Merrill Lynch Renews Private Equity Push –

NEW YORK -Merrill Lynch & Co. has certainly felt the backlash from the lagging income syndrome slamming investment banks’ brokerage and advisory businesses this year due to the economy’s less-than-stellar performance.

For the first half of this year, the firm has recorded net earnings of $1.4 billion, 30% lower than the $2 billion it posted for the first six months of 2000. In an effort to breathe some life into its deflated profits, the I-bank is looking to the private equity market to buoy its balance sheet.

Merrill is no stranger to the private equity arena, but its prior endeavors have a somewhat storied past. In the early 1990s, the firm was forced to shutter its private equity arm, Merrill Lynch Capital Partners, because of internal conflicts with its I-banking division.

A Merrill spokesperson declined to elaborate on the exact nature of the strife between the two groups, but she implied that they were in direct competition with each other.

After that unsuccessful run with Merrill Lynch Capital Partners, the firm pushed its private equity efforts to the back burner, spreading them out among its different business units. Merrill now plans to restructure its private equity operations and consolidate them under one umbrella, in a move that it says symbolizes a stronger commitment to that portion of its business.

“We were operating in private equity within our separate businesses,” the Merrill spokesperson said. “We’re just planning on expanding that and coordinating it on a global basis.”

As such, the firm intends to steer the bulk of its private equity transactions toward the health-care, emerging markets, real estate, defense and European sectors.

However, the spokesperson declined to comment on whether or not plans are in the works to raise a new fund to support the firm’s renewed push into the private equity market.

“We can’t really talk about what we are doing, but with Merrill’s own capital and its clients’ capital, this will be a multi-billion dollar business,” she added.

Will It Succeed In PE?

Still, whether its operation will be as big as Merrill claims remains to be seen. While Jamie Punishill, a senior analyst at Forrester Research, believes that Merrill has the potential to become a serious player in the VC arena, history has shown that I-banks typically have been hard-pressed to find returns in the private equity realm.

For example, before Chase Manhattan and J.P. Morgan merged in October 2000, the former’s earnings had dipped 26%, a downturn Chase blamed primarily on the heavy losses experienced by its private equity arm, Chase Capital Partners.

The bank had issued a disappointing third quarter 2000 earnings report, and even went so far as to issue alternative financials that excluded Chase Capital. In the third quarter of 2000, the bank’s private equity portfolio had taken a $25 million hit, as compared with gains of $298 million in the second quarter of the same year, and $377 million in the third quarter of 1999.

Although the economic slump was really only just starting its roller coaster tumble back then, Chase Capital had also made some bad investment decisions, most notably to back publicly traded Latin American online network Starmedia Network Inc. Although the company was Chase’s tenth largest holding-the bank held 11.1 million shares-Starmedia’s stock price hit an all-time low on the day before Chase was scheduled to release its earnings report.

Chase Capital’s portfolio also included other such struggling Internet and technology plays as Inc. and PeoplePC Inc.

Punishill is confident that the changes Merrill is making to its private equity strategy will work to its advantage.

“Anything a client wants is a good thing to have,” he said. “Private equity is a very successful business and the brokerage houses are trying to cater to upscale, wealthy clients. Initially, it may drag down profits but, ultimately, it will be a good thing. Merrill is one of the biggest placement agents and now it has a house product.”

John O’Connor, an executive partner with J.P. Morgan Partners, also said he thought that Merrill may have a good shot at being a successful private equity player this time around.

O’Connor, who came from Chase’s private equity division, said that perhaps Merrill’s biggest shortcoming in the past was that it didn’t treat its previous fund as part of its core business. The firm isn’t likely to make the same mistake twice, he added, especially because private equity is an area where an I-bank can create and sustain a competitive advantage.

It also helps to have a strong leader at the helm. Merrill seems to have found such a soul in Thomas Davis, a vice chairman who was tapped from inside to spearhead the firm’s new private equity operations.

He’s “as good as it gets,” O’Connor said. “If they weren’t serious about this, Tom wouldn’t be running it. This is not going to be a hobby for them.”

The Competition

As for the effects Merrill’s move will have on J.P. Morgan Partners, which has the largest private equity business of the I-banks with $25 billion under management, O’Connor said it only validates his firm’s strategy.

“We have always put more emphasis on our private equity business so we don’t have to change our strategic focus,” he added. “It is a long-term business for us. We take a lot of risks, but we are big and we think big. We have always operated in conjunction with an overall banking model, which gives us strength and puts us in places we wouldn’t otherwise be in,” he said.

J.P. Morgan’s funds focus on early- to late-stage deals in the telecom, media, life sciences and the health-care sectors.

Merrill’s push into private equity comes at a time when competition between venture capital firms is heightened due to the surge of new funds that were conceived during the bull market of 1999 and early 2000.

“How do these guys compete and get what they want? They buy it or hire away the best talent. Merrill is not a bunch of slackers. They will find the best and go with it,” Forrester’s Punishill said.