For anyone just coming back from a four-year stint on the Mir Space Station, Wall Street has shrunk. Specifically, its roster of investment banks and lending institutions has thinned dramatically through consolidation. In fact, between 1997 and this fall, better than $102.5 billion worth of investment banking/commercial banking/brokerage firm mergers were announced, according to Keefe, Bruyette & Woods, a New York consulting and research firm that follows the banking industry. Notably, more than $57 billion of such pairings were heralded in the second half of 2000. (See chart.) "What we're seeing right now is the globalization of the financial services industry, where foreign banks, mostly European, are attempting to achieve an immediate presence in the U.S. by buying domestic investment banks and brokerage firms," says Fadel Gheit, senior energy analyst for Fahnestock & Co. in New York. "What these banks are also targeting are the same perceived benefits that have driven consolidations in the oil and gas industry-economies of scale, efficiencies, cost savings and complementary skill sets." Gheit believes that Donaldson, Lufkin & Jenrette is probably stronger in U.S. investment banking than Credit Suisse First Boston; however, it doesn't have as much overseas exposure. "UBS is getting with the PaineWebber deal hundreds of billions of dollars in pension and mutual fund assets under management, as well as a large network of retail brokers-7,000 to 8,000 of them." Similarly, J.P. Morgan has hundreds of billions of dollars under management, a strong investment banking arm, and a solid foreign currency operation-all very appealing to Chase, says Gheit. "But there's another, more overriding reason for this deal. Chase needs to grow to keep up with the competition." The implications for the oil and gas industry? "Fewer investment banking choices mean less competition and slightly higher transaction fees down the road," he thinks. "Right now, the oil and gas industry doesn't have to go to the markets to raise capital, because it's flush with cash. However, we'll be seeing a lot more energy M&A activity. And that's where Wall Street is going to make its money-picking up 2% to 3% in advisory fees from each transaction." The prospects are excellent for further financial consolidations. "We'll probably see more hitches within months, not years. I still think Merrill Lynch-the largest brokerage firm in the world-is about to do something, possibly by combining with another large investment bank to achieve more market power." Gheit thinks a Merrill Lynch-Lehman Brothers match-up would be interesting. "Then you'd have a dynamite investment bank, as well as the largest retail brokerage house in the industry. Of course, there's Bear Stearns [which indicated this summer it's for sale-at $120 per share]. It has very good trading operations, but not as good an investment banking operation as Lehman." Understandably, more than a few energy companies share Gheit's concerns about a shrinking financial universe. "With less competition among commercial banks, we've already seen interest-rate spreads increase," says one Rocky Mountain producer. And in some cases, where lenders have linked up with investment banks, he has heard about instances where those lenders have pressured clients to use their new market-making arms to do equity deals. Another concern: is there a conflict of interest when it comes to M&A deals, if an investment banker has both buyer and target company as clients? "As more and more major investment banks merge, they're going to put greater emphasis on large, fee-driven transactions with larger-cap oils, leaving smaller E&P companies a bit stranded when it comes to help with loans or capital-raising needs," the operator says. David Wehlmann, chief financial officer for Houston-based drilling contractor Grey Wolf Inc., notes that, with fewer market-makers competing for energy business, there's reasonable concern about the level of investment banking service and analyst coverage that a small-cap drilling firm may receive. "When you merge 100 bankers at one firm with 100 from another, you're ultimately going to end up with less than 200 bankers," explains Wehlmann. "That could have an adverse impact on service for those companies not involved in large deals. Also, while we're covered today by nine analysts, that number could diminish as consolidation in the financial markets continues." The landscape of the financial marketplace could contract to a point where all that's left are very large investment banking firms and boutique-type houses-with a big void in the middle, Wehlmann says. "It's very possible that regional-type banking firms that serve the midcaps could soon be a thing of the past, and that the industry might be looking at a higher cost of capital." Rome Arnold, managing director, global energy and project finance group, for Credit Suisse First Boston in New York, sees his company's combination with DLJ as nothing but good news for the oil and gas clients of both firms. "What we're doing is matching the best with the best in both banking groups, such that any energy client, large or small, will be getting more depth and range of financial products and service-from M&A advisory and bridge financing to equity- and debt-raising, to structured and project financings." Osmar Abib, managing director, global energy and project finance group, in CSFB's Houston office-one of the largest investment banking operations in that city-elaborates. "DLJ has been known forever for the strength of its high-yield debt group, merchant banking and middle-market investment banking presence-areas where we also have dedicated efforts," he says. "But the combination also adds the financial services muscle of the Credit Suisse Group-with total assets of more than $500 billion-and a much larger international distribution team for equity or debt deals than DLJ had on its own. So together, we're bringing an expanded footprint in all these areas to more and more energy clients of different sizes." In addition, the CSFB-DLJ marriage puts together some of the top-ranked oil and gas analysts in the nation: Phillip Pace on the E&P side, Gordon Hall on the oil service side, and Curt Launer on the natural gas side. Indicative of its up- and down-market reach, Credit Suisse First Boston on its own this year advised Texaco on its pending $43.3-billion merger with Chevron; completed zero-coupon converts for Anadarko Petroleum, Global Marine, Diamond Offshore and Transocean Sedco Forex; and led recent initial public offerings for Chiles Offshore and Westport Resources. But will a bigger Credit Suisse First Boston and a smaller universe of Wall Street banking titans continue to be there for the patch's small fry? "There are probably a few too many investment bankers running around today," says Arnold. "So this recent wave of consolidation isn't going to reduce their number to the point where oil and gas clients have to worry about quality banking coverage. As for ourselves, we believe that today's small-cap E&P company is tomorrow's midcap producer and next year's large-cap company. So, as a company grows, we want to be there-from the beginning, if we can." From where he sits in the Tribeca area of lower Manhattan, M. Scott Van Bergh, managing director and co-head of the global energy group for Salomon Smith Barney, has had several years to ponder the effects of investment banking consolidation, including the merger that created his own company. And in his view, such pairings fit well with what's currently going on in the oil patch. "We're seeing more and more globalization of the oil and gas industry, and larger-cap companies are looking to us for the broadest range of product offerings and integrated financial solutions," he says. "Bundling financial services under one umbrella has enabled us to address those needs-at a lower cost of capital than if the client had to go to several different firms for those same services. For example, in the case of an M&A deal, we're able to provide bridge financing, equity and fixed-income debt to take out that bridge-at a lower all-in cost than if each of those transactions were provided separately." Van Bergh concedes, however, that with many major investment banks now focused on financing larger-cap oil companies, small-caps may tend to get ignored in the up-market reshuffling. Also, as energy lenders combine, that's going to mean less credit availability to the industry. "By and large, when you combine two banks, one plus one does not equal two, in terms of aggregate loan commitment in time. Why? The new combined bank wants to limit its risk-capital exposure to any one name. So energy borrowers ought to be looking to expand beyond their historical lending relationships." Where does Salomon Smith Barney itself stand, in terms of energy focus? "Since our own merger four years ago, we've continued a very robust focus on mid- and large-cap E&P and oilfield service companies-and we don't see changing that," says Van Bergh. The firm recently advised Forest Oil on its merger with Forcenergy and lead-managed the September IPO of oilfield service provider Hydril Co. "If commodity prices stay where they are, we should see a significant pickup not in equity offerings, but in M&A activity," adds Van Bergh. "The recent Chevron-Texaco merger, for instance, should lead to the divestiture of some noncore assets that fit well within the portfolios of midcap players. This is very much an industry where one man's crumb is another man's cake." John W. Sinders Jr., managing director and head of the U.S. energy group for RBC Dominion Securities in Houston, believes that despite recent contraction in the financial services sector, the energy industry actually has more capital-raising choices than ever before. "Even though there are fewer banks around today, more now focus on energy; 10 years ago, most didn't," he says. "Also, while many investment banks may have disappeared, others with an energy focus have taken their place. As one merged banking firm moves up-market, away from small- to midcap energy clients, another steps in to fill that void. It's still a highly competitive market." He notes that, except for investment-grade lending, his own firm wasn't in the U.S. a year ago. Now RBC Dominion's parent, Royal Bank of Canada, will expand its U.S. footprint through a planned $1.5-billion merger with regional, Texas-based Dain Rauscher Wessels, a well-known name in energy banking and research. Fortunately for all in the energy business, the menu of financial products has grown in the last decade. "Today, you routinely see high-yield markets-when I started, the high-yield market didn't exist for most E&P and service companies," says Sinders. "Also, many energy companies have restructured to the point where quite a few are investment-grade credits, so the general bond market is open to them. In addition, structured finance deals are allowing many non-investment-grade companies to access investment-grade financing, whereby they can monetize today their future E&P or oilfield service revenue streams on an off-balance-sheet basis." All this aside, there is some potential downside to financial consolidation, he admits. "When a bank buys an investment bank, it doesn't necessarily mean that the management of the new entity will retain and educate all its people, such that the firm's new, broader menu of financial products and services is delivered effectively to clients. Some will take the right steps; some won't. That's the challenge we and the rest of the banking sector face." But oil and gas clients face an even bigger potential threat from banking consolidation. "Energy is a volatile industry, and it's not that big a part of the global GDP," says Sinders. "So if the industry hits a couple of troughs, some of the bigger, newly combined financial players might very well say, 'I'm a global institution and I don't need to put up with all this volatility,' and they could walk away." It's not likely that RBC Dominion Securities would do so, says Sinders. "Energy is one of the largest industries we bank and it represents 20% of the securities we trade worldwide." Richard H. Lewis, chairman and chief executive officer of Denver-based independent producer Prima Energy Corp., says those financial mergers that are driven by excellent strategic fit and a desire to create value for shareholders, employees and clients will do well. "However, in the case of consolidations where the driving forces are 'bigger is better' and cost reduction, history has shown those won't do as well." Lewis believes strategic mergers, such as banks combining with investment banks, will create value for independents. The resulting new entities will be able to provide multiple financial services-from lines of credit, equity underwritings and research, to investment management services, financial planning and cash management. "As a result of having these capabilities-and more capital behind them-these banks will get to know their customers and their needs much better than has been traditionally the case." Bob Rose, chairman, president and chief executive officer of Houston-based Global Marine Inc., agrees. "It will be a net plus for those of us in the service sector because we'll be able to access from remaining financial players a broader range of services and resources than we could in the past." He isn't particularly worried that mergers will drive up the cost of capital for drilling companies. "There will still be sufficient competition among the remaining financial institutions to restrain any significant rise in fees. Also, I don't see these banks turning away from or limiting their exposure to the service sector. We've probably used most of the major investment banks in our history, and it has been our experience that if there's a deal to be done and a fee to be made, they're interested." Rob Jones, managing director and co-head of the energy group for Merrill Lynch & Co. in Houston, views consolidation within the financial sector as neither good nor bad. "It's simply an inevitable reflection of the broader economy and the consolidation going on within a number of maturing industries, particularly energy. Whether we're talking about investment banks or commercial banks, people who provide financial services to the oil and gas industry recognize that their client base is shrinking and that, to continue to economically provide services to that base, they, too, need to undergo consolidation." The impetus for the recent wave of financial mergers seems to be coming from the commercial banking side, he says. This sector has the largest package of assets and, with deregulation, it's moving into investment banking, as well as retail securities sales and insurance-agent businesses that don't require committed capital and hence, have higher margins. Nevertheless, lenders to the oil and gas industry have become fewer. In addition, there are fewer middle-tier market-makers available to the industry. "The good news is that during the past decade, we've seen the rise of smaller, boutique investment bankers," says Jones. "They're very much targeted to the oil and gas industry, and they can fill that gap with highly knowledgeable research coverage and financial services." Thomas A. Petrie, co-founder and chairman of Petrie Parkman & Co. in Denver, says, "As always, every time a major financial merger occurs, it creates second-order effects and opportunities. In fact, the formation of our company, which also has offices in Houston and London, came out of Credit Suisse acquiring First Boston Corp. back in the late 1980s. "At that time, Jim Parkman and I were at First Boston, and both of us felt there was an opportunity for a boutique to provide oil and gas independents-in a very focused, specialized way-the same investment banking services we were involved with at FBC," he says. "Today, as these giant mergers continue, I see even more opportunity for us-at any level within the energy industry." Petrie stresses the financial services market is very competitive-there is no lack of capital intermediaries waiting in the wings to court the small operator. "For every consolidation you're seeing, there are more investment bankers looking to get into the energy area. In addition, most of the banking deals that have been announced will continue to have a small- to midcap orientation." He points out that Chase and J.P. Morgan have long had a real presence in energy, and that isn't going to change by virtue of their merger. Ditto for RBC Dominion Securities, which will now have stronger U.S. retail and institutional distribution capabilities for their underwritings. Still, won't an undeniably smaller pool of financial players drive up the cost of capital? Not necessarily, says Petrie. "The cost of capital is largely a function of the returns that oil and gas companies can generate on a sustainable basis, and that cost will go up or down depending upon the efficiency of a given company. So it doesn't really matter whether there are 15 investment bankers in energy or 50." Matthew R. Simmons, president of Houston-based Simmons & Co. International, another specialized energy investment banking firm, believes the recent spate of financial mergers makes his company stand out even more from the Wall Street herd. "We've spread our wings from a pure oilfield service focus that we maintained for 22 years to offering finance and advisory services to every segment of the energy industry," says Simmons. "Our single greatest strength has been our ability to be a totally independent voice to our clients-both the companies we represent and the institutional investors we advise-without any corporate spin. By that I mean we've never come up with superficial research analysis that makes an energy company look rosy, just because there's a financing deal coming up. That's something the buy side respects. I suspect that if we were part of a big investment banking firm, we might not have the freedom to be that independent or controversial." Earlier this year, in its first foray into the upstream M&A arena, Simmons & Co. advised Union Pacific Resources on its marriage with Anadarko Petroleum-the largest merger ever in the independent E&P sector. Simmons' take on banking consolidation is blunt. "It's unlikely any higher-quality financial firms will be created out of it, and that's bad news for the energy industry. We're in the early stages of a decade-long energy crisis. And the only way we can slip out of that straightjacket is to embark on a massive expansion and rebuilding of the U.S. energy industry to create excess [supply] capacity. Unfortunately, the views on Wall Street during the past 10 years have been diametrically different-and I don't see mergers changing that." Bruce H. Vincent, executive vice president of corporate development for Swift Energy Co. in Houston, sees more positives than negatives coming out of investment banking mergers. "Consolidation isn't about minimizing competition such that the banks can raise their fees. Rather, it's about making them more powerful, more efficient and more effective, in terms of being able to deliver to the oil and gas industry a broader array of financial products and services, and better execution on transactions, from which they can derive better margins." But again, with fewer banking players, couldn't fees become excessive? Not really, contends Vincent. "The ultimate power rests with the people with the money-the big institutional buy-siders-and they're not going to allow Wall Street houses to charge outrageous fees to access capital such that it affects the economics of the businesses in which they invest. "Also, industry players like ourselves would balk at it. So in a free market there are competitive pressures on financial intermediaries to keep fees within a reasonable range." David A. Trice, president and chief executive officer of Newfield Exploration Co. in Houston, believes there's nothing wrong with consolidation in the banking sector, as long as that universe doesn't shrink to just a handful of major players. He says the big plus for the energy industry arising from recent banking mergers is that there will be more aggregators of capital that can facilitate larger financial transactions for small- to midcap producers. Trice notes that two years ago, Goldman Sachs handled a 4-million-share block trade of Newfield stock overnight. "At that time, there weren't that many investment banks around in a position to put risk capital to work in that fashion for a company our size. But now, through all these mergers, there are more, larger investment banking firms that can take on such a risk. That's a real positive for the 70 or 80 small- to midcap companies remaining in the E&P sector." Bill Montgomery, Dallas-based energy practice leader for Towers Perrin, the worldwide consulting firm, sees contraction in the financial sector as neither good nor bad, but merely a reflection of what's going on in the global oil patch. "Both industries are consolidating to drive down costs, offer clients a broader array of services and raise returns. So in each case, the big are getting bigger. Indeed, financial institutions need greater scale, to meet the worldwide business and capital needs of an Exxon Mobil or a ChevronTexaco." Small- and midcap energy companies won't get left out in the cold, he adds. "There are still so many sources of capital out there for these folks, between the specialty houses and regional investment banking firms that have emerged from earlier financial services consolidations. So the fewer number of players in the financial markets really isn't an issue for these energy companies." What is a major issue for them is the ebb and flow of capital from financial institutions during oil industry cycles, he says. "Too often during the good times-like we're in now-way too much capital flows into the industry. Then during bad times-which is the best time to invest for higher returns-the industry can't access much capital because financial institutions are suffering from the hangover of either lending or raising too much money for the industry during the good times."