| Thomas Davis | ||||||
Severe downturns have a nasty tendency to lay bare investment banks’ shortcomings, and the tough environment of the past year has been no exception. It would be difficult to point to a firm that has not lead-managed its share of bad deals, has not seen its results falter or that has not had its share of personnel problems.
But one firm has suffered less – even though its second quarter financial results were certainly weak – and has also impressed with its innovation and smart strategy. That firm is Merrill Lynch, which is this year’s winner of the award as the world’s best investment bank.
While some of its competitors have suffered from a sharp drop in business, or others improved simply because their main strength is the funding choice of the moment, Merrill’s broad franchise across products and across regions makes for a well-balanced mix.
Admittedly part of its success does come from the tech wreck: although a player in tech equities and M&A, Merrill was not top three, possibly not top five. Now that this particular sector is so quiet, Merrill looks less like a laggard.
“The environment of the last 12 to 18 months has been one which has enabled us to highlight our strengths,” explains Thomas Davis, president of the corporate and institutional client group, the investment-banking arm of Merrill Lynch. For as long as I recall, from my 24 years working here, we’ve tended to do extremely well in tough markets.”
Merrill’s debt franchise, while no longer the clear market leader it was in the 1990s, still packs a punch. Competitors still wonder if it has yet recovered fully from the turmoil following its near $1 billion loss in late 1998, but Merrill still sits at or near the top of several of the league tables, and still pulls off groundbreaking transactions. In the last year, for example, it has taken Uruguay and Colombia to the yen market, South African financial services firm Old Mutual to the euro market, and done the first US deal for Chinese red-chip firm CITIC Pacific, for $450 million.
“I think we’re punching pretty well in the debt markets,” contends Davis. “Our euro and yen franchises are particularly strong. But we have reprioritized other parts of the business, such as municipal bonds.” And, says head of new issues James Quigley, Merrill has had to adapt more than most. “We used to be able to pitch purely on the basis of market share, but as clients look more for solutions, that approach simply isn’t appropriate any more.” So Merrill has been reorganizing. First it changed its structure from regional to focus on industry groups, incorporating foreign exchange and derivatives from high grade to high yield debt – just as many other banks are.
Second Merrill has set up a global enterprise solutions group focusing on product development and innovation to make the bank more agile in meeting clients’ needs.
And third Merrill has been at the forefront of developing its e-commerce offerings, both internally such as with its very successful liquidity management system for short-term debt, as well as externally such as its leading role in developing would-be on-line debt exchange BondBook.
Its M&A division is one of the few actually growing. That stems in part from the firm having been a relatively late entrant while Morgan Stanley and Goldman Sachs have always had M&A as a core franchise. “Morgan and Goldman have been in the business longer,” says Steve Baronoff, global head of Merrill’s M&A business. “So to break into the market we used other means initially, such as producing really good analytics.” Now Baronoff believes that 2001 could be a good year for his department, approaching last year’s record figures.
It is also because those sectors that play to Merrill’s strengths, such as energy and power, financial institutions or the food industry, are now becoming active after several years of relative quiet. “We spent four years covering the food sector, expecting deals to come,” says Baronoff. “But there was nothing until this year, when suppliers and supermarkets have been consolidating. We’ve been in virtually all of the deals so far.”
But it is equities where Merrill has shone most obviously. Again this is in part because of the poor market. Morgan Stanley and Goldman Sachs, and to a degree CSFB, had been running away with the IPO business in recent years, mainly because of tech deals. But now that such IPOs are scarce, and have also stymied issuance across other sectors, Merrill has been able to pick up market share.
Perhaps more important it is the undisputed leader in convertible bonds, which have accounted for more than 50% of all US equity issuance so far this year. Whether for innovative structures, sizable deals, continued deal flow or distribution capabilities, Merrill rules the equity-linked roost.
Outside the US, Merrill is the dominant force in Latin America, and acted as bookrunner on Petrobrás’ $3.8 billion IPO in the US last year. It’s a top four player in Japan, top two in Canada, and in Europe has capitalized well on its acquisition of Smith New Court in 1995. It also has some of the most highly regarded research, and has formidable distribution to all three legs of the sales stool – institutional, high net worth and retail.
Merrill has also proved itself to be an innovator. In June last year it became the first bank to buy a Nasdaq market maker, Herzog Heine Geduld – Goldman Sachs and Deutsche Bank followed suit a few months later. The drop in trading volume might have taken some of the gloss off the deal, but it has added an important facet to Merrill’s equities franchise.
The other major innovation was quietly introduced in March last year: Merrill Lynch became a fully fledged bank in the US, able to take deposits and hold them on the balance sheet. This was something that the Glass-Steagal regulations forbade brokerage firms from doing, instead forcing them to treat all money in retail accounts as assets under management. Merrill has thus far transferred over $70 billion in retail assets to become liabilities on the balance sheet of its bank. It may appear to be nothing more than a cosmetic change at first, but in this credit- and liquidity-intense market the ability to extend capital where needed quickly and prudently is becoming ever more important.
Luckily for shareholders, Merrill does not appear to be keen to become a big player in the term-loan market, in part because it doesn’t have a big enough balance sheet, in part because loans aren’t that profitable, and in part because it doesn’t have the expertise to be a regular lender. Thus far, though, Merrill has lent roughly $15 billion to 40 or so clients.
It was an exceptionally clever move on Merrill’s part, and it is somewhat astounding that neither UBS PaineWebber nor Morgan Stanley has followed suit.
Rounding out Merrill Lynch’s offering, although not part of the investment bank, are its private-client group – the retail brokers – and Merrill Lynch Investment Managers. Both are performing much better than even two years ago. The private-client group was dogged by fears of the brokers being disintermediated on the one hand by poor product from MLIM and on the other by the rising tide of the internet, encapsulated when Charles Schwab’s market cap was for a time bigger then that of the Thundering Herd. Now that individual investing has taken a hit, and that Merrill has its own internet offerings, the threat appears to have receded.
And the brokers are also getting much better products from MLIM, which has proved to be a good turnround story and an emerging successful division in its own right.
The question for the investment bank is whether it can transform this solid performance with pockets of innovation into a world-beating franchise in the next bull market.
Davis seems sure it can. “We’ve been on a forced march to globalize the business over the last decade, and the trick now is to integrate it fully as fast as we can.”
