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Citigroup may force mergers
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April 7, 1998: 3:38 p.m. ET
Analyst says smaller firms could feel forced to link up to keep market share
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NEW YORK (CNNfn) - As the dust settles from the Monday announcement that Citicorp and Travelers would be joining to create the world's largest financial services firm, a leading analyst says that other companies in the financial sector soon may feel driven to continue the mergers in order to compete.
Vincent Farrell, chief investment officer for Spears, Benzak, Salomon and Farrell, said on CNNfn's "Business Day" that the megamerger was "the best combination possible," and that smaller companies would be "almost forced to consider a combination" or risk becoming niche players.
He also forecast a first quarter filled with slightly better earnings than earlier warnings would indicate, but still considered the U.S. stock market overvalued.
Here are some of his comments.
JOHN DEFTERIOS, CNN ANCHOR: God bless those financials, right? They held up the Dow Industrials [Tuesday] but it's amazing because Citicorp and Travelers were gathering momentum all day yesterday.
VINCENT FARRELL, CHIEF INVESTMENT OFFICER, SPEARS, BENZAK, SALOMON & FARRELL: It's a powerful combination and the best thing about it is it's taking separate businesses and putting them together. So, you lay off the risk of your business by taking in the stream of another businesses' revenue. And that's probably the best combination possible.
I'm not sure that you'll see more [consolidation] because if , say, Banker's Trust were to link up with somebody -- which has been rumored -- they're in the same business. So I'm not sure that you accomplish much by doing that.
DEBORAH MARCHINI, CNN ANCHOR: Bank and brokerage stocks were certainly up quite a bit yesterday. You don't think there are any other possible candidates out there?
FARRELL: Oh, I think they're all possible candidates now, but I wonder if you haven't already priced all the good news into it.
But yes, there could be [more mergers] because now you're going to feel if you don't do something, you might be left behind. You have this behemoth out there that really can swing its financial weight around.
Does Merrill Lynch (MER) get put into a position where they have to make some sort of combination in order to stay competitive? I don't know the answer to that because I think Merrill Lynch is a superbly managed organization that can certainly go it alone. But will they feel compelled to link up?
As an aside, I think that this might be the golden opportunity for Goldman Sachs to take itself public while all this focus is on financial assets.
MARCHINI: It certainly will get the highest price/earnings multiple they could possibly get.
FARRELL: It probably could the get the highest price that it could have gotten ever in its history. Whether they want to go public or not is debatable, but I think it's a terrific opportunity for them.
DEFTERIOS: PaineWebber (PWJ) didn't shoot up here. It's a smaller player. There were rumors that PaineWebber would have to team up with somebody. Is this a case where if you don't get in this next round, you're going to be isolated and alone and to the downside?
FARRELL: Well, I think you'd be isolated and alone, but whether it's downside or not, I'm not quite sure. I think you might find yourself to be more of a niche player. And you get some mid-size firms that really aren't by definition niche players, but they might be very clearly dominant players in their niche. If you're kind of that mid-size firm, what do you do? I think you're almost forced into considering a combination.
MARCHINI: It looks like in order to make money in the world now, you have to manage money. That's essentially what this combination would seem to be about. What are the implications of that going forward and do you think that kind of a philosophy is warranted?
FARRELL: Well, I think the philosophy is sound in that when you have a money-management stream of revenue, it tends to be fairly predictable, and Wall Street loves predictable revenue streams because you can put a consistent multiple on those.
In the old days, the brokerage firms were much more transaction-oriented. You never knew what the next transaction was going to be, so what you wanted to get into was fee-based businesses. If you can get a significant portion of your revenues from fee-based businesses, you'll get a higher multiple.
Even in the banking business, the fees tend to be regular, but of course you're subjected to the whims of the yield curve, so a combination of all these things makes sense.
Whether something this big is manageable or not is one question and whether you can really cross-sell products from one unit to the other is also a big question. It's never worked before.
Will the investment bankers and the brokers at Solomon Smith Barney offer loans? Well, they haven't offered insurance from the Travelers side. To be determined, I guess.
DEFTERIOS: You talked about predictability. You don't have the predictability in terms of earnings right now. That's the big question mark going forward. Do you feel very comfortable outside of the financial sector that the first quarter's going to get through in decent stead?
FARRELL: You know, I think the first quarter's going to surprise us because corporate management has become so astute at managing expectations. At the end of last year, first quarter estimates by the analytical community were for earnings to be up about 10 percent. Well, right now, first quarter earnings are expected to be flat.
While I think that corporate management has talked earnings down so much that what's going to happen is we'll have a nice little surprise and they're likely to be up by very small percentages, but not flat.
I don't know that the market at 24 times earnings is validly priced for a flat first quarter. But don't worry, because the fourth quarter's going to be just fine. I'm concerned, as Deborah knows, about the valuation in the market, but markets don't go down just because they're overvalued -- even though it is getting a little lofty. 
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Travelers
Citicorp
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