Bank investing arms crowding buyout turf

By Jonathan Keehner and Michael Flaherty

NEW YORK (Reuters) - Despite efforts by Wall Street to paint their merchant banking arms as co-investors and partners to private equity, major leveraged buyout firms are viewing them as direct competitors.

Such sentiments were expressed this week at the Reuters Hedge Funds and Private Equity Summit in New York, where several private equity executives addressed the growth in buyout investing by investment banks.

Wall Street, which earns billions of dollars in annual fees from buyout firms from advising and financing deals, shrunk or pulled out of buyout investing about four years ago, fearing it would pit them against their prized private equity clients.

Morgan Stanley (MS.N: Quote, Profile, Research, Stock Buzz) and JPMorgan Chase & Co. (JPM.N: Quote, Profile, Research, Stock Buzz) were among those that spun off their divisions, while Goldman Sachs Group Inc. (GS.N: Quote, Profile, Research, Stock Buzz) was the only investment bank that substantially boosted its merchant banking group.

Now the banks are ramping up their buyout practices, and private equity firms are taking notice.

"We went through a cycle where investment banks pulled out because I think they viewed a conflict with the private equity firms that they wanted to finance and help to take companies public," said Bain Capital managing director Paul Edgerley. "Clearly our view would be that we prefer investment banks not to have that conflict," he said, speaking at the summit.

Private equity related fees, including those from advising and underwriting, accounted for $15.6 billion, or 20 percent of total global investment banking revenue in 2006, up from $5.0 billion, or 13 percent in 2002, according to data provider Dealogic.

At the same time, the huge success of private equity firms -- with top-tier firms hauling in returns of 30 percent or more -- has prompted companies like Morgan Stanley to get back into the buyout game.

Morgan is raising a $6 billion buyout fund, Lehman Brothers Holdings Inc. LEH.N has upped its buyout fund investing, and Goldman is raising what could be the largest-ever fund, estimated at around $20 billion.

And they're doing bigger deals. Merrill Lynch's (MER.N: Quote, Profile, Research, Stock Buzz) Global Private Equity group participated in a $21 billion deal for HCA Inc., and Goldman's group is involved in the $32 billion deal for utility TXU Corp. TXU.N

Thomas H. Lee co-president Scott Sperling said that while there isn't a lot of ill will brewing, banks need to decide on their role in a transaction.

"When they become a private equity participant in a given situation, we certainly wouldn't want them financing or advising us on the other side of it," he said at the summit.

Morgan Stanley, JPMorgan, Deutsche Bank (DBKGn.DE: Quote, Profile, Research, Stock Buzz) all spun off buyout arms after private equity clients complained of banks encroaching on deals several years ago. JPMorgan still has a private equity arm known as One Equity.

The return of investment banks to the private equity game doesn't concern Elevation Partners co-founder Bret Pearlman. A bigger issue is with so many banks vying for a role in a private equity deal, keeping a deal within a tight circle gets harder.

"If (banks) don't get the piece of business with you, they're probably going to stir the pot and look for other sponsors to go work with," Pearlman said at the summit.  Continued...