Merrill Lynch shored up its capital base by as much as $7.5 billion after selling a stake to Singapore's government and an asset manager, and unloading much of a lending business, as it wrestles with huge subprime mortgage losses.
Temasek Holdings
Merrill plans to sell up to $6.2 billion in shares to Singapore's Temasek Holdings and asset manager Davis Selected Advisers. Both investors bought their stakes at $48 a share, or more than 13 percent below where the stock closed last Friday.
These deals are likely a prelude to another large writedown for Merrill Lynch in the fourth quarter. Some analysts estimate the hit will be bigger than the $8.4 billion writedown Merrill recorded in the third quarter.
Fox-Pitt Kelton analyst David Trone estimated the deal's dilution to existing shareholders would be about 13 percent from the total potential investment. Trone and other analysts estimate Merrill's potential losses on mortgage-related securities could exceed $16 billion in 2007.
"Coming into this debacle the company had several billion in excess equity capital," Trone said in a research note. "On balance, this continues to signal that problems are significant, but management is taking steps to get beyond it."
Temasek will buy $4.4 billion worth of Merrill stock with an option for $600 million more by March 28. Merrill gave Temasek a discount partly in exchange for a lock-up agreement that keeps the investor from selling shares for a year.
Davis Selected Advisers, a $100 billion U.S. based asset manager that also runs mutual funds, will buy $1.2 billion worth of Merrill shares as a long-term investment. Davis is known as a value investor with an annual portfolio turnover of about 5 percent.
About 35 percent of Davis's holdings are in financial services companies. Ken Charles Feinberg, a co-portfolio manager at Davis, said his company contacted Merrill about two weeks ago, inquiring if they would be interested in an outside investor.
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Merrill Lynch
Temasek and Davis will be passive investors, Merrill said.
Earlier this week, the bank said it would sell most of its middle-market lending business to General Electric'scommercial finance arm to free up $1.3 billion in capital. GE is the parent company of CNBC.
Merrill's shares fell $1.64 to close at $53.90 in a shortened session the day before Christmas, when the market is closed. Merrill shares are down 42 percent this year, compared with a 13 percent decline for the sector as measured by the Amex Securities Broker Dealer index.
Bolstering The Balance Sheet
Chief Executive John Thain, on the job less than a month, has been quick to bolster Merrill's sagging balance sheet.
Feinberg said Davis believes in Merrill Lynch's franchise value, citing the strength of its more than 16,000 brokers and its 49 percent stake in asset manager BlackRock. "We think (Thain) has very high integrity," Feinberg said. "We have the right fellow at the top."
Thain and co-President Greg Fleming personally negotiated the deal with Temasek, which had been seeking an investment in a U.S. financial services company. Temasek has a long history of investing in foreign banks, including China Construction Bank, Bank of China and PT Bank Danamon Indonesia.
Meanwhile, there's speculation Merrill Lynch would consider selling its 20 percent stake in financial news and data provider Bloomberg. Some analysts have valued that stake at more than $5 billion.
Merrill Lynch is the latest in a growing number of Wall Street firms to receive cash from sovereign wealth funds. Temasek is an investment vehicle for Singapore and manages a portfolio of more than $100 billion. Temasek's website says total shareholder return since inception 33 years ago is more than 18 percent compounded annually.
Morgan Stanley said it would receive $5 billion from China after recording $9.4 billion of write-downs. Citigroup last month agreed to sell up to a 4.9 percent stake to Abu Dhabi for $7.5 billion, while UBS accepted a $9.75 billion investment from a separate Singapore state fund.
Neither Temasek nor Davis would have a role in Merrill's governance, and Temasek's stake would never exceed 10 percent of outstanding common shares, Merrill said.
Capital infusions from new share issues can reduce the value of existing shareholders' investments, but analysts say it's better than having a weak balance sheet as more mortgage-related losses loom.
Merrill reported 855.4 million shares outstanding at the end of September. The shares issued for Temasek and Davis could boost that number to more than 1 billion on a diluted basis.
"It's very positive that Merrill Lynch is taking the steps that it needs to shore up its balance sheet," said Sean Egan, managing director of independent credit-rating firm Egan-Jones Ratings.
Marshall Front, chairman of Chicago's Front Barnett Associates, which has $700 million of assets under management, also applauded Merrill's move.
"Historically the Fed has been the lender of last resort. Now the lenders of last resort are these sovereign entities," Front said. "And it's great."