Merrill Lynch - Accounting and Finance

2007

Merrill Lynch's CFO, Jeffrey Edwards

Coming off a year in which Merrill earned record profits of $7.5 billion, advised (and invested) in the consortium that completed the $21 billion HCA Inc. deal, made six bolt-on acquisitions, and merged its asset-management business with Black Rock Inc., CFO Edwards, 46, is on a roll. Of course, any slowdown in merger-and-acquisition activity or further concerns about conflicts of interest (the Securities and Exchange Commission has renewed its scrutiny of insider-trading risks, including banks' trading ties to hedge funds) could spoil the party. But even a 416-point plunge in the Dow, which took place just before Edwards sat down with CFO, left him undaunted. "The markets will allow us to continue to grow over a long period of time," he says.

How much of your recent success can be attributed to the boom in private equity — specifically to the deals you've done with your own capital?

We have seen private equity play a role in our results really since the second quarter of 2005. So it's a relatively short history, and in generally favorable markets, at a time when transactions have cycled from going private to going public again fairly quickly. Now I would guess that, over the course of a full cycle, that process would generally take longer than we've seen over the last few years. But I also believe we've been very effective at executing that strategy and in making sure we've been very prudent with the investments we've made.

That strategy led to record earnings last year. But you also acquired 17 companies and merged your asset management business with Black Rock Inc. Will such deals fuel growth going forward, or is it going to be more organic?
Our first focus is absolutely organic growth. We look at acquisitions and strategic transactions as ways that we can accelerate that growth. And in the case of those 17 odd transactions they really fit the prescription.... In many cases, what we’ll try to do is establish a platform that we can then grow more aggressively than [the acquisitions could] grow by themselves. A good example has been the success that we’ve seen in our commodity business, where we acquired a trading platform and expanded it geographically to Asia, [and] expanded it by product, opening up oil and coal trading and now metal trading capabilities.

Can the good times last for private equity overall?

Private equity is a business that will also go through cycles. But over a full cycle, we think it offers very attractive investment opportunities. And it has been proven over several cycles dating back to the beginning of the private-equity business — at this point more than 25 years ago.

You're advising on such deals at the same time you have a private-equity business yourself. Is there a risk of alienating some of your best customers?
It's certainly something we pay close attention to. In general, we're working on transactions where our interests and our clients' interests are aligned and that we can manage very effectively. Part of that is the structure that we've adopted.... We've invested our company's own money, which has allowed us to look at transactions in their totality for what is in the best interest of Merrill Lynch and our clients.... But we recognize that there's potential uncertainty.

Will there be any slowdown in the deals that you do with your own capital?

We don’t have a specific target for how much we’re going to invest and in what time period, because it’s really dependent on when we see the opportunities. It’s critical to be selective in that business.

The buyout of HCA was done on a consortium basis — a club deal — a process the Department of Justice is now looking into. Are you worried about regulatory backlash?

I won't comment on any matters related to the Department of Justice or any other such inquiries, other than to say that it's our policy, obviously, to cooperate in any investigation. But with large transactions — something like the size of HCA — it's hard to envision how it wouldn't be appropriate to have consortia involved in putting those bids together based on the size of the equity that needs to be invested.

It appears the $45 billion TXU Energy deal — the largest private equity deal to date — will also be done on a consortium basis.

These are just very large deals that require a lot of equity, and it’s the nature of portfolio management that says you should only have so much risk concentrated in single investments. The same is true on the underwriting side, when you’re looking at large debt transactions. The nature of those commitments requires syndications because the size of the debt commitments are larger than it’s prudent for any one player to commit to.

What other areas of conflict do you consider most pressing?

Inevitably we have clients who have different interests, and we need to manage that. And we also need to manage how we [position ourselves] in the markets as an active participant. We're quite sensitive to that and we've added to the resources we dedicate to managing that conflict. For example, we hired somebody from one of our competitors who specifically focuses on managing conflicts. The challenge that has been put to us as an industry is to try and think as broadly as possible about what those conflicts could be, and try to manage them as best we can. So he has a very broad mandate.

Since your revenue stream is closely tied to the deals pipeline, what effect would a slowdown have on you?

Deals are absolutely important to our pipeline, primarily in the investment-banking space, but they have additional impact on some of the other businesses as well, primarily institutionally. Origination tends to be a smaller part of the wealth-management business, however. That business has really migrated from being heavily transaction-oriented several years ago to now being much more based on annuitized revenue streams. So it tends to be less deal-dependent than perhaps it used to be.

Will there be any slowdown in the deals you do with your own capital?

It's critical to be selective in that business, so we don't have a specific target. It really depends on when we see opportunities.

Market risk cuts across so much of your business. What gives you the confidence that you're adequately insulated?
Part of our business is to take risks, but we have a very diversified business model. Within the fixed-income business, for example, there are several different platforms, of which residential real estate is simply one. Even within residential real estate there are large parts of that business that are not subprime related, and even within the subprime sector residential real-estate markets around the world tend to be relatively uncorrelated. So a key part of the strategy is not to fully insulate the business from risk, but to build a very diversified platform of businesses with the belief that different individual asset classes are going to go through [changes], but not all at the same time.

http://www.cfo.com/article.cfm/9057948/1/c_9064230
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