by Abigail Hofman
“Rosey,” I wrote. “Things are so bad out there that I can’t open the Financial Times in the morning without a bottle of vodka by my side.” “Pour me a glass,” responded David Rosenberg, Merrill Lynch’s chief North American economist. Rosenberg is one of Wall Street’s biggest bears and thus I have nicknamed him Rosey. However, charming, convivial and highly intelligent Rosenberg has also been right – at least for the past year. I spoke to him in June 2007 as markets were frolicking ever higher; Citi’s former CEO, Chuck Prince, was still dancing; and Bear Stearns’ hedge funds were starting to unravel. I confessed that I was more pessimistic than Cassandra herself. David was a kindred spirit: “I never trust market highs when bank shares lag,” he said.
Just over a year later, in July 2008, I was in New York and went down to Merrill’s World Financial Center headquarters to meet Rosenberg. And I can report that Rosey is still gloomy. “When will it end?” I pleaded, panic rendering me incoherent. Rosenberg looked across his desk, piled high with papers and pamphlets. “When will what end, Abigail?” he queried benevolently. “The housing downturn, the credit crunch or, most pernicious, the consumer recession? America is behaving more like Japan than I envisaged,” he continued. “I thought we would get a more aggressive Fed response. And as for Congress, temporary tax cuts are like using a band-aid to cure cancer! There is no quick fix for sorting out the issues with financial and consumers. And, despite the current short-term inflation scare, I consider that we’re heading into a very deflationary environment (a weak labour market, excess capacity and a contraction in credit). The US recession started in January 2008. The official numbers we have at the moment will all be revised down: negative GDP growth lies ahead and there is no bottom in sight for the housing market. The stock market may find a bottom this autumn but downturns take three to four years to work themselves out and it’s going to feel bad for a while. Our advice to clients remains: own high-quality bonds and be defensively selective in the equity markets (avoid financials and consumer discretionary stocks).” Rosenberg concluded our conversation in his normal cheery fashion: “Most people under the age of 40 are in shock, Abigail. For them this environment is like seeing an unidentified flying object.”
In New York, I also met Larry Fink, chairman and chief executive of asset management firm BlackRock. Fink who started his career at First Boston and is widely credited with developing the first collateralized mortgage obligation, founded BlackRock in 1988. BlackRock was originally part of Blackstone. The name shows that you can be a top financier and still have a sense of humour. In 1995, the stone and the rock separated; PNC, a regional bank, purchased BlackRock and in 1999 BlackRock went public. The firm now manages $1.4 trillion in assets and has made a profit in the past four quarters. BlackRock Solutions is its highly regarded risk management platform, which has been retained by both the Federal Reserve and UBS to value sub-prime portfolios. I asked Fink why he thought he had been so successful. He answered my question on two levels. BlackRock has a client-centric business model (although most financial institutions would claim that) and a powerful one-team business model, which means that it only uses one brand name and has one technology platform. On a personal level, he insisted: “I still work harder than ever, I’m still in the office at 6.15 in the morning, I still visit clients continually and I’m just as paranoid today as I was 20 years ago.”
BlackRock is no longer related to Blackstone but it is related to Merrill Lynch. In February 2006, BlackRock and Merrill announced that Merrill would merge its investment management business with BlackRock to create a new asset management firm. Merrill took a 49.8% stake in the new entity, which retained the BlackRock name. This was a smart trade for Merrill as Merrill was effectively acquiring half of a leading asset manager at an affordable price by using the currency of its own asset management business (which had a higher implied P/E multiple than the broker/dealer itself). The BlackRock deal made a lot of sense: it gave Merrill a significant position in asset management, which in turn had synergies with Merrill’s brokerage business.
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John Thain is a forced seller of assets. This is not a good place to be. He has rummaged around in grandma’s closet to see what gems he can find to pawn and come up with several potential gems |
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Fast forward two and a half years, and at Merrill former Goldman Sachs president John Thain has taken over as chief executive from Stan O’Neal. Merrill has written down more than $40 billion on sub-prime debt, leveraged loans and hedges with bond insurers. As sovereign wealth funds become less enamoured of loss-making western financial institutions, Thain is a forced seller of assets. This is not a good situation to be in. He has rummaged around in grandma’s closet to see what jewellery he can find to pawn and come up with several potential gems. He has sold Merrill’s 20% stake in Bloomberg back to Bloomberg Inc and is looking to offload a controlling interest in Financial Data Services. But it looks as if the stake in BlackRock (valued at about $14 billion) will stay. I am sure that Merrill looked at reducing its BlackRock stake but was unable to pull this off. Unfortunately for Thain, the rating agencies consider that the asset manager is now a core part of the Merrill franchise. I would have loved to be a fly on the wall at the negotiations between Fink and Merrill’s president, Greg Fleming. Fink knew Merrill was in a weak position. Fleming knows Fink extremely well as in the past he has been his investment banker and Fleming negotiated the BlackRock deal on behalf of Merrill in 2006.
In December 2007, Thain was trumpeted as the saviour of Merrill. A Merrill board member gloated to me: “We were so lucky to get him, Abigail.” I hate to be the ugly fairy at the wedding but I’m starting to wonder if Thain will turn out to be Merrill’s messiah after all. Although he has hired several former colleagues (such as Noel Donohoe and Nelson Chai), the engine room of the securities business is leaderless until Tom Montag joins as head of sales and trading in August. So it is amazing that the rates and currencies division produced record first-half revenues. Investment banking under the delightful Andrea Orcel also did well, contributing more than $1 billion in second-quarter revenue. This July, Merrill Lynch was named Euromoney’s global M&A house for 2008.
Montag left Goldman last December and comes in to Merrill on a dream package worth nearly $90 million (whoever said the credit crunch would puncture banking compensation?). Monty (whom a source describes as gloriously unconventional, arriving for dinner in Tokyo on a Vespa and wearing a pink T-shirt), might be good but is he that good? And my guess is he will hire more Goldman people, which in turn will alienate existing Merrill employees. “It’s tough to impose a Goldman-type culture on a brokerage organization,” a source mused. “It would probably mean changing the commission structure, which could be disastrous.”
Thain probably has one more card up his sleeve: he might be able to sell some of Merrill’s private equity portfolio, which is rumoured to be robust. But ultimately can an independent investment bank survive in this new era of less leverage, greater regulation, high volatility and mediocre returns on equity? My gut feeling is that when Thain ascended the Merrill throne, he hoped to drastically write down assets, blame the previous management, stabilize the ship, perhaps achieve some write-ups and then sell the firm, leaving him free to ride off on a white charger to join president John McCain as US Treasury secretary. Things are not going to plan however. Not least since Barack Obama will probably win the election. I don’t rule out the possibility that Bank of America might buy Merrill but the honeymoon is over for Thain. Nine months in to the job, he has to stand up and take the blame or credit for what is happening at Merrill.
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