A lasso on Merrill Lynch? Run-up in brokerage stock spurs rumors of takeover try
At one time or another over the last five years, E. F. Hutton or PaineWebber has taken center stage in a rumored takeover play. Lately, a new actor has stolen the limelight: Merrill Lynch. Who's after the biggest retail firm in the business? (A Merrill office is within a half-hour drive of nearly 90 percent of the American population.)
The whispered suitors included IBM, Aetna Life & Casualty, Metropolitan Life, American Telephone & Telegraph, and Citicorp. The stock is posting 52-week highs almost daily -- jumping from $30 in November to about $43 this week. But despite two weeks of heavy trading, most analysts remain skeptical about a takeover.
``The rumors are just that,'' ventures Nancy Young, a brokerage analyst at Cyrus J. Lawrence. ``I have a hard time understanding why anyone would buy the largest broker in the business.''
Perrin H. Long at Lipper Analytical Services ``cannot discount the possibility'' of a takeover, but Merrill Lynch would not be his first choice, either. ``With 110 million shares outstanding at $43 per share, you're looking at a lot of money. I would be more inclined to go after PaineWebber, with 17.5 million shares selling at about $36.''
The rumored buyers and Merrill Lynch all deny knowledge of a merger or takeover plans. And the Glass-Steagall Act precludes Citicorp from buying Merrill because of its investment-banking activities.
Still, somebody's pumping up the price. If it is a takeover gambit and the person or group has acquired 5 percent or more of Merrill Lynch stock, as the trading activity suggests, by next week the phantom buyer(s) will be exposed when a 13-D report is filed with the Securities and Exchange Commission.
If no one files, that might be an indication that action was stimulated largely by arbitrageurs gambling on the rumors.
Merrill Lynch isn't the only brokerage house with rising share prices. Retail brokers (those that serve individual investors) generally benefited from the October-to-December rally. Investors buy these stocks on the assumption that the bull market will continue. Bullish sentiment on Wall Street remains strong, although it has tempered somewhat in recent days. With the 350-point rise in 1985, talk of 2,000 on the Dow doesn't sound as far fetched as it once did.
``We're bullish on the market and very biased toward the retail brokers,'' says Stephen Fisher, a brokerage analyst at Prudential-Bache Securities.
Mr. Fisher's favorite is the cost-cutting PaineWebber. It has been closing or merging offices as well as reducing personnel and expenses. In recent months, the firm fired 500 of its least productive brokers (out of 4,000-plus brokers) and lured 360 better producers from competitors.
Fisher prefers PaineWebber because ``they're leaner than Merrill Lynch and three-quarters driven by the retail side.'' The firm has also been broadening its revenue base by beefing up trading and underwriting activities.
Quick & Reilly, a discount broker, also garners a top spot on Fisher's buy list: ``You couldn't have a purer play on the individual investor in a bull market. . . . Quick & Reilly is the most profitable securities firm we follow.''
Pretax profit margins of full-service brokerage houses average about 10 percent. At Quick, those margins are 35 percent, Fisher says. A discount broker's costs are lower because it lacks expensive research analysts. And account representatives are salaried, not commissioned. Thus, when market volume rises, so do the profit margins. Quick & Reilly stock is trading near its record highs.
But the earnings outlook for retail brokerages depends heavily on an optimistic stock market scenario. If individual investors stay skittish about the market (the 39-point drop Jan. 8 has taken the wind out of many sails), then the retail brokers are a lot less attractive in 1986.
``These stocks have had a good run-up; they're not cheap now,'' notes Larry Eckenfelder, a brokerage analyst at Dean Witter Reynolds.
He concedes that most of the earnings reports coming out will be strong for the quarter ending Dec. 31, 1985. This week, in fact, PaineWebber reported that it more than doubled its net income last quarter.
But last year's profits may already be reflected in brokerage stock prices. And Mr. Eckenfelder says: ``In 1985, Merrill Lynch, Hutton, and PaineWebber didn't do as well as they might have. There are still a lot of cost pressures, so the margins aren't that great. Most will come in with about a 10 percent return on equity -- not a spectacular performance.''
Although E. F. Hutton has reorganized and is getting back on track after last year's check-kiting debacle, this year the firm plans to move its headquarters to midtown Manhattan. Eckenfelder figures that move could hurt earnings as much as 50 to 60 cents per share this year. Merrill Lynch will also be incurring relocation expenses.
But the main problem for retail brokers, he says, is that they're still smarting from losses in 1984. In '83 many investors were burned in the sizzling technology sell-off. Since then investors have channeled their enthusiasm mainly into mutual funds rather than individual issues. In 1985, dollars flowing into mutual funds more than doubled the record $47 billion taken in '84.
And which brokerage offers the biggest array of mutual funds?
Merrill Lynch, with $51 billion socked away in mutual funds. Indeed, some say the rumored suitor(s) may be eyeing Merrill (with the biggest distribution network in the business, 10,500 brokers) as a ready path to the mutual fund bonanza.
The rise in mutual fund and other institutional trading, meanwhile, has prompted brokerages to seek a fresh influx of capital.
``Not long ago, a 10,000-share block was a big deal,'' says Ms. Young at Cyrus J. Lawrence. ``Today, you regularly see 100,000-share trades crossed. To stay competitive, a brokerage firm has to have the capital to take down the whole position.''
She thinks more private firms will go public this year, following in the recent footprints of Bear, Stearns & Co. and Alex. Brown & Sons.
While such firms as E. F. Hutton and PaineWebber remain subject to perennial takeover rumors, company officials vow to keep the firms independent. To that
end, they have been raising capital through debt and equity offerings.