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The Ignored Information Content of Stan O’Neal’s Call To Wachovia

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The New York Times got a hold of a hum-dinger: that Merrill Lynch’s CEO Stanley O’Neal had called G. Kennedy Thompson, the CEO of America’s fourth largest bank, Wachovia, last week to feel out a possible merger. Thompson’s reaction was cool, and his stated reason was that the Charlotte, NC bank was still digesting earlier acquisitions.

Merrill’s board was reported to be furious at the move, despite the fact that initiating this sort of call is not a hanging offense in the executive suite (although having it run on the first page of the New York Times puts it in another category). O’Neal is not expected to last the weekend as Merrill’s chief.

The reaction in the press and in the markets was knee jerk. Merrill’s stock was up 8.5% by the end of the day and most analyses focused on what a merger would have done for O’Neal’s pay package (a sale of a 30% or more stake would trigger payments estimated at $200 million or more) , and what he might get upon his ouster (the New York Times and Bloomberg disagree by a pretty big margin).

But no one seems to be reacting to the information content of O’Neal’s move. Things look so bad for Merrill that calling, of all institutions, Wachovia, a domestic bank that has about zero in common with Merrill, and suggesting a merger, seemed reasonable. That is a move of sheer desperation, and everyone assumes it was desperation for O”Neal to save his severance package.

What if everyone has this wrong? What if O”Neal thought this was a reasonable move to save Merrill? This scenario says that, having finally gotten his arms around the dimensions of the problem, O’Neal thinks Merrill should make the best deal it can before things deteriorate further.

If that’s what the phone call was really about, the people who ran Merrill’s stock up today have got this badly wrong.

Let’s consider a few facts. Most CEOs like being CEOs. Once you fall off that perch in disgrace, it’s rare indeed to make a comeback (how many can you name besides Steve Jobs and Robert Nardelli?). And even with the lavish paydays, the ones I’ve come across in the year or two after having lost out by being fired or having their companies acquired look very diminished, like shells of their formers selves. The current conventional wisdom, that O”Neal called Thompson to pull his personal rip cord, flies in the face of how corporate leaders operate.

Plus the board was already out for his head. If O”Neal really wanted to get fired, all he’d have to do is have a couple of lousy analyst presentations, or get snippy with the board. At this juncture, it wouldn’t have taken much for them to terminate him, which also would have triggered cash and prizes.

Consider this discussion from the New York Times:

According to people with knowledge of the deliberations, Mr. O’Neal pitched the idea of a merger with Wachovia as one option that the firm was considering. Other possibilities raised included a direct equity infusion by an investor and a sale of Merrill’s 20 percent stake in Bloomberg, a holding that some analysts have valued as high as $4 billion.

According to these people, the view of the board was that Mr. O’Neal was pushing the Wachovia deal. Indeed, compared with the other proposals, the Wachovia option does come across as a more proactive proposal, notwithstanding the fact that Wachovia’s chief executive expressed reservations.

Mr. O’Neal would be entitled to a payout worth more than $274 million if he left after a deal, according to a pay analysis by James F. Reda & Associates, a compensation consulting firm, using yesterday’s closing price. The other options, a capital infusion and selling the Bloomberg stake, would convey to the market a notion that Merrill had concerns about whether it had enough capital available after the write-downs, these people said. Such vulnerability, perceived or real, could hurt a large investment bank like Merrill that relies on its capital and reputation to cut big deals or engage in sophisticated trading strategies.

The message here is plain and simple. The easy options to shore up Merrill’s capital base could make matters worse by raising worries about the soundness of the firm. But any time a merger looks like a better solution than a capital infusion (and recall, sale of a 30% stake would also have triggered a big O’Neal payday), that says a firm is on the ropes.

The drama about Stan O”Neal is a sideshow to a much bigger and more difficult problem: what will it take for Merrill to right itself?

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9 comments

  1. CrocodileChuck

    Yves

    It’s Robert Nardelli (recently picked from Home Depot’s scrap heap by a hedge fund named after a three headed dog which guards the gates of hell: to run the recently privatised Chrysler Corporation).

    You can’t make stuff like this up.

    CrocodileChuck

  2. Brad

    Merrill is in rough shape, and it has a lot to do with O’Neil’s own folly and lack of sound risk management policy. I think it is clear he was trying to save Merrill (or at least get the best package for its shareholders sooner, rather than later). The reason is that Merrill’s stock price is going to collapse. Folks – the game is over on Wall Street. With the credit crunch, all of a sudden the revenue streams for these firms (Merrill, Morgan Stanley, Goldman, JP Morgan) are drying up, with little hope in sight for a turnaround anytime soon.

    If I were one of these large institutions, I would put together the most crack group of asset divestiture, bankruptcy, and business reorganization team in town. This is where the booming business is going to come, from shoveling the ashes of the next wave of America’s failing economic fortunes off the ground. Think GM, Ford, a few supermarket chains, Sears/K-Mart, multiple mid-cap manufacturers. This next downturn is going to expose how frail so many American companies are since we have opened up our markets to competition from low-cost countries. They have slowly declined, and this folks, is finally going to kill them. As such, there is going to be a lot of demand from bankers and consultants to help investors salvage pennies on the dollar from these corpses.

    Since Merrill is not known as a powerhouse in the investment banking world, and is more a wealth-management powerhouse for the mildly-wealthy, upper middle-class types, its outlook is bleak. I think O’Neil knows this, and lo and behold, was trying to get the deal put together before the share price drops so low, they become a takeover target by….Bank of America or Wachovia itself.

  3. Anonymous

    The future of the investment banking business lies in the merger of themselves with retail banks or finding retail banks as acquirers. On this topic the M Lynch chairman is lucid, though too late for bargaining power. Rest assured you will see many of these attempts the I Banks are so cleaver that they will move in despair and not in strength.
    Resources are going to be scarce; funding is an issue as they deploy most of the Fed gratuities in non-performing assets. The M/A financing is beyond their means, they have screwed their chance to securitize anything after their foray in the sub prime loans.
    Their traditional business brokerage of stocks and bonds have known their best days, long term interest rates for the next decade ought to be up (neglecting the next short term cyclical downwards course)

  4. Yves Smith

    CrocodileChuck,

    Thanks for the catch. Knew I was uncertain as to Nardelli’s first name, but then got a cal (after midnight!) and forgot to Google. Dunno why I have such mental block as regards names. Also, when next in Oz, will most assuredly want to take you up on your offer to shout me a drink (are you in Sydney?)

    Brad,

    Agreed re your view of prospects for the industry. The downturn of 2000-2001 was nothing like what they went through in 1991-192, and this cycle is more like the earlier one.

    Also, while Merrill’s real franchise is still in brokerage and asset management, and therefore banks will perceive there are synergies, I don’t think a bank acquirer/investor will have a good time of it. Look how BofA botched the US Trust deal, and that is a lot closer to their business. Banks have strikingly different cultures than brokerage firms, and it’s because the underlying business requirements are different. The biggest single point of differentiation is that securities industry needs to give its staff far more autonomy, and that is alien to banks.

    Anon of 11:45 AM,

    Agreed that brokerage won’t be as attractive a business as it has been, but I suspect it will take a while for the financial services industry to internalize it. Look how stock focused the business media has become. That may give any struggling securities firm more funding/exit options than its fundamentals suggest.

  5. CrocodileChuck

    Yves

    1) yes, am a Sydney resident
    2) my ‘ex’ worked for Merrill here-when O’Neal came in he eviscerated their management; don’t think there would be anyone left there who would be old enough to remember the last big recession (’91); all they have known is debt fuelled bull markets with the odd seizure (LTCM of ’98)
    3) yes, an ale we shall have when you’re next down; we shall do so at the Lord Nelson and Man ‘O War pubs (oldest in Australia); this is in thanks to your blog which is the best on the ‘Net: THANK YOU!

  6. a

    “Merrill is in rough shape, and it has a lot to do with O’Neil’s own folly and lack of sound risk management policy.”

    I think all of the American IBs are in bad shape, once their losses become fully accounted. So it’s not particularly O’Neil’s folly; he’s just the first to smell the coffee.

  7. catherine

    no wonder the Wachovia guy didn’t bite, I don’t think they will be around. The losses they bought when they bought World Savings are huge, they were the home of the option arm tied to Libor (retard mortgage) and they were where we sent illegals. With unemployment headed up the illegals are just going to leave and they already are running out of reserves at Wachovia……..nope stock AND housing going down together, first time in history……….

  8. Haywoode Jablomi

    Cathy, baby … ummm … you really don’t know what you’re talking about!

    World is certainly the home of the option arm … but tied to COSI and CODI … now W-COSI. Not a volatile index ala LIBOR by any stretch – look at the charts comparing indicies. FNBA did the “illegals” as all serious players in this crappy biz know. WSB made loans to true foreign nationals – with 30-day seasoned asset documentation in $USD @ 70% LTV and appraised by their own conservative staff appraisers. Certainly not No-Doc or High LTV! We can debate the merits of lending to retards, but at least have your fact straight sugar …

    That said, the WB takeover of WSB has absoulutely killed a great company. They were well managed and an absolute money machine through thick and thin – look at their historical stock charts.

  9. Anonymous

    as a former employee of World Savings / Wachovia, I can give a little bit of insite to the company and the merger.

    The wholesale department of Wachovia / World Savings will survive any market, for the simple reason that it’s very thrift, and they simply don’t pay their employees. They are the Wal-Mart of the wholesale industry.

    Here is the breakdown of the pay structure at World Savings / Wachovia for wholesale reps, processors and underwriters-

    Processors – $8 per hour
    Underwriters – $9 to $10 per hour
    AE’s- $1800 per month salary, $150 for car & cell phone, $230 per loan closed.

    Considering they CHARGE mortgage brokers (or end customer) an upfront fee of $350 to submit the loan, whether or not it closes, and they don’t do anything above 80% LTV on their OWN appraisal (not the submitted fee appraisal), they will be in business for a very long time.

    Here is the joke that circulated around the local office-

    “How do you get a Wachovia rep off your doorstep?”

    “Pay him for the pizza”

    Considering less than 10% of the employees of that division (World Savings) make more than $30,000 per year, they have nothing to worry about.

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