Will Merrill's Bleeding Stop At $15 Billion? (MER)

By Wayne Pinsent | January 14, 2007 AAA

The New York Times reported on Friday that subprime wounds suffered by Merrill Lynch (NYSE:MER) are probably much worse than experts feared.

The article quotes people familiar with the matter as saying the damaged investment bank will report $15 billion write downs due to bad mortgage investments. If true, this is more than the already high estimates of $12 billion and will cause more trouble for Merrill. (To learn about write downs, see Understanding The Income Statement.)

Piling On
There has been essentially no good news for Merrill recently. The "best" news has come in the form of capital injections, but these are still a negative for the stock. The news of a $15 billion write down is nearly twice what Merrill originally predicted, and it far exceeds the $12 billion that most of Wall Street expected. This is another big blow for the once high-flying firm.

Merrill Lynch stock has dropped nearly 40% over the last six months. One thing this shows is that problems are moving past the first round of write downs, in which Merrill took a $7.9 billion in the third quarter and included other big concessions from Citigroup (NYSE:C), Morgan Stanley (NYSE:MS) and Lehman Brothers (NYSE:LEH). Big hits are still to come for the financials, and this messy situation will continue to work itself out over the coming months.

Thain to the Rescue
John Thain inherited a mess when Stan O'Neal was booted from the CEO post. He knew what he was getting himself into, and he is doing what he needs to do to get the company back on its feet: large write downs and capital injections. Merrill is writhing on the floor now, but eventually it will be revived.

Right after Thain took over last month, Merrill sold a $5.6 billion stake to Temasek Holdings, which is controlled by the Singapore Government, and Thain is looking to raise more. While Thain has stated that he won't sell the company's stake in asset manager Blackrock (NYSE:BLK), he has considered selling less significant assets like Merrill's stake in Bloomberg L.P., which is expected to be worth around $4 billion. These steps will continue to damage the company's shares, but are probably the only choice the company has to rebound in the future.

Deteriorating Value
While I mentioned above that the stock is down nearly 40% over the recent months, it has been a justified sell off. The write downs and dilution effect of capital injections are both working to negatively affect the stock price. The price-to-book value ratios of all the financials are sickeningly low now, but a lot is due to the uncertainty still in future write downs. If Merrill does take a $15 billion write down the current price-to-book of 1.3 becomes a little more justified. (For more on using the price-to-book ratio, see Value By The Book.)

The Bottom Line
John Thain is taking the right steps to building the company back up over the long term, and I think he is a positive force for the company. However, with the possibility of a $15 billion write down on the horizon, and uncertainty about how long the credit crisis will take to move through the system, considerable pressure will remain on Merrill's shares.

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