Speculation 101: A Chase Merrill Deal?

Wall Street is abuzz. Here's what a combo could look like

Deal of the century? Banks such as Bankers Trust New York Corp. and NationsBank Corp. are snapping up securities firms. And that has sparked a fair amount of speculation on Wall Street about whether Chase Manhattan Corp., the nation's largest banking institution, and Merrill Lynch & Co., which has the country's largest brokerage network, might get hitched. Such a pairing would dwarf most rivals. Based on current market and yearend 1996 figures, a combination would have a mammoth $549 billion in total assets, $4 billion in net income, $360 billion in assets under management, and 118,000 employees. The current market capitalization would be $70 billion. It would be the world's third-largest banking company, behind Bank of Tokyo-Mitsubishi Ltd. and Deutsche Bank.

There is no hard evidence that such a deal is in the works. Still, Merrill Chairman and Chief Executive David H. Komansky, 58, visited Chase Chairman and CEO Walter V. Shipley, 61, after Komansky assumed his post last December. And Street sources say both have examined the possibility of a merger, which just a couple of years ago would have seemed preposterous.

REVERSE TAKEOVER? To be sure, a friendly marriage of these two giants would have to overcome daunting financial, cultural, and managerial hurdles--not the least of which is who would be in charge. Chase would probably initiate such a move because it has much more to gain. Having wrung most of the cost savings out of its mergers with Chemical Bank and Manufacturers Hanover Corp., the new Chase is faced with slowing revenue growth. "It's something senior management is really concerned about," says one Chase banker. If Chase acquired Merrill's investment bank, it would end the bank's frustrating attempts to build an equity underwriting business.

Merrill has far less incentive. Some analysts believe that Merrill has a stronger management and brand name than Chase. And in 1996, Merrill posted a 26.8% return on equity, vs. Chase's 18.4%. Merrill's price-earnings multiple is also higher than Chase's, 16.1 vs. 13.2. But in a world of 800-pound gorillas, Merrill might want to be even bigger. Says a Wall Streeter: "It gives them a stable base for the next decade."

Shipley would likely become the first chief executive of the new entity. But Merrill's aggressive, high-powered management team could eventually dominate in a so-called "reverse takeover."

A Merrill spokesman plays down the possibility: "We believe we have the right strategy in place to make the most of the considerable growth opportunity ahead for Merrill Lynch and that we can, on our own, continue to do an excellent job of serving clients and building shareholder value." Says a Chase spokesman: "It is totally inappropriate to respond to hypothetical conjecture."

Even so, the merged firm could develop an awesome marketing machine to promote one-stop financial shopping for retail and corporate customers. And it could enjoy major economies of scale by combining asset management, trading, and back-office operations. Few legal and regulatory obstacles stand in the way of a deal, experts say. Says Harvey P. Eisen, senior vice-president of investments for Travelers Group Inc.: "That's one of the few deals I think would be spectacular."

On the retail front, a marriage would give the combined entity much greater national presence. Chase operates branches only in the New York City area and Texas. Yet Merrill has 680 brokerage offices throughout the U. S. And the firm would be a powerhouse in mortgage lending, credit-card issuance, and gathering consumer deposits. James M. McCormick, president of First Manhattan Consulting Group Inc., sees a big payoff. If Chase could capture the banking business of even a "modest" portion of Merrill's upscale customers, it could boost retail banking profits dramatically. "The top 10% of households are about ten times as profitable as the average bank customer," he says.

Chase probably wouldn't buy Merrill, since the goodwill hit would be too large. Any deal would likely be structured as a stock-for-stock transaction using "pooling of interest" accounting.

Most agree, though, that executing a merger would be extremely tough.

Merrill's rough-and-tumble investment bankers would clash with Chase's more staid commercial bankers. Says bank analyst R. Harold Schroeder of Keefe, Bruyette & Woods Inc.: "How do you structure it without people running? I don't think you can."

Moreover, experts say the combined entity might be forced to pare Merrill's real estate, insurance, and merchant banking activities to comply with Federal Reserve bank rules. Indeed, for Merrill, just talking to bank regulators might be like a cold shower. Which is another reason this potentially hot deal might have to simmer for some time.

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