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Merrill's picked pockets

Merrill Lynch is supposed to know something about buying and selling assets. So how come it got so little upfront for its stake in Bloomberg?

By Roddy Boyd, writer
August 6, 2008: 2:19 PM EDT

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Merrill Lynch CEO John Thain has been praised for asset sales that, it turns out, the firm mostly financed.

NEW YORK (Fortune) -- When Merrill Lynch announced last month that it would sell back its long-held stake in financial data provider Bloomberg L.P., chief executive John Thain was praised for moving aggressively to restore the firm's capital position and slim its bloated balance sheet.

But a look at new Merrill (MER, Fortune 500) SEC filings suggests that enthusiasm for the $4.43 billion deal is misplaced, as the transaction adds virtually no cash to Merrill's depleted pocketbook.

According to Merrill's quarterly earnings report, filed Tuesday, the giant brokerage received just $110 million in cash in the sale of its 20% stake in Bloomberg back to its parent company, which is owned by New York City mayor Michael Bloomberg.

That means Merrill is getting less than 3% of the value of its Bloomberg stake in cash, despite the widely-held belief on Wall Street that the investment was increasingly profitable and - unlike so many assets on Merrill's balance sheet - posed little risk to the firm.

In addition to the paltry cash payment, Merrill will receive $4.3 billion in 10-year and 15-year notes. Thain had indicated on Merrill's quarterly earnings conference call last month that Merrill would be financing the sale of the Bloomberg stake, though he didn't describe the terms.

Merrill has been under intense pressure since last fall's disclosure that the firm stood to take huge losses on its holdings of collateralized debt obligations, which are risky debt tied in many cases to the imploding U.S. mortgage market.

Since then, Merrill has raised some $30 billion in new capital to fill holes created by more than $40 billion in writedowns. Share issuances tied to various capital-raising moves have diluted the stake of existing shareholders by more than 30%.

Owner will finance!

The disclosure of the Bloomberg financing terms comes as the market continues to puzzle over another deal Merrill struck last month to reduce its CDO exposure. The company sold securities once valued at $30.6 billion to Lone Star Funds for $6.7 billion, or 22 cents on the dollar.

Merrill agreed to finance 75% of that transaction, meaning it got $1.7 billion in cash while extending $5 billion in loans to Dallas-based Lone Star.

While some investors have criticized Merrill for agreeing to finance the sale of the CDO portfolio - they argue the deal's structure essentially gives Lone Star the upside on a recovery in the CDO market, while potentially saddling Merrill with any losses beyond the cash payment - it's striking that the broker is receiving more cash upfront in its CDO distress sale than it is in the sale of an appreciating, safe asset.

Why Merrill agreed to finance so much of the Bloomberg deal isn't immediately apparent. A Merrill spokeswoman declined comment, and a Bloomberg representative didn't return an e-mail seeking comment.

Merrill purchased a 30% stake in Bloomberg in 1985 for just $30 million, then later sold a third of that back to Bloomberg at a substantial premium. Since then, Bloomberg has become the leading provider of financial data to Wall Street and has branched into television and magazine publishing.

One common criticism of Merrill's asset transactions - that because of Merrill's financing involvement, the deals don't effectively insulate the firm from losses and therefore aren't truly sales - doesn't seem to hold water.

Merrill "relinquished control of the assets to the buyer, who now bears the risk of loss and who has the right to pledge or re-sell the assets as they wish," notes accounting consultant Robert Willens. Accounting rules, he adds, "don't say this has to be a good deal for the seller."  To top of page

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