The third quarter was tough on all of the major brokerage firms as bets on mortgage derivatives came home to roost. According to an October 26 story in The New York Times, it got so hot at Merrill before the third-quarter earnings announcement, that CEO Stan O'Neal called his friend Ken Thompson over at Wachovia to float the idea of a possible merger.
Crazy right? So crazy, that some industry participants and observers doubted it was true. (The Times told us the paper learned of it from a reliable source.) That said, the incident begs the rather astounding question of whether a mega-merger of wirehouses could actually happen. Who wants 35,000 brokers? Going once, going twice … Advisors we know hate the idea: “There will be two firms left, and they'll have the power to cut my payout,” grouses one advisor at Wachovia Securities.
It didn't take long for analysts to make up their minds about the story. Punk Ziegel analyst Dick Bove called the story “a hatchet job,” engineered by an anti — O'Neal cohort (see our story on page 40). Fox-Pitt Kelton analyst David Trone said it was “borderline implausible … such a bad idea, that we seriously doubt O'Neal would have entertained it.”
But could it happen? Merrill-Chovia? Or any other two wirehouses? Would it work? Probably not — and for a variety of reasons. For one, despite the horrendous write-downs of recent months, all of the firms have strong core businesses and capital bases, says Bove; selling out — being rescued — isn't necessary. In the case of Merrill, the major roadblock to any sale is the vast amount of capital it would require: Only a handful of U.S. firms — Citigroup, Bank of America, JP Morgan Chase — have the $1 trillion-plus in assets it would take to actually buy the firm. (Analysts dismiss a foreign-takeover possibility for political and historical reasons.) A merger between any of the five wirehouse firms would also involve major alterations to the acquiring firm's core business model.
Bove made both points in a research report three days after the Times story broke: “Does anyone really believe that merging Merrill [about $1.4 trillion in assets] with a smaller company [Wachovia, $756 billion in assets] operating in businesses that are not Merrill's specialties was ever seriously considered?”
It's All About Scale
Scale is still the name of the game, says Sanford Bernstein analyst Brad Hintz. But while adding throngs of new reps is nice, growth needs to be organic too — that is, fueled by increased productivity. How do you increase productivity? Expanding fee-based business, lending, and other cross-selling opportunities, improving training and expanding into new channels.
In fact, Robert McCann, president of Merrill Lynch's Global Wealth Management Group, seems to have big ideas for expanding the unit, according to Hintz: In what would be a huge development, Hintz says McCann has expressed interest in developing an independent channel that caters to RIA businesses, much like Schwab Institutional. “More channels is better than fewer channels,” McCann said, according to Hintz. (McCann declined to comment.)
It's no wonder: Charles Schwab has been raking in new assets at a far greater clip than Merrill lately. But Hintz expressed confidence in McCann's abilities, and likes another move he's already made: the recent acquisition of San Francisco-based First Republic, a private bank. Not only did Merrill get high-net-worth advisors and clients, it got a respected regional brand that it intends to keep the way it is — instead of pasting a giant bull on the front door. “It's the same way Clorox can make Hidden Valley Ranch without scaring the bejeezus out of people,” says Hintz. Historical note: Merrill may have also learned a lesson from past re-branding attempts, such as the Mercury Asset Management fiasco in the 1990s.
Meanwhile, the days of gobbling up large — and often faltering — regional firms to add a few thousand reps quickly — albeit not usually on the cheap — may be over. Every wirehouse except Morgan Stanley has made a “bolt-on” acquisition or two in the past two years, reducing the ranks of standout regional firms to two: Raymond James and Stifel Nicolaus. Both are doing well, have soaring stock prices and are independently minded.
Fortunately for the wirehouses, they don't have to buy to grow, says Bove. For one thing, training programs at firms such as Merrill Lynch and Morgan Stanley are alive and well. In fact, he says, the growth that will come from purchases like Advest are tiny in comparison to what Merrill has done with its own force. “In the last five years, Merrill has gone from around 9,000 brokers to 16,000, the bulk of which has been organic growth,” he says. Of course, training is notorious for its high failure rate: On average, to get one good rep, you have to train four.
The firms have also gotten better at tweaking the reps they have to make them more profitable — the push to fee-based business is a fine example. Chip Roame of Tiburon Strategic Advisors says 31 percent of brokerage firms' new assets are going into fee accounts, which will provide 38 percent of future revenues.
Lastly, the relationship FAs have with their firms' banking sides is a work in progress. All the firms have put in place bank deposit sweep programs for smaller brokerage account balances, and are getting reps in the lending game. Most notable, perhaps, is Citigroup, which has begun putting Smith Barney brokers in select bank branches throughout New England in the hope of getting its high-net-worth banking clients to open brokerage accounts. Merge in order to grow? Stan, your Wachovia idea was nutty.