Merrill Ready to Expand European Reach in Deal

With its recent agreement to acquire the United Kingdom's Mercury Asset Management, Merrill Lynch & Co. is poised to become a global powerhouse in investment management.

And with Mercury's location on Europe's doorstep, Merrill is also ready to take advantage of the changing landscape on the Continent.

The evolving equity cultures of Central and Eastern Europe, together with changes in the European pension fund business, could prove a boon for such a colossus, industry observers said.

Neither Merrill nor Mercury, the second-largest U.K. fund manager, has much experience in those areas. Merrill's funds are mostly invested in U.S. shares and bonds, while Mercury's core business is managing traditional pension-fund plans for British companies. Merrill, however, is intent on changing that.

By combining forces with Mercury-something which Merrill has agreed to pay $5.2 billion to do-the investment bank aims to shore up its U.S. investor base and then pounce on markets farther afield. Mercury has $177 billion of assets under management. With Mercury in tow, Merrill would command $449 billion of assets, making it the third-largest fund manager in the world, after Fidelity Investments and Barclays PLC's asset management business.

And opportunities in Europe's emerging markets are certainly ripe. Last year, for instance, the Budapest stock exchange produced the strongest performance of any exchange in the world although by U.S. standards it is far from liquid; it had just 12 companies accounting for more than 90% of the exchange's capitalization. But as these markets undergo further reform and privatization, liquidity will most certainly grow as well.

And the fast-approaching 1999 deadline for European monetary union is destined to hasten the privatization of Europe's largely state-funded pension industry, creating yet more business for a Merrill-Mercury combination, industry observers said.

Aside from Britain and the Netherlands, much of Europe's pension plans are still state-funded - a financial burden that will become increasingly untenable as the deadline for monetary union draws closer.

In Germany alone, the privatization of the pension industry "could be very, very large-several hundred billion dollars," said Mark Hoge, an analyst at Credit Suisse First Boston in London. The question, however, is how long the process will take-and how successful it will be.

"It's obviously the trillion-dollar question because that's roughly the minimum level of assets you're talking about," said Michael Lipper, president of Lipper Analytical Services, Summit, N.J. "If the euro (single currency) goes through, then the government has to function as an unfunded business-it cannot do this through taxes because this will drive countries out of the euro."

Merrill could be in a unique and fortuitous position when the privatization process does sweep Europe because of the investment bank's U.S. expertise, said Mr. Lipper.

"What will be critical is whether Europe will follow the level of service offered in the 401(k)s," he said. "If so, existing fund managers on the Continent don't have that kind of technology. Merrill would have the technology to service these markets."

Overall in these areas, Merrill could glean an additional 3% to 4% in annual earnings, analysts said.

"I don't see over time why they couldn't double their business," said Matthew Czepliewicz, an analyst in the London office of Salomon Brothers Inc.

For Merrill's part, a company official noted: "Mercury is a great launching pad. They're familiar with the European markets, even though 80% of their business is in the U.K."

And some of that remaining 20% market share is already entrenched in Continental Europe, which he noted is "more than we've had."

But Merrill is not the only one with its eye on the Continent and emerging markets. It will be up against established competitors, such as Foreign and Colonial, Invesco PLC, and Fidelity Investments.

And other U.S. pension funds, anxious to produce richer yields for their investors, are looking offshore as well. Intersec, a research firm, forecast that 14% of America's pension-fund assets under management would be invested abroad by 2001, up from 11% now.

Indeed, penetrating these markets will inevitably occur slowly, possibly taking five to 10 years. But given Merrill's vast distribution network and Mercury's back door to these markets, Merrill should be a tough competitor.

A wait of five to 10 years should just about fit into Merrill's own time frame, Mr. Lipper said. He speculated that it could take Merrill that long to develop expertise in local markets.

But then, thundering herd aside, "Merrill tends to think in those time frames," said Mr. Lipper.

And the prospect of Merrill as a competitor is already rattling some. One fund management firm that uses Merrill's vast distribution network expressed concern that it will now be a competitor rather than simply a distributor of emerging-market funds.

"We always go to people like Merrill to sell our funds," said one Foreign and Colonial fund manager in London. This nervousness could be just a taste of what's to come for other likely competitors.

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