Merrill Lynch & Co. Inc. has taken a giant step toward becoming a global multiasset manager for U.S. pension funds with its proposed purchase of Mercury Asset Management Group PLC.
In the process, control of Merrill's $48 billion in institutional and high net-worth assets will shift to London from the United States.
The 3.1 billion pounds ($5.25 billion) cash deal would create the world's third largest active money manager. The combination of the United Kingdom's leading pension fund manager and one of the United States' leading mutual fund managers results in a firm with $449 billion in assets under management.
In addition, the deal would:
Give Merrill access to Mercury's strong international investment products for U.S. defined benefit, defined contribution and mutual fund clients. Merrill Lynch Asset Management, Plainsboro, N.J., will retain control of $225 billion of mutual fund assets.
Position the combined firm to take advantage of the growth of defined contribution plans around the world and the global demand for mutual funds.
By purchasing what one U.S. pension executive called a "King Kong" money manager, Merrill -- through what will be known as Merrill Lynch Mercury Asset Management -- is on its way to becoming a competitor of such global multiasset-class institutional money managers as J.P. Morgan Investment Management Inc., Morgan Stanley Asset Management Inc. and Goldman Sachs Asset Management.
Merrill's purchase last year of U.S. value equity manager Hotchkis and Wiley, Los Angeles, was its first step in a journey that observers expect will include acquisitions of two or three other institutional money managers. Some say U.S. growth equities will be next; others say Europe or Asia may be in the cards.
Mercury in a class by itself
Despite the relatively high price Merrill has offered for London-based MAM -- 3% of assets under management -- observers praised the deal.
"There has been nothing in the U.K. in the past 25 years to compete with Mercury," said Paul Haines, head of the European investment consulting practice for Price Waterhouse, London. "There's the first division, which is Mercury, and there's everybody else."
Added Thomas Courtney Jr., president of The Courtney Group Inc., a New York investment banking firm: "The earnings power of the business drives the deal. What Mercury has built would take someone else a generation to do, if they could. It's a once-in-a-lifetime opportunity" for Merrill.
Said Tom Pipich, a consultant with Buck Consultants, New York: "Merrill could use the relationship as a way into the U.S. institutional business by offering international products" to pension funds.
Merrill's $272 billion in assets, mostly from U.S. mutual funds, will complement MAM's 104.4 billion pounds ($177 billion) in assets, two-thirds of which come from U.K. pension funds.
Merrill Lynch Mercury will have tremendous U.S. retail distribution capabilities, the leading presence in the U.K. pension market, and strong footholds in institutional and retail markets around the globe.
One major potential growth area is budding defined contribution markets, as governments cut state pension benefits and shift toward individualized pension arrangements.
Merrill will run the business in two parts: Merrill Lynch Mercury Asset Management will be in London, and Merrill Lynch Asset Management will remain in New Jersey.
Herbert M. Allison Jr, Merrill's president and chief operating officer, will oversee both units.
Merrill Lynch Mercury will be responsible for the firm's $224 billion in global institutional and high-net-worth assets.
That figure includes Mercury's $177 billion in assets plus $48 billion in institutional and high-net-worth money now handled by Merrill Lynch Capital Management Group. Mercury Asset Management International Ltd., New York, also manages $7.5 billion in international stocks and bonds for U.S. pension clients.
Merrill Lynch Asset Management will retain responsibility for $225 billion in U.S. mutual fund assets, including Merrill's $25 billion in defined contribution assets. The London-based entity, however, is expected to develop international products for the mutual fund side, enhancing Merrill's defined contribution offerings.
A transition committee has been named to resolve issues on how to integrate Merrill's U.S. institutional business -- which includes $12 billion in U.S. pension assets managed by Hotchkis and Wiley -- with London-based MAM.
While observers believe the organizations will be integrated as far as management, distribution and probably branding, it's much less clear whether the two firms' very distinct investment philosophies will be married.
In equities, MAM is an opportunistic, rotational manager, a style that has fallen out of favor among U.S. pension funds, while Merrill Lynch's institutional unit, Merrill Lynch Capital Management Group (which includes Hotchkis and Wiley), is a value-oriented manager.
Hugh Stevenson, MAM's chairman, said the "last thing anybody would want to do" would be to change investment styles for Merrill Lynch institutional clients.
Nor did Merrill clients anticipate any change in investment style.
Hotchkis and Wiley runs about $1 billion, primarily in equities, for the $11 billion employee benefit plans of American Airlines Inc., Dallas-Fort Worth Airport. "Our expectation, based on conversations we have had, is that nothing changes," said William F. Quinn, president of AMR Investment Services Inc., which oversees the pension fund.
MAM officials in charge
The proposed acquisition clearly puts MAM officials in charge of the global institutional business.
MAM Deputy Chairman Stephen Zimmerman and Vice Chairman Carole Galley will co-head the business, and will join Merrill's executive management committee, which now has 16 members. It is expected they will report directly to Merrill's Mr. Allison.
Arthur Zeikel, president and chief executive officer of Merrill Lynch Asset Management, will retain control of Merrill's mutual fund business. Mr. Zeikel reports to David Komansky, Merrill's chairman and chief executive officer, and to Mr. Allison.
Mr. Zimmerman and Ms. Galley will serve on the transition committee that will focus on integrating the two firms, as will Michael Quinn, managing director, Merrill Lynch Capital Management Group.
Mr. Quinn, who previously reported to Mr. Zeikel, now will report to Mr. Zimmerman and Ms. Galley in London.
Still, the deal, which is subject to shareholder approval, raises a number of questions, in addition to the future of the U.S. institutional operation.
How will Merrill's retail and transaction-oriented environment fit with MAM's traditional U.K. money management culture?
Will Merrill make additional money manager purchases, particularly in continental Europe and Asia, where each firm's presence is small?
Will Merrill keep MLMAM at the helm of its global institutional business, as it says, especially if purchases of other managers follow?
How will MAM take advantage of Merrill's enormous administrative capability, particularly for defined contribution plans?
Some observers believe MAM's reputation as English public-school elitists is wrong, although the firm might be guilty of arrogance. While MAM's Mr. Stevenson is viewed as "blue-blooded," Mr. Zimmerman is a Jew from north London and Ms. Galley comes from working-class roots in Newcastle. Plus, the firm runs very much as a meritocracy.
Mr. Stevenson, who will be non-executive chairman of the combined manager for a year after the purchase, dismissed cultural concerns, saying: "We've known the Merrill people for a long time."
What the deal does do is move both Merrill Lynch and Mercury closer to being a global money manager.
"Mercury is a firm we would have classified as partly global," said Roger Urwin, head of Watson Wyatt Worldwide's investment consulting practice, Reigate, England. "Now . . . if the deal goes through, they are much closer to being truly global."
MAM has been making major inroads in the Japanese pension market, sweeping up $5.2 billion in Japanese pension accounts, including half of the top 50 Japanese corporate pension funds and five of the 10 largest pension funds in the world. It's also been winning business in northern Europe.
MAM is the leading manager in the infant U.K. defined contribution market, but still has just more than 1 billion pounds in assets under management. Opportunities are beckoning on the Continent as well.
Price is fair
While the L17-a-share cash offer represents a hefty 3% of Mercury's assets under management and 25 times Mercury's earnings per share, observers think the price is fair.
"It's a good deal for Mercury shareholders," said James Cross, who covers the U.K. financial sector for UBS Ltd., London. "But that doesn't necessarily follow that Merrill Lynch paid too much.
"The financial logic of the deal will depend on making two plus two add to five."
Money managers typically have been selling for 1% to 4% of assets, depending on the size of the business and the mix of assets under management, said Craig Ueland, managing director-international operations for Frank Russell Co., Tacoma, Wash.
"Three percent is a big number but it's not out of line," especially for a group the size of Mercury, he said.
Chas Burkhart, whose firm, Investment Counseling Inc., West Conshohocken, Pa., was a business and strategy adviser to Mercury, said: "There are fewer and fewer chances for very powerful combinations, and this is one of them."
Shares of other U.K. managers jumped after the deal. The U.K. market now views money managers as growth stocks, said Tony Cummings, an analyst with Schroder Securities Ltd., London. "What we moved from was a short-term, market warrant to a long-term growth type of industry," he said.