Merrill: Your Questions Answered

A very loyal reader writes:

Why did O’Neal defenestrate while Cayne at Bear and Prince at Citi

have managed to hang on to their jobs? Is a takeover of Merrill realistic,

considering the handicaps of the few firms big enough to do it? Is Merrill

stock fairly priced?

Let’s take those questions in order.

O’Neal’s gone because he had no support: that’s the long and short of it. He

was good at making himself unsackable, both by posting very impressive financial

results and also by more political means: firing anybody who got too powerful,

stocking the board with allies. But Merrill Lynch is a firm of brokers, and

O’Neal was never a broker, which meant that he could never count on any support

within the firm. Indeed, fingers

are pointing at Merrill broker Bob McCann as the man who orchestrated the

strategic leak

to the NYT which triggered O’Neals departure.

Without the support of his employees or executives, O’Neal was forced to rely

on his board. But that’s where the leak was so smart: it revealed O’Neal’s cavalier

attitude not only towards his lieutenants (board members are often OK with that)

but also towards the board itself. And that’s something boards find much harder

to stomach. When O’Neal couldn’t convincingly explain why Merrill’s losses were

so big or whether there was any chance of them recurring, the reasons for continuing

to pay him his large eight-figure salary diminished to zero. Not only did he

have no support within the company, he also seemingly had no control over it,


Niether Cayne nor Prince is quite as lonely, in this respect, as O’Neal was.

While O’Neal was an outsider to Merrill culture, Cayne is Bear Stearns.

And Prince, for the time being at least, retains the support of key lieutenants,

chief among them Bob Rubin. But neither is exactly immune from defenestration.

Is a takeover of Merrill realistic? I’d say it depends largely on the

new CEO. An insider, like Fleming or McCann, will be much less likely to

sell than an outsider like Thain or Fink. And I can promise that there won’t

be any hostile approaches: if Merrill is sold, it will be sold because that’s

what the new CEO thinks will be best for the firm and its shareholders.

The who-might-buy-Merrill question

is tougher: it would take serious cojones for any banker to attempt

a merger of this magnitude in the context of a potentially massive credit crunch.

Such a deal would, however, be transformative for anybody who did it, which

means that there’s possibly a handful of banks who might try. Merrill’s US retail

presence is unrivalled, and I can imagine that a few big European banks would

love it: they are probably more likely suitors than a US shop like JPMorgan

Chase or Wachovia.

As for the price of Merrill stock, it’s now trading at about $66, which puts

it on a price-to-book ratio of about 1.5. But it’s entirely possible that Merrill

assets including its 20% stake in Bloomberg are worth rather more than the official

book value lets on. Reports

Peter Eavis:

An influential banks analyst, Mike Mayo of Deutsche Bank, estimates that

Merrill is even cheaper when you factor in other assets not fully reflected

on the balance sheet. He reckons Merrill trades at 0.7 times his adjusted

book value. If potential buyers share Mayo’s view, they could swoop in soon.

For the time being, the most likely scenario by far is that Merrill remains

independent. As an independent bank, is it worth $66 a share? That depends entirely

on your view of the markets and the economy going forward. There’s no real reason

to believe that Merrill has completely cleansed the Aegean stables of its balance

sheet, and if credit markets continue to get worse, it might be a while before

Merrill reverts to the kind of profits it has historically made. What’s more,

there’s a very serious risk that credit markets might eventually drag equity

markets down with them, which would have a nasty effect on Merrill’s bread and

butter brokerage operation.

So I’d say that there’s a significant downside risk to buying the stock at

this level, which probably more than counteracts the upside risk of a takeover

bid. On the other hand, if neither of those two things happen, the stock could

muddle along quite happily where it is.

To put it another way, the stock might go up, or it might go down, or it might

go sideways. You’re welcome.

Update: Dana

Cimilluca notes that Merrill’s Greg Fleming lives to do M&A deals in

the banking sector. If the board wants Merrill to remain independent, they might

want to choose McCann.

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