Merrill Lynch has changed dramatically from the firm it was in the 1990s to the one it is today. How would you define Merrill in 2006?
You have to look at the sweep of the history of the firm. We started out as a retail firm only, and only in the last 20 years or so have we really built an institutional business. Some aspects of it have been consistent over the entire two decades, such as the openness and the ability to integrate lots of different talents even at very senior levels, both from internal promotions and hires from other firms.
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The other thing is the variety of backgrounds and types of individuals, with different ethnic and national differences, as well as varied experience bases in terms of training, personal temperament and make-up. But it really blends together as a team, and the culture that is able to embrace and connect those kinds of disparate backgrounds and capabilities in individuals is one of the hallmarks of what has always been true, and is still true, at Merrill.
Another one is the idea of doing the right thing, particularly for the client, that is deeply ingrained and I think comes out from the very beginnings of the firm, all the way back to Charlie Merrill, and it’s been transmuted to the institutional culture as we’ve begun to grow that business over the last 20 years.
There are some ebbs and flows, in capabilities and degrees of proficiency, which in some respects in recent history have been more deficient than they needed to be in order for us to achieve all the things that we need to achieve to be successful. These are about operational excellence imbued with the need to excel and find ways of adding value in the marketplace and to clients. We place a huge premium on that, and make people aware that there is pride and reward beyond just the pure sort of financial market share: it is part of being a winning organization.
It comes down to discipline, quality of decision making, and being able to find ways of excelling on behalf of our clients. And, if we can’t do that, then we must be prepared to be realistic about it, be accountable for changing that reality, or making hard decisions about what’s necessary in order to move from where we are to where we need to get.
Those are things, I think, that are unchangeable. And I think they speak to the competitiveness of the financial service industry and financial markets around the world.
What went wrong with Merrill, the powerhouse of the 1990s, that eventually led to its root and branch reform?
Success is often the route of hubris and maybe indulgence; in many respects it’s loss of discipline on many fronts. Because we’d been so successful doing a number of things, we came to believe that if we just did more things in more places, that we would continue to be equally successful without necessarily thinking about what was required in order to make it a reality, or adequately testing the assumptions that underlie the business thesis. We also had a firm-wide view that the world would evolve in a certain way – namely the expansion in equities as an asset class around the world. And that turned out to be true for a period of time, both in terms of volumes, in terms of the number of investors involved, both individuals and institutions, and the effect that it had on equity markets prices around the world.
"We should never have abandoned private equity – I said it at the time, when I ran the leveraged finance business and Merrill Lynch Capital Partners was one of my biggest clients, and I say it now"
It continues to be true – it is a real secular trend. The problem, however, is that for a period of time what we thought was a real environment was partly a bubble. And we expanded into that bubble more than any other firm. So we bought a brokerage operation in Canada, a brokerage operation in Australia, and it led us to expand into Nasdaq trading here in the US. It was also part of the thesis behind our acquisition of Mercury.
None of these in and of themselves were necessarily bad ideas but the cumulative weight of all of them, at price levels that reflected what turned out, with the benefit of hindsight, to be a bubble environment, was a mistake.
Did you always aspire to be CEO of Merrill Lynch?
I had the great benefit since I’ve been here to have lots of different jobs, not always at my own request. Many times, even though I protested, it would have been a mistake not to take those jobs. One of them was the chief financial officer role, which initially I did not want, because I didn’t come to Merrill to be part of what I viewed as a staff job.
You wanted to be a deal maker, because that’s what you liked doing?
That’s right, I could have been part of the financial staff in a lot of places, it was what I was trained to do. And it wouldn’t have been an outrageous aspiration to just stay where I was and be chief financial officer as opposed to moving to an investment bank or a number of other companies for that matter. But I came here to be part of investment banking, not to be part of a financial staff.
The definition of how we look at the chief financial officer and the financial staff has changed markedly over the past several years. And I’d like to think that part of that evolution came with asking me to take on that role. Certainly for me it was an educational and an eye-opening experience. For the first time, aside from being someone who was involved in my business, which mostly up until that point was leveraged finance and capital markets, I was looking at the firm as a member of senior management and with the critical eye of an outside observer.
As CFO, I began to realize there were things we ought to do differently, which would have an impact on all the good things that we were doing.
And then I got a chance to put some of these ideas into practice, in running a business, which was our domestic retail franchise and our private client business. And when I got both the opportunity as well as the challenge of putting them into practice for the firm overall when I was made president in 2001, it also happened to be at the time when the tech bubble was in the process of bursting.
As a CEO, it must be a very tough thing to make 25,000 people redundant, a lot of whom were victims either of markets or of management failure. How does going through something like that inform how you run the bank today?
We’d never like to make those kinds of mistakes again. And it’s not just about the employees, although that is a terrible process to go through. But it’s also about the clients we no longer do business with, and their perception of our firm. Frankly, we’ve been in and out of Canada twice in the retail business.
Now there were good reasons for our decision. Canadian retail is dominated by banks, and is a very transaction-oriented business, which doesn’t lend itself very much to our approach, which is more fee-based consultative. We were actually making money in the business at the time. We just didn’t think we had a distinctive offering there that we could build on over time.
But the second-guessing about “they’re in this market and then they’re out again”, is not the kind of thing you want as an image for the firm, both in terms of our customer base and also for employees. And you don’t want to have to eliminate jobs because of over-expansion. This is a cyclical business and there are some times in the business that are going to be less attractive than others. But I think it is possible to minimize the impact if you manage things smartly.
Merrill went through a restructuring while other firms were building businesses. Does it worry you that you may be playing catch-up?
People said – and I really love these observations – when we acquired the Entergy-Koch Trading platform for commodities about two years ago, that it looked like a late entry into the cyclical peak of a commodity frenzy. If that was a cyclical peak, I’m not sure what we’re in now.
But we were not swayed by the cycle at all. We had been wanting to move into commodities for three years, actively evaluating every single opportunity we could find in the marketplace. We’d looked at the Enron trading platform when Enron went bust and decided to take a pass there, for various reasons. We looked at forming a joint venture with a private company. We looked at hiring teams and building platforms from scratch, and we didn’t like that option in terms of the timeframe, execution risk and cost. And then we had this opportunity with the sale of EKT: we evaluated it, and found out it would fit very well – not perfectly but very well – everything that we had been looking to build for the prior three years. So we entered that transaction with a high degree of certainty that it would be at least a huge positive. It’s turned out to be even better than we could have expected.
It’s not only that it was good from a pure financial return point of view, it’s been fundamentally important to our ability to continue to serve our clients.
So when people say you’re getting into the game late ... well, if we weren’t already a large-scale global fixed-income shop with an investment banking business, where we saw the secular demand for these types of products and room for another competitor on the scale on which we thought we could compete, perhaps they’d have a point but that is not where we started from.
|How O'Neal went from the production line to the front line of investment banking|
Stan O’Neal’s story is unique in investment banking. Born in Roanake, Alabama (because his home town’s hospital refused to serve African Americans), raised in Wedowee (population 750), he was educated in a schoolhouse built by his grandfather, who was born a slave.
O’Neal’s father moved his family from the cotton fields to Atlanta, where he worked on a General Motors assembly line. Stan O’Neal worked there as a teenager but GM spotted his strong intellect and sent him on a scholarship to the GM Institute, where he gained a degree in industrial administration. He then took an MBA in finance at Harvard, graduating in 1978.
For the first eight years of his career he worked at General Motors, first as an analyst. Within three years he was a director in the treasury division. He joined Merrill Lynch in 1986, and again his ascent was remarkably swift. By the early 1990s, he was running Merrill’s then-dominant leveraged finance division.
After spells as global head of capital markets and co-head of the corporate and institutional client group, he spent two years as CFO from 1998 to 2000 – he admits to taking up the role despite reservations and in spite of never having looked at Merrill’s balance sheet – during which time he played a prominent role in solving the firm’s exposure to Long Term Capital Management.
He then briefly became president of Merrill’s US private client group, making him the first non-broker in the firm’s history to run the brokerage business, before becoming president of the firm in 2001. By 2003, he was CEO and chairman.
So it’s a considered approach, but once you’ve made the commitment, it’s total?
In the case of some of our-risk taking capabilities and trading skills that we’ve added, would I have preferred to do all this on day one? Yes. Was it feasible to do so? Absolutely not. But in my tenure we first had to deal with our cost base and restore discipline. Only then could we more proactively and aggressively search out opportunities, hire the right people and, while still producing strong near-term results, make acquisitions.
So if you accept that in some areas you are entering later than you would like, can you still make it work?
The answer is yes, because of what we start with. We have a global franchise which, even after we went through the restructuring, is present in almost 40 countries; we have a global fixed-income business at the top of its game; a cash equity business which is better than any other in the world, although it needs certain attributes to be added to it; a very strong investment banking franchise; a best-in-class wealth management platform; and a very solid and improving retail equity investment business, Merrill Lynch Investment Managers, which has huge new opportunities through the Blackrock tie-up. All of that was in place. The question is, how could we enhance the value of that, not whether or not we wanted to be in certain businesses.
How far towards meeting your goals in terms of new or expanded product offerings are you?
We’ve been doing this in a conservative way for about three years now, and I’d say we are 75% of the way towards what we would ideally like to achieve. The only reason we’re not 100% of the way there is because we either haven’t seen the acquisition opportunity, or we haven’t yet been able to add the right people.
One area you’re on record as wanting to build, through acquisition, is the US mortgage business. How can you make inroads into the incumbents such as Lehman Brothers and Bear Stearns?
It will complement our existing product offerings, of course, but we wouldn’t do it if we didn’t think we would have some way of making our offering distinctive.
Our Indian securities business is a good case in point. We owned 40% of a joint venture with DSP. We believe that a lot of opportunities in India will evolve around the fixed-income product space. To stay ahead of the competition, we need to put more capital to work, have more capabilities on the ground, and take more risk on behalf of clients and in the marketplace.
To do that with a 40% ownership was not a workable proposition economically. So we now own 90% of the business, and from the date we announced it we began to put more capabilities in place and broaden the product platform.
What about prime brokerage? Is that a game you need to be in?
Prime brokerage is a great example. Why would we want to get into prime brokerage? Do we think we can be competitive and bring something distinctive, versus Bear Stearns, Morgan Stanley, Goldman Sachs? The answer is yes. Because we bring a cash equity business that is second to none, a high quality of service and a research capability and a client orientation that I think is distinctive from all the other firms we compete with.
If we can then combine that with first-class prime brokerage capabilities, along with some of the new trading and product creation capabilities that we’ve been adding, I think we have something distinctive.
People talk about the holy grail of this business being the ability to break down the walls between investment banking and capital markets. Is that one area you are ahead, given the very clear reporting lines in the firm?
It’s a very flat organizational structure, which helps. Only six people report to me directly. And it has also been helpful to me that I’ve worked in most every part of our business, and worked on every side of every wall that you can describe: the investment banking side, the capital markets side, the retail side; I’ve even sat on the wall, if you will, as chief financial officer.
One of the things I think is true here is that people ultimately want to do the right thing by the client. The inhibiting factors tend to be organizational. You’ve got to organize some things by geography, some things by product, and some things around clients. There’s a need to do that in every global enterprise like ours, and there are conflicts inherent in these three organizational constructs.
The key is who you put in charge of those businesses, what kind of climate you create and how bureaucratic the structure is around them. I think we’ve tried to be as minimal in bureaucracy as possible.
We spend a lot of time talking about common purpose. No one would mistake me for being ambiguous about what I think is the right form of behaviour and the right operating mode and objectives. And so I’ve tried to be very clear as we’ve gone through this evolution about what’s expected from our senior leaders.
"People said when we acquired the Entergy-Koch Trading platform for commodities about two years ago, that it looked like a late entry into the cyclical peak of a commodity frenzy, If that was a cyclical peak, I'm not sure what we're in now"
We have made some changes over time, where we’ve had people who just didn’t get it, who couldn’t understand that this was about the enterprise more than it was about them, and it was more about excellence in individual performance as part of team, as opposed to simply distinguishing yourself. Conflicts arise and different points of view exist, of course, but we put them on the table and we talk about them in fairly stark terms.
We’ve never had such an outstanding group of leaders across our product silos in the history of the firm. And today we have a common commitment among all the senior people to that purpose. And it’s not just my vision, it’s a vision that’s bought into and shared by the entire executive committee. It’s quite powerful, if you have an organization on the same page like that.
From my interviews it’s not just the executive committee, it seems to have permeated around all the senior managers.
I had a recent experience with a non-US regulator who has spent time with our people outside the US at various levels, all the way through the organization. And they were here in the US to do something similar, and on the last day in the last hour or so, I spent some time with them. And the first question that they asked me was: “Look, here’s the story that we hear, and we hear it from everyone. How is that you have been able to rehearse this script so successfully?” I said to him it’s one of the best compliments that I have been paid.
We hear a similar story from our stockholders, who are often clients of the firm as well. I believe that if you have everybody on the same page you’ve got a chance of getting from point A to point B. You just have to make sure that you want to be at point B when you get there. And that’s what we keep debating all along the way: are we making the right choices?
In your interaction with investors in the stock, do you feel pressure to present the story simplistically? You’ve talked about the cost-cutting phase, the growth phase. What type of stock are you now?
I’m sure I could be better at reducing our themes to more simplistic terms, I just don’t know how to do that. I’ve had advice from people saying if I can get the Merrill story down to a few pithy statements and a couple of sound bites, it would be a much more digestible buy. I’ve even had a friend of mine tell me the same thing – who is still a friend.
It’s more complex than that. Over time the story is told largely based on results, telling people where we want to go and then getting there.
There are times when you need to explain in detail. That was the case when we restructured in 2001 and 2002. It’s been the case as we have grown over the past three years. Recently we’ve had a few misunderstandings, about a perception of pressure to do something in retail banking, a perception of pressure to do something in the mortgage space. Neither were true, and I spent a fair amount of time talking to analysts and investors to clarify some of the confusion.
How did the Blackrock/MLIM deal come about?
We were very content to continue to pursue the organic build-out and enhancement of our investment management franchise. Bob Doll came to do a magnificent job in driving performance – the track record speaks for itself. He also cleaned up the cost structure, which allowed us to drive margins and then rebuild our credibility with the distribution channel here in the US, which has begun to pay dividends in a very clear way. We also solved some of the residual issues that were part of the old Mercury institutional business in the UK.
At the same time we were looking at how we could accelerate even further and enhance the value of that franchise. We debated various options for three years. Once it was clear that we were going to be able to get what we wanted organically, the question then became different: was that the limit of what we wanted to achieve, or was there something else that we might do to further enhance the value?
"In the case of some of our risk-taking capabilities and trading skills that we've added, would I have preferred to add all this on day one? Yes. Was it feasible to do so? Absolutely not"
The answer was, in an ideal world, we wanted to be bigger in the institutional space, and we wanted to be larger in third party distribution in the US. But it would be difficult to acquire other asset management companies trading at multiples of 20 times earnings or higher, when brokerage stocks traded at around P/Es of 13, and create value in the process, as we found out with Mercury.
So we didn’t do that transaction either to exit for sure, because we kept an economic stake equivalent to what we contributed. And we didn’t do it because we couldn’t realize value in the franchise that we had. We did it to transform what was an increasingly valuable franchise into one that was even more so.
Isn’t branding the business as Blackrock an admission of something lacking in the Merrill name?
No. The challenge for us in increasing third party distribution in money management was a broker challenge. We could never get another broker to distribute a Merrill product.
From the outside, it seemed as if Merrill was unsure what to do in private equity. It’s a huge topic of debate for investment banks now. Was it a tough decision to re-enter the business?
In the 1980s Merrill Lynch Capital Partners was the largest broker-affiliated private equity firm in the world. In 1992, the businesses were separated based on specific facts at that time. In my opinion we should never have abandoned it – I said it at the time, when I ran the leveraged finance business and MLCP was one of my biggest clients, and I say it now.
Private equity is a logical adjunct of investment banking. One of my first decisions as president was that I would bring it back to Merrill. I knew I wanted to put Nate Thorne in charge of it, who has done a terrific job, and how to shape the business.
In the end I think we found a great model and our timing was spot on. Of course, the doubters said: “Oh here goes Merrill again, in and out of a business.” But the returns have been better than we expected. And we’ve enhanced our ability to cooperate with clients.
And you don’t see any potential conflicts with investing the firm’s own capital?
Well we’ve not been a sell-side adviser and a bidder at the same time, and we don’t plan to be, and I think that is the source of the debate. But I can see nothing wrong with investing alongside your clients.
Merrill used to be famous for always wanting to be top of the league tables, notably in bond underwriting. Where does the firm want to be now?
There was a time when this firm mistakenly defined being number one in a league table as being equivalent to the quality of the franchise. But it’s far more complex than that. There is certain business we’re not interested in buying. Being top of an investment grade bond league table is not an indicator of profitability.
As the firm grows, how will you be able to keep the most talented people here but keep a streamlined management structure?
We spend a lot of time with people making sure they develop. We’re confident that if the organization is successful then the best people will stay. At the same time we have been very successful in recruiting talent from our opposition. Our pitch is this: the firm is successful, we have momentum, but we still have need for certain talents. That spells opportunity for some individuals. We think it’s a compelling story.