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Merrill's Line of Bull


CEO only kidding when he said no further capital was necessary.

Wall Street stalwart Merrill Lynch (MER) has seen better days. This past week, analysts reported that the firm may take a big second quarter write-down of $5.4 billion; reports are now surfacing that CEO John Thain may sell all or part of the banking behemoth's 49% stake in money-management company BlackRock (BLK) in order to raise capital.

Such a move would fly in the face of Thain's previous statements about Merrill's direction: As late as March, the CEO has repeatedly been quoted as saying that he saw no need to raise capital, and that the firm's financial health was improving following billions of dollars in losses during the subprime crisis.

As a newcomer to the company, Thain has been working hard to prove to the Street -- and to employees, for that matter -- that he can wrestle the wayward banking giant back on course. If he's forced to go back on his word, he runs the risk of losing whatever confidence Merrill's beleaguered shareholders have in him and his stewardship.

Since Merrill's acquisition of a larger share in 2006, BlackRock has grown to a $25 billion market cap, eclipsing that of Lehman Brothers (LEH). Moreover, BlackRock head Larry Fink was passed over for the Merrill CEO position in favor of Thain.

In light of these facts, Blackrock, which has first dibs on any sale of Merrill's stake, may be particularly receptive to ending their partnership.

Another important question remains unanswered: How much capital would be raised by the sale of some or all of the bank's holdings in BlackRock? Given widespread news of its troubles, Merrill would hardly be bargaining from a position of power.

Even if the stake were to be sold for the full amount of its current value (estimated to be about $10.5 billion), it's unclear whether that would be enough to cover the firm's future writedowns. If not, Thain would be forced to further dilute shareholder value - which is precisely what such a sale is designed to prevent.

Shareholder confidence could be further battered if Merrill copes with heavy second-quarter losses by writing off everything it conceivably can so as to underscore next year's earnings and improve investor relations. In the interim, however, the stock would almost certainly slide.

Many analysts are probably opening their Merrill spreadsheets even as you read this: In the last seven days alone, analysts have ratcheted down their full-year 2008 estimates enormously, from a loss of 2 cents to a loss of $1.11 -- and I would argue that we still haven't hit bottom.

On Friday Merrill closed at $32.70, down 35 cents or 1.06%.
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No positions in stocks mentioned.

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