O'Neal Finally Out at Merrill Lynch


By Jason Simpkins
And William Patalon III
Money Morning Editors

Just days after reporting the biggest quarterly loss in its history, Merrill Lynch & Co Inc. (MER) yesterday (Tuesday) forced out Chairman and Chief Executive E. Stanley "Stan" O'Neal, ending days of speculation about the embattled executive's fate.

The New York-based Merrill has, in recent weeks, been the focus of scathing media and analyst reports after it badly misjudged the severity of its own subprime mortgage losses. Just last week, in reporting its biggest quarterly loss in 93 years, Merrill wrote off $8.4 billion in subprime debt and other obligations.

But what really stunned Wall Street about the third-quarter earnings report was the fact that Merrill clearly didn't have a clue about the depth of its problems. Not only was the $8.4 billion hit nearly double what the firm had predicted only three weeks before, the write-downs of subprime mortgages, asset-backed bonds and leveraged loans combined to generate a third-quarter loss of $2.24 billion - six times the company's initial estimate.

When Merrill's plan for reducing its remaining overall debt exposure also failed to reassure Wall Street, the investment-banking firm found that it had lost even more credibility. And some analysts predicted that Merrill might well be looking at $4 billion in additional write-offs in the fourth quarter, according to Forbes.com.

O'Neal shouldered much the blame afterwards, even admitting himself that the company was not adequately protected from the subprime mortgage collapse.

As bad as the company's financial performance has been, it was apparently O'Neal's failure to inform his board of directors about some merger talks he'd held that sealed his fate, The New York Times reported. On Friday, revelations surfaced that O'Neal floated the idea of a merger deal past Ken Thompson, CEO of the Charlotte-based Wachovia Corp. (WB) - without first informing board members. When his attempted maneuverings became public, the board soon decided that O'Neal should be dismissed.

Bloomberg News reported that O'Neal would depart with $161.5 million of securities and retirement funds, according to a Securities and Exchange Commission regulatory filing. In its announcement, the company said that O'Neal was "retiring'' effective immediately, a technicality that allows the executive to keep any prior stock bonuses that he might otherwise have to forfeit. As part of the termination agreement, O'Neal gets an office and an executive assistant for up to three years, the filing said. But he won't get a bonus for this year, Merrill Lynch said.

Merrill, the world's largest brokerage house, said that board member Alberto Cribiore will serve as a non-executive chairman - on an interim basis. And, in a move that surprised Wall Street, the day-to-day operations will be supervised by current Merrill Lynch co-presidents, Ahmass Fakahany and Greg Fleming, according to a report by Reuters.

Cribiore, founder of private equity firm Brera Capital, will chair a search committee to find a permanent successor to O'Neal. In a company statement, Merrill said the committee would look inside and outside the company for a replacement.

Fleming's will oversee risk management, a task previously associated with Fakahany, who the company said would lead global support, finance and human resource functions.

Michael Holland, who oversees $4 billion of assets at Holland Co, told Reuters that the market seemed to be saying that Merrill's troubles are not over. Indeed, Holland said he was actually surprised that Fakahany remains in leadership. Before the announcement, sources told Reuters the Fakahany was expected to resign and later added they still did not expect the executive to remain with the company over the long term.

With a new management team coming in, the speculation about additional write-downs might well become a reality, Deutsche Bank analyst Mike Mayo wrote in a research note Sunday night. The new CEO - wanting to make a decisive statement for Wall Street - is likely to adopt a "more conservative" approach than O'Neal in valuing the collateralized debt obligations (CDOs) that remain on Merrill's balance sheet. [CDOs combine slices of assorted types of debt into a tradable financial instrument backed by that debt].

Mayo, of Deutsche Bank (DB), estimates that Merrill would have to write down another $4 billion worth of its CDOs to make that happen. The result: Merrill will have to deal with a second straight quarter of operating losses.
Mayo said a new CEO would face three challenges in taking the helm at Merrill:

  • Get the financial numbers right and restore investor confidence.
  • Regain credibility and trust with investors.
  • And address the lack of risk controls without hampering the innovation and corporate culture that pervades "the 7/8ths of the company that is performing well."

In a research note and in media interviews, Punk Ziegel & Co. analyst Dick Bove - whose analyses of financial firms during the credit crisis have proved prescient time and again - was skeptical that forcing out O'Neal would, by itself, be enough to fix Merrill.

"Pin the tail on O'Neal, blame him for all of the company's current problems, and kick him out," Bove told The Associated Press. Then bring a white knight in and immediately resolve these problems and, possibly, in the process, merger Merrill out of existence, so that everyone will make their fortunes."

However, such an outcome may not be realistic, Bove said, further expressing his skepticism in a research note, CNNMoney.com reported.

Wrote Bove: "Can a company with an estimated $1 trillion-plus in assets and tens of thousands of employees spread out over multiple businesses and in multiple countries be turned around simply by changing the CEO?"

As Forbes magazine reported, Merrill Lynch may now be in the market for a new leader - but it just as badly needs a well-crafted corporate strategy.

Over the past decade or so, Merrill has developed a reputation for putting its full effort behind a number of "big ideas," only to cut and run when things didn't work out or after it met with more than a modicum of resistance.

Indeed, in an interview with Forbes, in his inimitable style, Punk Ziegel's Bove criticized Merrill's "hummingbird" pattern of doing business, stating that "they are the next-trade guys. They can't hold onto a strategy. They need to stumble onto something they can embrace."

Like most brokerage firms, Merrill was staggered by the implosion of the dot-com bubble. Since that time, Forbes reports, Merrill "vacillated" between a number of strategies, an approach that all-too-often had it in the very position it would exhort clients to avoid - chasing an already hot market. In fact, it piled into subprime mortgages last year - at the housing market's peak - and in December spent $1.3 billion to buy lender First Franklin from National City Corp. (NCC).

A week ago, O'Neal promised shareholders to ratchet back on its more-risky fixed-income activities, to throttle down risk-taking in general, and to pursue business in potentially more lucrative areas, such as private-equity investments, last week to pull back on fixed-income activities, rein in risk-taking and steer capital spending toward potentially more lucrative activities, like private equity.

But it was clearly too late. Delays in the announcement on O'Neal's forced departure touched off speculation that Merrill may have been trying to strike a deal with a rival - the initiative that sealed O'Neal's fate when he tried to engineer a deal all by himself. Right now, however, some of the most likely suitors are dealing with problems of their own.

While it might take some additional time to strike a deal, it might be worth the effort for the buyer. Deutsche Bank's Mayo says Merrill is worth $100 a share to $120 a share in a takeover, a premium of 50% to its current price. The hidden value: Merrill's brokerage unit and its investments in BlackRock Inc. (BLK) and Bloomberg, he said. At that price, a buyer would be getting the investment banking division - which as a standalone businesswould trade at an estimated 1.4 times book value - essentially for free, Forbes reported.

Merrill's shares closed yesterday at $65.56, down $1.86, or 2.76%, per share. In the last 52 weeks, the shares have traded between $59.14 and $98.68 each.

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