Dueling Fools
The Wise Guys
May 5, 1999

Merrill Lynch Bull Argument
by Rick Munarriz ([email protected])

A Fool backing the Wise? Sisyphus, take a breather. Let me roll that boulder up the hill for a while. Yet, oddly enough, this big old rock feels more like a pebble when you think about it. Sure, we here at Fool Central shake our heads disapprovingly at the full-service brokerage community. One might even say we pride ourselves in having put the lynch in Merrill Lynch. But that does not mean that investing in the Wise can't be Foolish.

Is Merrill that bad? I think the case can be argued that they were the original Fools, who just got lost along the way. Fifty years ago the company's noble slogan was "Bringing Wall Street to Main Street." In theory, isn't that what Fooldom is about? In the 1970s, the company created the Cash Management Account, trimming the fat off of the bank money market accounts and giving investors a superior yield on parked capital. Empowering the individual to cut out the slothful middleman? Foolish, indeed.

The problem with Merrill, and the same can be said for the full-service brokerage industry as a whole, is that it became that slothful middleman. It took the stock market and made it accessible to those a notch lower on the caste system, but not low enough. It took the financial services industry and gave back some of the wealth to the investor and created superior returns, but not high enough.

All this, yet Merrill Lynch just reported its most successful quarter ever. All this, yet client assets have risen to a staggering $1.5 trillion. I hear folks say that Microsoft's <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSFT)") else Response.Write("(Nasdaq: MSFT)") end if %> Windows interface is stodgy, but it remains untoppled. The running gag is that America Online <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AOL)") else Response.Write("(NYSE: AOL)") end if %> is the Internet on training wheels, but it's still the most popular online service. Folks, Merrill Lynch is number one.

Is it buggy? Sure. But if the worst thing one can say about Merrill is that it's a waiting room for investors who will eventually get smart and become Fools, then that is not a shabby place to be. Many of Merrill's clients are recovering bank addicts. Even with a load charge tacked on to a substandard mutual fund, they probably did better than the 4% a year they were earning on that bank CD. Then again, this is the stereotype. There are plenty of satisfied Merrill customers doing quite well with their brokers; they are only overpaying in transaction fees.

Would they be better served if they took complete control of their finances and transferred to Charles Schwab <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SCH)") else Response.Write("(NYSE: SCH)") end if %>? Maybe. If lower fees is your only criterion, then most Schwab investors should transfer out to the deep discounters like Ameritrade <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AMTD)") else Response.Write("(Nasdaq: AMTD)") end if %>. I guess we'll keep going down that ladder until someone offers commission-free online trading because it will make it up in banner ad revenues.

That's the color of the ideal world, but reality has a different hue. Assets continue to grow at Merrill. That means that more money is coming in than going out. Why not go with the inflow?

Merrill is a quality name. Maybe it stems from the lineage. Co-founder Charles Merrill left the company, started up the Safeway <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SWY)") else Response.Write("(NYSE: SWY)") end if %> supermarket chain in the 1930s, then came back to reign over Merrill Lynch once again. Donald Regan watched over the company in the 1970s until he became the country's Treasury Secretary. How can a company that has shown a persistent knack in tapping pedigree and in revolutionizing the growing financial services sector go flat overnight?

It can't. My opponent Bill is no doubt awash in bearish potshots. I know because he told me. He has so much ammo he doesn't know what he will have to leave behind. But I have a feeling his argument will probably key in on how Merrill has become a laggard because it has failed to embrace the online medium.

It's a popular misconception. After all, Schwab is granted 50% more market cap than Merrill but on a fraction of account assets. That's the irony of it all. If you were to add up all of the accountholder assets from every single online broker you would barely crack $500 billion. Merrill Lynch has three times that in overall client assets. Is online trading a growing market? Sure. Does Merrill need it? Eventually, sure.

Last summer, Merrill's John Steffens, who heads up (and many might say has held back) the company's brokerage division, said some unPC things at the PC Expo. "The do-it-yourself model of investing, centered on Internet trading, should be regarded as a serious threat to Americans' financial lives." He's a caveman, right? He's hoarding twigs for a fire perchance? It may have been a zany thing to say, yet he was eventually partly vindicated. A few months later the largest online brokers set up restricted lists of volatile Internet stocks with tighter margin requirements and online order restrictions.

Is Steffens so backwards that he's a visionary? Probably not, but the prognosis is not terminal. Remember when Bill Gates dismissed the Internet as a growth industry? When you're the biggest, which by many indications may also mean you're the best, you can make up in time what you have earned in reputation. Today, Microsoft is an online leader. Would it shock anyone here, despite being a present slowpoke, that America Online <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AOL)") else Response.Write("(NYSE: AOL)") end if %> will come to dominate broadband access in a few years?

Merrill is slowly rolling into the online world. Right now www.askmerrill.com is there for online research and some clients are beginning to receive online trading accessibility. This is how it starts. Pack the snowball nice and tight. Then roll it down that hill. As the wired Schwab has proven, charging 3-4 times as much as some deep discounters for the same transaction is acceptable to a growing customer base.

Again, it's not as if Merrill needs to learn these new tricks to succeed right away. It would certainly help boost the only sluggish division, investment banking, if the company could show a little more for Silicon Valley. Steffens still has time to reinvent himself. Merrill already has. Yet, last quarter the analysts were looking for Merrill Offline to earn just $1.23 a share and it came in at $1.44. For the eighth year in a row the company has hiked its dividend. That is what quality companies do. That's the Triple-X approach to wowing Wall Street. Exceed expectations. Exude confidence. Excel in operations.

Next: The Bear Argument