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Staking a Claim

Companies like mine will have to compete through global brand names--much like Coke and Pepsi now compete.--Philip Purcell, Morgan Stanley Dean Witter CEOIf youre thirsty, youre never far from a can of Coke--whether you live in Chicago, London, Rio de Janiero or Tokyo. Now imagine if you need your retirement nest egg managed anywhere in the world and you could grab a Merrill Lynch adviser, product

Companies like mine will have to compete through global brand names--much like Coke and Pepsi now compete.--Philip Purcell, Morgan Stanley Dean Witter CEO

If youre thirsty, youre never far from a can of Coke--whether you live in Chicago, London, Rio de Janiero or Tokyo. Now imagine if you need your retirement nest egg managed anywhere in the world and you could grab a Merrill Lynch adviser, product or service as easily as a can of Coke. Wirehouse CEOs cant get enough of the idea: They want to create a brand-name identity among retail investors overseas and are paying big bucks to do it.

Worldwide deregulation means there is now only one strategic question facing each large financial services firm--to be global or not, Purcell said in a Feb. 26 speech to the Economic Club of Chicago. ... If you decide to be global, that strategy requires total commitment. And to be successful on a global scale, every securities company, bank and insurance firm must decide now.

Wirehouses are going after any fertile retail market with zest, says Michael Flanagan, an independent brokerage stock analyst in Fort Washington, Pa. Its opportunism at its finest.

Merrill Lynch made three major acquisitions in seven months. It put up $5.3 billion in cash for Mercury Asset Management Co. in the U.K., becoming the third-largest active asset manager in the world. It picked off most of the branches of failed Japanese brokerage giant, Yamaichi Securities, expecting to spend up to $300 million to make it profitable. It paid almost three-and-a-half times Midland Walwyns book value to acquire the Canadian firm, estimated by analysts at C$986,000 per retail broker. More than 30% of Merrills revenues now come from outside the United States, up from 19.5% in 1992.

Salomon Smith Barney, in less than a year, has found itself in a global position no one could have imagined. The stunning $71 billion deal between parent Travelers Group and Citicorp was made possible, say analysts, because Travelers wanted Citicorps global retail distribution power.

Travelers has a global footprint because of Citicorp; it didnt before, says Hal Schroeder, a senior financial services equity analyst for Keefe Bruyette and Woods in New York. Travelers soon anted up $1.6 billion to bolster Japans troubled Nikko Securities Co., and turned the job over to Salomon Smith Barney.

Edward Jones is not to be left out. It opened its first Canadian office in 1993, then set foot in the U.K. this year. But the firm is working on a master plan of countries it will move into within three years and five years.

It took three years of research to move into Canada, three to four years of research to move into the U.K., but it wont take that long to move into the next country, says Gary Reamey, who heads Jones new international division, based in Toronto.

Retirement Assets Whats making retail such a global darling? Think retiring baby boomers.

Its only a matter of time before everyone realizes the U.S. is the retirement model for the world, said Jeff Schaefer, executive director of the Asian Securities Industry Institute, at the SIA Savings and Retirement Conference June 4. Europe and Japan have the same potential for a retirement market as the U.S. has.

Merrills corporate and public policy research director, Jack Lavery, echoed Schaefer at the same conference. The European Monetary Union has a GDP of $6 trillion to $8 trillion, which now makes Europe a formidable economic player. Its also a long-term savings problem ready to happen. Twenty-one percent of the population of both Italy and Germany will be over 65 by 2010, compared to 13% in the U.S. Its a pension and social security time bomb that needs to be defused.

The U.K. market is the most open and flexible to foreign investment and the furthest along in privatizing pensions. Firms are finding U.K. investors are about 20 years behind Americans in their understanding of financial services, says Allan Anderson, managing director of Edward Jones Ltd. in London. The reason: Prior to Margaret Thatcher, the British lived in a government-controlled economy with defined benefit pensions.

The government now has said, Dont expect to retire on your government social security and has put a number of personal savings plans in place, Anderson says. A plan similar to a 401(k) is the newest.

The large middle market of investors has very little experience with brokers and almost no concept of service, says Anderson. The investors also arent accustomed to buying all financial services under one roof. If they want equities, they go to a stockbroker. If they want mutual funds (unit trusts in the U.K.), they see an independent financial adviser.

Andersons sales force is transplanting the marketing approach that Edward Jones used in the states in the early 80s, Anderson says. Theres no advertising of specific products or services yet.

Were just explaining how basic investments work, the stages of an investors life cycle and how you change diversification as you get older, Anderson says. They see investing in black and white terms: The stock market is risky, period.

What makes us unique is that were putting it all together--equities, unit trusts, pensions, insurance, estate planning, says Anderson. Well have the opportunity in three years to build a national brand.

Anderson doesnt yet see any targeted competition from other U.S. firms. Merrill Lynch entered the British market in 1995 with its purchase of brokerage Smith Newcourt but didnt take on the middle retail market. The Mercury Asset Management acquisition is so big, though, that Merrill Lynch will be a formidable presence everywhere in the U.K.

To be successful in a retail market, you not only have to identify your customer and have product to sell, says Schroeder, you have to provide local market research coverage and be well-enough respected globally to provide quality research coverage of other countries.

Canada over the past few years looks like its becoming the retail market U.S. firms hoped for in the 1980s. The government has liberalized rules on foreign ownership of securities firms and allowed pension funds to increase investment in foreign securities to 20% from 10%.

No wonder, then, that Merrill snapped up Midland Walwyn. It was a move made mainly to capture retail distribution in Canada, say analysts, and to a lesser degree, gain entre to IPO underwriting.

For Midland, it brings U.S. research and a whole range of new products that just cost too much to do on their own, such as CMAs and mutual funds, says Schroeder.

Although Edward Jones has yet to turn a profit on its four-and-a-half-year Canadian investment, thats business as usual for the firm, maintains Reamey. Our start-up costs here are the same as with any U.S. office after the same amount of time, he says. We see no difference in profitability in our branch offices anywhere in the world.

Welcoming Re-education What firm wouldnt want to get its finger in the more than $8 trillion personal financial asset pie held by Japanese investors? Most of it sits in Japanese post offices in savings accounts earning less than 1%. A firm can make a lot of money simply convincing Japanese investors to buy CDs yielding 4% to 5%.

Thats one prong of Travelers retail strategy. With the Citicorp merger, Travelers will have access to a brand-name platform--Citibanks branch network in Japan.

Citibank linked its ATM network to Japans postal savings network. It also introduced a credit card that allows holders to pay off balances in U.S. dollars. More retail market products may follow now that the Japanese government has begun allowing banks to directly sell mutual funds, and individuals to open foreign currency money market and brokerage accounts.

Travelers and Merrill Lynch also are taking advantage of Japanese disillusionment with homegrown brokers. For many years the only game in town for mutual funds, Japanese brokers pushed fads, telling investors mutual funds should be switched as soon as they show gains.

As the economy soured, so did investors. Japanese brokerage firms dumped their worst stocks into their mutual funds, said Schaefer at the SIA conference. Japanese investors remember what Nomura and the other Japanese brokers did to them. U.S. firms see great opportunity to re-educate investors and Japanese brokers about funds, Schaefer said.

In Japan and most of Asia, foreigners now are viewed as a source of new technology and new skills, so they are being welcomed, says Wendy Dobson, international economics professor at the University of Toronto. Also, some of the existing major institutions may not be around too long, so theres an opportunity to replace them. Bottom fishing is great right now.

Merrill Lynch began reopening Yamaichi branches in July. Its 1,000 brokers will sell only 17 Merrill Lynch mutual funds and seven outside funds and wont have to meet sales targets for a while. Merrill has said it doesnt expect to turn a profit for three years.

Although Travelers only bought a 25% stake in Nikko, it is imprinting the Salomon Smith Barney way of doing business on its retail network, say analysts. And even though Nikko will have majority ownership of the investment-banking joint venture, it too will be run by Salomon Smith Barney.

For the Long Haul? Wirehouses have made noise before about going global. Merrill set up a half-dozen retail offices in Japan in the early 80s only to shutter them in 1993. A retail presence in Canada also ended in 1990. Can Travelers really make a success of Nikko Securities, which has lost money in five of the past seven years? Are the high prices being paid--some in shaky economies--worth it once U.S. markets soften?

For the long haul, wirehouses are committed to a presence in Asia, Europe and Latin America, says Tom Finucane, co-portfolio manager for John Hancock Financial Industries Fund in Boston. Those firms who want to be there in five years have to stay there now. They cant afford to pull back.

Wirehouses are pursuing a methodical strategy, says Schroeder. Theyre going down their global checklist: Where do we not have franchises? Theyve taken care of Japan, the UK and Canada. Next will be Germany, France, Italy, Brazil and Spain.

Edward Jones had been doing piecemeal research on expanding into such countries as Chile, Argentina and the Netherlands. In April, it regrouped and began developing a list of criteria a country needs to meet to be a good expansion target for the firm. By the end of the year, the firm will choose an A-list portfolio of countries it will expand into within three years, says Reamey, and a B-list portfolio slated for a five-year timetable.

To prepare, all the firms new software is being made multilingual. Meetings also are being held with non-securities multinational companies to learn how an international infrastructure needs to be built.

Our goal in all countries is to see if we can do well doing what we do best--focus 100% on conservative individual investors, Reamey says.

Flanagan is convinced that the earnings dilution brokerage stocks endure in the short term due to the high cost of global expansion will be a plus for the long-term investor. New growth [overseas] should be offsetting new investment, he says.

Merrill Lynch is likely to get a stable, growing, high-multiple business from its Mercury acquisition, says Finucane. He calls Nikko a big risk for Travelers that will take a long time to turn around. But if its a complete bust, it wont have a material effect on Travelers earnings.

Morgan Stanley Dean Witter has been conspicuous in not announcing expansion deals. Theyre moving very cautiously and probably were involved in all the discuss ions of the recent deals, Schroeder says. If they dont find someone exactly right, theyre dead.

As committed as firms are to managing retail assets worldwide, what firms are betting against, warns Flanagan, is global recession.

Nov. 19, 1997: Merrill Lynch acquires Mercury Asset Management Co. for $5.3 billion in cash, making it the third-largest global active money manager with $449 billion in assets under management at the end of 1997. Merrill Lynch Mercury Asset Management, based in London, takes charge of global institutional and high-net-worth assets. Merrill Lynch Asset Management in the United States retains control of U.S. mutual fund assets, including defined contribution assets.

Feb. 12, 1998: Merrill Lynch acquires 33 branches of failed Yamaichi Securities of Japan with plans to invest $300 million in the next two years.

March 1998: Edward Jones opens U.K. offices with eight U.S. brokers and adds six more offices with U.K. brokers by June. Another 22 U.K. brokers are in training to open offices soon.

April 6, 1998: Travelers Group and Citicorp agree to a $71 billion merger.

June 1, 1998: Travelers Group buys 25% of Nikko Securities Co., Japans third-largest brokerage, for $1.6 billion. Nikko has 8,000 employees and 125 branches. Nikko plans to transfer most of its overseas operations to Salomon Smith Barney, freeing up money to expand its retail network in Japan to 300 branches in the next few years.

June 22, 1998: Merrill Lynch acquires Midland Walwyn for $855 million in stock, to form Merrill Lynch Canada. The company becomes Canadas fourth-ranked brokerage by revenue and third-ranked by number of brokers at 1,275 in 116 branches.

June 23, 1998: Salomon Smith Barney acquires Australian fund management operations of J.P. Morgan & Co. for $73 million, beginning a move into the Australian retail market.

Securities firms used to be an easy read for analysts and big institutional buyers: Take a hard look at trading and underwriting revenues. Next, decide whether earnings were volatile enough so the stock might trade at a discount to the market. Then, check out asset management.

Its that last step that is rapidly changing. As the big brokers grow bigger and take on global asset management, analysts find themselves considering new variables. But are the securities firms really any different? Are they transforming themselves? Absolutely, experts say.

Theres a massive amount of pushing to grab assets, says Louis Navellier, a money manager in Incline Village, Nev. If you look at the wholesale rate for trading--four-tenths of a cent--you can understand why.

In the past 10 years, Merrill Lynchs numbers show a gradual decline in sales and trading as a portion of total revenues, says Hal Schroeder, senior financial services equity analyst at Keefe Bruyette and Woods in New York. Its not because theyre doing less of that business, but because asset management has become relatively significant.

Analysts value earnings from asset management as an annuity business, Schroeder says, assigning it a multiple of 25 to 30 times earnings, compared with the typical 15 to 16 times earnings assigned to firms other revenue sources. He says securities firms overall multiples will be boosted as asset management revenue increases.

But theres still a big gap in how firms such as Charles Schwab trade and how wirehouses trade, Navellier says. Schwab trades at about 26 times earnings, with its OneSource program successfully dampening earnings volatility. Wirehouses trade at around 14 times earnings, still impacted by trading and underwriting volatility. However, Navellier says the gap is closing. Wirehouses will be priced more like mutual funds and banks, he says. Their P/E ratios should go to the low 20s.

Michael Flanagan, an independent brokerage analyst in Fort Washington, Pa., predicts global expansion might destabilize wirehouse stock prices in the short term. Weve seen a couple of times with Merrill where its shares suffer a downtick whenever it makes a long-term [global] investment that even hints at short-term dilution, he says.

Even if wirehouses successfully build global asset management, dont expect market perceptions to change easily, Flanagan says. I still see brokerage stocks trading at a significant discount to the broad market, he says. They still suffer from the Rodney Dangerfield syndrome, despite markedly improved quality of revenues.

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