NEW YORK — Merrill Lynch & Co. Inc., best known for its retail brokerage network, has also become a powerful player as an investment banker for companies looking to buy other firms or sell parts of their operations. Last week, the firm took on a new and potentially troubling role in the massive buyout of hospital chain HCA Inc.
Besides being the HCA's long-term adviser, Merrill also was one of the principal investors in a consortium that bid $21.3 billion to take over the Nashville-based company. It also advised that group on the deal and how to finance it.
That involvement showcased Merrill's initiative to build its private-equity business, something that it plans to grow by tapping its existing business connections.
"Our growing force of investment bankers is increasing its focus on sourcing scale opportunities, where we often find ourselves investing alongside our clients," Merrill's chief financial officer Jeff Edwards said during a recent conference call with analysts and investors, according to a transcript provided by Thomson Financial's StreetEvents.
"Private equity investments often give rise to additional incidental revenue opportunities for investment banking, where we advise on and arrange financing for deals."
So far, the strategy is paying off: Earnings in its private-equity segment nearly tripled in the second quarter from the year before. While Merrill declined to give specifics, a report from Sandler O'Neill Partners put that figure in excess of $700 million in revenues, and estimated that such gains contributed 19 cents a share to Merrill's per-share net of $1.63.
It's not surprising that the securities firms are attracted to the private-equity business. That market is booming with a rush of buyouts, especially in the health-care, retail and transportation sectors.
So far this year, buyouts have totaled a record-setting $372.6 billion, more than double the $176.9 billion over the same period in 2005, according to Dealogic.
Firms like Kohlberg Kravis Roberts & Co. and Bain Capital LLC have generally been behind much of the activity. Not only have they been able to build massive war chests with billions of dollars in funds, but they are also seeing an increasing interest from corporate America to take companies private as a way to shield themselves from regulatory and shareholder scrutiny.
And the returns on such investments have been huge. They've profited by cutting costs or changing business practices. They've paid themselves handsomely with fat dividends and management fees. Then, they often make huge windfalls by selling shares back to the public through IPOs.
Now, Wall Street firms want a piece of the action. To succeed, they must tread carefully. Put simply, it raises questions over whether they are placing their own activities ahead of their clients' concerns when they start stepping up their private-equity business.
In the case of HCA, Merrill joined Bain and KKR in what is being called the largest leveraged buyout ever, with the bid including $21.3 billion in equity and the assumption of $11.7 billion in debt. Should that deal go through, it would eclipse the $30.6 billion takeover of RJR Nabisco in 1989 when not adjusted for inflation.
According to The Wall Street Journal, Merrill's bankers learned of HCA's interest in going private and they connected the company's executives with Merrill's private-equity team, who came up with the buyout deal. Merrill also advised the group of private-equity investors, as well as put up its own money in the buyout bid.
Merrill did not return requests for comment.
With such connections, "the potential for conflict is certainly there," said Colin Blaydon, who heads the Center for Private Equity and Entrepreneurship at Dartmouth College's Tuck School of Business. That's why he suggests companies with many hands in a given deal "create an open and transparent process" to avoid accusations of ethical lapses.
In the case of Merrill, he said things might not be as bad as they look. He notes that Merrill took some careful steps to insure itself against major conflicts.
For instance, the securities firm stepped down as HCA's financial adviser, and two other firms, Credit Suisse and Morgan Stanley, were brought in to advise a special HCA committee. Merrill also helped facilitate what's known as a "club" deal for HCA, meaning that a group of investors together are buying the company rather than Merrill competing with the private-equity firms for ownership.