To hear Smith Barney chief executive officer James Dimon talk, the proposed merger between Morgan Stanley and Dean Witter Discover is one of the best things that could have happened to his firm. "It has legitimized everything we've ever done," beams Dimon, at 40 the youngest CEO on Wall Street. "In some small, peculiar way, it helps. It's hard to say Morgan Stanley Dean Witter makes a lot of sense without saying Smith Barney makes a lot of sense."
In the past, Smith Barney's retail investor focus has been disparaged by blue-chip investment bank competitors. Thus the decision of that most elite of such banks, Morgan Stanley, to join forces with down-scale retail brokerage Dean Witter, is no doubt a source of reflected glory at Smith Barney.
But there's little for Dimon to gloat over. Smith Barney has been the institution viewed until now, perhaps as Merrill Lynch's closest competitor in the lucrative retail business and a close rival in asset management through parent Travelers Group's mutual funds. Now the creation of a new colossus in the industry is causing domestically-orientated Smith Barney to rethink its strategy for building investment banking and research and expanding internationally.
To that end, says Dimon, "we have an open mind to think through who we would partner up with" a comment that sounds like an advertisement for a foreign suitor. Smith Barney recently reached an agreement to share research internally with BZW in London, though both institutions say the deal is too small to be a prelude to a merger. At the same time, says Dimon, "we'd be happy if it led to additional things. It is good for both of us."
Other Wall Street firms are pondering their positions from a similar point of view. So too are European universal banks, which until now have decided to build in, rather than buy into, the big American market. Other actors in the unfolding drama are US commercial banks, which this month are unleashed to buy brokerages as a result of Federal Reserve Board interpretative changes to the Glass-Steagall law that separates investment and commercial banking.
"We've been waiting for these things to happen," notes Dimon. "You knew you were going to pick up the newspaper and read about it someday." It's not clear yet which institutions have the most to gain or lose in the suddenly transformed environment after the Morgan Stanley/Dean Witter merger. Few expected these two to get together, though in retrospect the combination seems logical, given each institution's strategic weaknesses.
Immediately after the merger, the fourth-largest US retail brokerage, PaineWebber, emerged as the next possible takeover target, followed by speculation about AG Edwards, a highly regarded regional brokerage. Asset managers, which for some time have been selling at high prices, are expected to become even hotter properties. Among the big ones remaining that are publicly held are Franklin/Templeton (which is itself a merged company), T Rowe Price, Alliance Capital, John Nuveen and Pimco Advisors. Another frequently mentioned merger candidate is regional brokerage Legg Mason, 50% of whose earnings derive from asset management.
Morgan Stanley Dean Witter, as the new, combined company is to be known, is being created by a stock swap. Its market capitalization of $21 billion and its $270 billion in assets under management mean that by these measurements Morgan has effectively jumped from bottom to top of the top-tier bulge-bracket companies. So, its two fiercest competititors, Merrill Lynch and Goldman Sachs, are unlikely to stand still.
Merrill, now knocked off its perch as the largest firm, can no longer claim to be the only investment bank to offer retail and institutional services and asset management, note competitors with glee. But it is Goldman Sachs, which so far has shunned retail, that many bankers think has been most outflanked by the move. "It will be interesting to see if Goldman thinks it can survive without that lower-grade business," says a former Morgan salesman. Investment banks, he explains, historically have disliked the retail business because it is "time-consuming". Others suggest that Goldman may seek to join with a bank for greater capital strength.
The only major US investment bank to remain a private partnership, Goldman has been rumoured as a merger partner for such unlikely candidates as Citicorp and discount brokerage Charles Schwab. Indeed, Goldman has begun a mini-acquisition spree, albeit solely of asset-management firms: last year it bought US-based Liberty Investment Management and British pension fund manager CIN Management. At the very least, Goldman will be buying more asset managers, according to people familiar with the firm. "The world has changed a lot," says one such individual. "Goldman is looking at competitors all the time and if it thought it had to make changes to be competitive, the firm would change in a minute."
The future of less profitable, second-tier bulge-bracket firms such as Lehman Brothers and Salomon Brothers is even more uncertain. Lehman has been looked at by many potential suitors over the years yet has insisted that it wants to remain independent. Salomon this year announced a deal with the biggest US fund manager, $430 billion-asset Fidelity, whereby the latter will receive Salomon's equity research and be guaranteed 10% of its stock offerings.
Upping the ante
Bankers say the deal may help Salomon. Given its focus on proprietary trading, Salomon has long lacked distribution. Moreover, while US securities regulations forbid brokers to place new issues in their own mutual funds, such is not the case if those are sold to outsiders in this case, Fidelity.
Nonetheless, many observers are sceptical of such strategic alliances. "We've seen a lot of these attempts to market services through someone else's distribution channel," says one Wall Street executive, "but if there is no proprietary interest in one another, no common ownership, more often than not these things collapse." And now that Morgan and Dean Witter have upped the ante by their merger, such deals are viewed as even less exciting. On the other hand, the executive suggests, "if this is a marriage looming, then it is something worthwhile watching".