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Thain in Vain

Merrill Lynch needs capital and has no good options. It has its C.E.O. to thank.


On Christmas Eve last year, exactly 24 days into his as chief executive of Merrill Lynch, John Thain had good news to share with investors. The embattled bank was raising $6.2 billion from the Singaporean Temasek and the money manager Davis Advisors. Merrill's shares traded for $54.

A few weeks later, Thain announced that Merrill had raised another $6.6 billion from a slew of international investors, bringing the new cash total to $12.8 billion. When he took over at Merrill, Thain had pledged to shore up the firm's deteriorating balance sheet. By all accounts, he was doing just what shareholders would have wanted.

But now, more than seven months into his new gig, the great expectations for Thain remained unfulfilled. The former Goldman Sachs executive and chief made the all too common and sometimes fatal error of assuming that the worst of Merrill's mortgage nightmare was over when it was still far too early to tell.

In fact, Thain's challenge today remains much the same as it was the day he started. Merrill's assets continue to deteriorate and the bank still needs to raise more capital.

But to tackle it today is much more difficult than it was in December not because of the continued turmoil in the market but because of a deal that Thain made with Temasek last Christmas Eve. Thain has no good options on the table today, and he has himself to thank for that.

When inking its deal with the fund, Merrill agreed to give Temasek unusual price and dilution protection. Merrill must compensate Temasek if the bank issues additional common or convertible stock below $48 within one year. The terms with the international investors in the January capital raise had similar terms, whereby the conversion price of the preferred stock can reset from $52.50 if Merrill issued more than $1 billion worth of stock in one year.

Merrill Lynch was evidently so confident that it wouldn't be necessary to raise more capital with new common shares that it was willing to put it in writing. Moreover, Thain repeatedly insisted that Merrill had no intention of divesting other assets such as its 49 percent stake in Blackrock or its 20 percent stake in Bloomberg.

On Friday, Merrill shares closed at $26.61. Analysts expect the bank to report write-downs for its second quarter of as much as $6 billion when it announces its earnings this Thursday, on top of the $30 billion it's already taken. Raising more capital is now imperative.

But none of Thain's options look good. If Merrill did issue new shares and compensated its earlier investors, the dilution to existing shareholders would be too great to bear. Cutting its dividend would anger shareholders and not likely be sufficient.

That leaves selling Blackrock or Bloomberg as its best options, and Thain finally admitted last month that the bank is considering the sale of one or both of these assets. But getting rid of either one isn't particularly enticing.

Blackrock is an important strategic partner of Merrill's, something that Thain reminded investors back in January. And the value of its stake is falling fast-earlier this year, Merrill's stake was worth $13 billion and it's now worth less than $10 billion.

And the Bloomberg ownership - valued at about $5 billion-isn't likely to fetch a premium for the very fact that there is seemingly only one interested party in purchasing it, and that's Bloomberg himself.

Thain must have known that taking the job as Merrill Lynch's turnaround C.E.O. would be taxing. What he may not have anticipated is just how few easy answers there are to the company's most vexing problems.

And what he's undoubtedly learned by now is that you can never be sure when you've safely turned the corner. And that giving shareholders what they want is not a guarantee for reward.

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