Painewebber: Eat Or Be Eaten

As rivals get bigger, it becomes more vulnerable

PaineWebber Inc. faces an uncomfortable choice: With the bigger fish aggressively buying up the smaller fish, the brokerage finds itself too large to make it as a niche firm like Lazard Freres & Co. but too small to go head-to-head with such new global giants as Morgan Stanley, Dean Witter, Discover & Co. Morgan Stanley has a market capitalization of $30 billion and close to 10,000 brokers. PaineWebber has a market cap of $3.4 billion and 6,100 brokers.

No surprise, then, that over the past year, everyone from Chase Manhattan Corp. to J.P. Morgan & Co. has been rumored to be buying the retail brokerage firm. PaineWebber Chief Executive Officer Donald B. Marron, though, insists that he has little to gain by being gobbled up. "We haven't been approached" by any potential buyers, he says.

What Marron, 63, would like to do is get bigger. PaineWebber has a history of acquisitions, the most recent being Kidder, Peabody & Co.'s retail branches in 1994. But the firm has been curiously quiescent during the current merger wave--including overseas, where major firms are expanding. Marron, who has been PaineWebber's CEO since 1980, just hired an investment bank to search for an asset management firm, a brokerage, or a small investment bank, such as Furman Selz LLC, which was just sold. "Size is not the issue. It's momentum--are you growing?" he says.

BOUNCEBACK. Right now PaineWebber has plenty of momentum. Return on equity in 1997 was a healthy 20%, up from past anemic levels of 13% in 1995. Broker productivity has improved. Earnings were $193 million in the first half of 1997, bouncing back from sorry performances in 1994 and 1995. "PaineWebber has a terrific position and a terrific business," says Sanford C. Bernstein & Co. analyst Sallie Krawcheck.

The firm is focusing sharply on its crown jewel, the sales force. PaineWebber ranks fourth in number of brokers, after Merrill Lynch, Smith Barney, and Morgan Stanley, Dean Witter, Discover. In 1996, PaineWebber brokers made average annual commissions of $383,735, above the industry average of $348,359. The firm will spend $25 million to train 650 new brokers this year, with plans to train an additional 1,250 in 1998. It has also invested $500 million in technology this year, including new broker workstations. "We know we've improved dramatically," says Mark Sutton, director of PaineWebber's private client group.

After flirting for years with grand ambitions in investment banking, PaineWebber has finally arrived at a more realistic equilibrium between that and retail brokerage. The firm has narrowed its emphasis to a few investment-banking areas. It is one of the top three underwriters of municipal bonds and has a strong record in equity research, both of which help it serve its affluent customer base.

BULL PRODUCT? But some analysts believe PaineWebber's current upturn is just an unsustainable byproduct of the bull market and that the firm is still prone to management turnover and bloopers. In 1994, a flagship PaineWebber mutual fund had serious losses, damaging Mitchell Hutchins, its asset management arm. Marron installed PaineWebber veteran Margo N. Alexander as head of Mitchell Hutchins in 1995. But it was only five months ago that PaineWebber went from net mutual-fund redemptions to net sales.

Another problem for Marron is how to globalize PaineWebber. The firm has offices in the world's main financial centers and shares research with ING Barings and UBS. But it lacks a solid international presence. Marron says the firm will keep its U.S. focus for the next few years but ultimately will have to buy or build overseas. "We're going to have to do something," he says.

But buying a good firm won't be easy. Bankers say the firm covets Prudential Securities Inc., but it is unlikely that parent Prudential Insurance Co. will sell it. "We have looked at a lot of things and have yet to find something totally right," says Joseph J. Grano Jr., PaineWebber's president. Marron, who owns 1.5% of the firm, and Grano say they feel no pressure to sell. Marron says General Electric Co., which is still a 23% shareholder in PaineWebber after reducing its stake in early August, is not anxious to bail out. "A deal has to be done on friendly terms. That puts us in the driver's seat," says Grano. But if the firm's executives don't make a move soon, they may find themselves in the passenger seat.

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