When Martin McGuinn became CEO of Mellon Bank four years ago, few expected much change. An attorney by training, the 18-year Mellon veteran was already 55, the whispers went, a perfect caretaker for the venerable financial name, but certainly not one to turn the institution on its ear.
Today, the mild-mannered McGuinn is considered something of a revolutionary. In just three years, hes sold off Mellons credit card, mortgage, and flagship retail banking operations, among others, while beefing up the Pittsburgh-based companys capabilities in areas like asset management, shareholder services and human resources consulting.
The result, McGuinn asserts, is a companynow known as Mellon Financialthat at once boasts less risk and greater earnings potential than the one he inherited. We wanted to be perceived as a growth company, and yet have more stability and quality in our earnings stream, he says. To achieve that, we had to significantly sharpen our strategic focus. The technological shift has been no less stunning. While McGuinns Mellon has spent $1.1 billion on acquisitions, and registered pretax gains of $1.3 billion from divestitures, it has plowed $1.5 billion into overhauling its tech capabilities and approach. Today, individual business lines, not a centralized information technology department, are responsible for plotting technology strategies and spending, supported by an enterprisewide infrastructure and technical expertise that sources say has been dramatically enhanced since his arrival.
Whats left is a company with two predominant lines of business, neither of which directly concerns banking. Today, Mellon ranks as the worlds sixth-largest global custodian, with nearly $3 trillion in assets under custody or administration, and No. 7 in asset management, at $610 billion. Its also a powerhouse in processing and corporate services, ranking No. 1 globally as a provider of performance analytics and investor services, fourth in human resources consulting and eighth in cash management.
In contrast, it now holds just $8.5 billion in loans on its booksvirtually all of them to corporations or private banking clients. Mellon rarely lends money unless its part of a larger relationship capable of generating an 18 percent return on equity or better. The main purpose of the banking franchise is to further our fee-based business, says senior vice chairman Steven Elliott.
The transformation hasnt come without pain or controversy. Last years sale of Mellons 345-branch retail bank sparked an outcry in Pittsburgh, and prompted the state to yank Mellons contract to administer Pennsylvanias 529 college savings plan. Some warn that Mellon could become a takeover target if it fails to achieve its return objectives amid fears of recession and terrorism. The companys image wasnt helped when the Internal Revenue Service yanked a processing contract last year after it lost or destroyed thousands of tax returns.
But analysts are generally enthused. Mellons first quarter net income on continuing operations was $211 million, up from $194 million a quarter earlier. Earnings-per-share rose 12 percent, to 47 cents. Return on equity was 24.8 percent, compared to 20.4 percent in the fourth quarter. Mellon [has] signaled that it has the capacity to grow at an impressive pace, noted Judah Kraushaar, an analyst for Merrill Lynch, in a recent report.
The company now gets 86 percent of its revenues from fees, more than rivals State Street or Northern Trust, with a virtually even split between asset management and corporate services. Tom Brown of Second Curve Capital calls the repositioning as bold of a transformation as weve seen in the industry, and says McGuinn has the pieces in place to grow earnings by 13 percent or more annually. I would be very surprised if they werent successful.
Remaking one of the nations most-revered financial institutions has been no small feat. Mellon was founded in 1869 by its namesake family, one of Americas wealthiest. Over time, it bankrolled the rise of Americas steel industry and played a hand in the founding of such industrial icons as Alcoa and Westinghouse.
Times change. Many old-line steel mills ground to a halt in the 1980s, bringing economic calamity to western Pennsylvania. By 1987 venerable Mellon itself was left teetering on the edge of bankruptcy, forcing then-CEO J. David Barnes to resign. His replacement, Frank Cahouet, engineered a recovery. And by the mid-1990s, Mellons fortunes began to turn with the acquisitions of asset manager The Boston Co. and mutual-fund giant Dreyfus Corp.
Cahouet declared his goal was to turn Mellon into a diversified financial services company with a bank at its core. Investors sent share prices soaring, but many remained unclear about the ultimate strategy. Failed acquisition bids for traditional banking rivals CoreStates Financial and BankBoston further muddled the picture. In 1998, Mellon had to face down an unsolicited takeover attempt by the Bank of New York. A short time later, Cahouet announced he would depart.
McGuinn, former general counsel and Mellons vice chairman at the time, concedes he was hearing from customers and investors that they were confused. Within two months of taking the reins in early 1999, he sold Mellons credit card business to Citigroup. By the end of the year, the companys mortgage operations, and its teller machine services unitbusinesses where Mellon lacked scale, or that were prone to cyclicalitywere gone. Several, including the mortgage business, were sold at a loss to speed up the repositioning. Divesting was really the first step to building on our strengths, he explains.
In 2000, Mellon went shopping. On the asset-management side, it bought The Trust Co. of Washington in Seattle, Van Deventer & Hoch of San Francisco and Boston-based Standish, Ayer & Wood, as well as the 25 percent of London-based Newton Management Ltd. it didnt already own. It also bolstered human resources consulting subsidiary Buck Consultants with purchases of iQuantic and Unifi, bought out junior partner Chase Manhattan to take full control of Chase Mellon Shareholder Services, and bought Eagle Investment Systems, a maker of investment-management software.
The most illustrative deal was last years sale of the retail bank to Providence, RI-based Citizens Financial Group. Mellon had already sold most of its out-of-state branches, but knew it would be dicey to get rid of its core Pennsylvania franchise. Pittsburgh boasts streets, colleges and arenas that carry the Mellon name, and McGuinn, who once ran the retail franchise, had close ties to its employees. The irony is, Marty was hired as CEO because he turned around the retail bank and made it a much stronger performer, says Jim Schutz, a Chicago-based analyst with Stephens, Inc., and a former Mellon banker.
Early on, McGuinn challenged all business units to devise three-year plans for achieving his aggressive growth targets. Those that couldntor that werent centerpoints for valuable relationships, such as corporate lendingwere considered candidates for divestiture. Even though the retail bank contributed nearly 25 percent of Mellons total earnings, it was in slow-growth Pennsylvania, and fell into that category.
The sale wasnt pursued lightly. Mellons board, concerned about how a deal might impact the companys image, required a buyer that would commit to keeping most of the employees and branches. Before signing off on the deal, Mellon officials went so far as to visit the headquarters of Citizens parent, the Royal Bank of Scotland, to assure themselves of the buyers character.
Still, to many Pennsylvanians, the sale smacked of betrayal. Is this any way to serve the community that helped make you great? seethed a Pittsburgh letter writer. The state pulled the previously awarded 529 contract, saying Mellon lacked the in-state distribution it desired.
The company countered that its headquarters, along with 8,000 local jobs, would stay put, and noted that it still maintains 19 private banking centers in the state. (At Mellons annual meeting this Spring, none of the attendees voiced any concerns about Citizens post-merger handling of the branches.)
To management, the move is about the future. A major thrust of the repositioning was creating a firm with stronger long-term growth prospects, even if that means having lower earnings in the short-term. While Mellon earned $1.3 billion in 2001, income from continuing operations was just $749 million. We asked, Are we better off with more earnings and lower growth over the next five or 10 years? Or are we better off with lower earnings from selling [the retail bank], but then have the market recognize that whats left is going to produce much stronger growth? vice chairman Elliott explains. It was difficult to give up 25 percent of our earnings. But it was clear that we were much better off from a shareholder-value perspective to have lower earnings today, but a higher growth rate and P/E.
The result of all this juggling, analysts say, is what could become the ultimate cross-selling machine for corporate and institutional clients. By combining its asset-management prowess with recently beefed-up human resources consulting and processing capabilities, for instance, Mellon can potentially provide companies with soup-to-nuts employee services that include plan design, payroll and pension or 401(k) administration and processing, and management of those retirement assets.
And by meeting corporate client demands to make such services more self-service, Mellon has the potential to gather crucial information about individuals, and subtly sell them additional investment products. There are going to be a lot of natural triggers that spawn information flows from end-users, explains Marc Pramuk, senior human resource services analyst with IDC. By using indirect prompts and calculators, and making their service portable, they could get a lot of additional sales.
Technology is central to achieving such promise. This emphasis has shown up in Mellons merger moves, where CIO Allan Woods says his unit has vetoed a handful of prospective deals. If we say were not comfortable with it, we get listened to, he says. Its also evident in the heavy tech investmentssplit almost evenly between infrastructure and development initiativesand the hiring of top-flight strategists, including Janey Place, a highly regarded e-commerce visionary.
But McGuinn is clear that technology is merely a means to an end, not an end in and of itself. Spending authority and accountability for tech initiatives lies in the hands of business-line managers, who pay for tech usage out of their own budgets. We dont go out building things and hoping results will come, Woods says. The role of technology here is to support and enhance business-line strategies. Period.
With the bulk of the repositioning done, McGuinn says the focus is now on making it work. On the technology side, that means continued investment in security, disaster recovery, and system capacity, and building the skills to ensure that a diverse, decentralized web of technologiesincluding those from recent buyout targetsfunctions as a whole. Its important to be strategic, Woods says. But the devil is in the details.
The same holds for the whole firm. Analysts say shedding businesses has left Mellon with a short-term problem: At the end of the first quarter, the company had $2.7 billion in cash on its balance sheet. The question is, What will they do with this cash hoard? Stephens analyst Schutz says. Earnings could drag in the short-term, because you cant get a spread on cash in this environment.
Company officials have been making progress. Since McGuinn took over, Mellon has repurchased more than $4.1 billion in stock. And even amid this years unsteady market conditions, the acquisition pace has continued with buys of institutional asset manager HBV Capital Management, which is based in both New York and London, and Weber Fulton & Felman, a Cleveland money manager. More acquisitions are likelyparticularly in Europe, to bolster the companys asset-management production and distribution.
At a recent price of $30, Mellon shares have fallen more than 20 percent since the beginning of the year, due mostly to general market malaise and the companys disclosure that it had loaned $100 million to WorldCom, the troubled telecommunications company.
But the longer term looks bright. McGuinn promises a company that is bigger, stronger and faster-growing over the next decade, and says returns on equity will grow by 22 percent a year. Analysts are buying into the argument. Ten of the 26 who follow the company have its stock rated a strong buy, while seven more have it at a buy. Schutz notes that Mellon shares are trading at a multiple of less than 16 times his projected earnings per-share of $1.95 for the year, compared to multiples of 18 to 20 for peers like State Street, and has a $50 price target.
Financial performance is how McGuinn and his lieutenants will ultimately judge the makeovers success. The proof will be if this mix of businesses produces earnings the way we think it can over the next five years, Elliott says. If it does, then the new Mellon may merit the same lofty reputation its predecessor once did.
