10 14.2

4 UBS Warburg 1,334.90 6.6

5 Goldman Sachs 1,070.70 5.3

Source: Thomson Financial.

Global Debt, Equity and Equity Related (Jan. 1–Dec. 31, 2002)

Rank Bookrunners Vol.($ mil) Share (%) 1 Citigroup/Salomon Smith Barney 414,924.50 10.6

2 Merrill Lynch 316,788.50 8.1

3 CS First Boston 309,362.20 7.9

4 Morgan Stanley 286,394.50 7.3

5 J. P. Morgan 286,072.30 7.3

Source: Thomson Financial.

SPRING 2003 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 9