Merger of Investment Giants Collapses

A deal that would have created the world’s largest investment bank collapsed Thursday when U.S. investment house Morgan Stanley Group Inc. and its British counterpart S.G. Warburg Group called off merger talks.

But analysts said the main sticking point in the $7.8-billion deal--how Warburg’s 75%-owned Mercury Asset Management Group would be treated--could be overcome.

“Remember, the two companies we’re talking about here are world leaders in (mergers and acquisitions). So they know all the negotiating tactics,” said Sanford Bernstein analyst Guy Moszkowski.

The proposed merger stumbled over the price demanded by the minority owners of Mercury, the jewel in the Warburg crown, according to analysts and a source close to the deal.

“The hang-up was the fairly high price tag attached to the minority interest in Mercury,” Moszkowski said.

That stake is largely owned by Mercury managers, and “they wanted to be bought out at a high multiple,” he said.

Under the proposed deal, Morgan Stanley would have ended up with two-thirds of the combined entity and Warburg with one-third. It would have merged the strongest London merchant bank with the old-line establishment firm of Morgan.

While Morgan would have given Warburg clients entree to the U.S. market, Warburg would have given Morgan an extensive shot at expanding its global business. Warburg’s client list includes more than half the companies listed on Britain’s Financial Times Stock Exchange 100 Index.

“While the discussions between Morgan Stanley and S.G. Warburg were proceeding on the basis of a market-for-market merger, the price and terms on which Mercury Asset Management Group indicated it would be willing to participate in the transaction were unacceptable to Morgan Stanley,” Morgan Stanley said. “For its part, Morgan Stanley was unwilling to proceed with a transaction excluding Mercury.”

Even before the talks were called off, the treatment of Mercury, and in particular the minority 25% holding, had been identified as a possible deal breaker.

It seemed likely that the British watchdog Panel on Takeovers and Mergers would have required an offer to be made for the minority holding on the grounds that Mercury was the main reason that the merger was taking place at all.

Analysts said that despite its excellent British and European client list, good market-making operations and high profile in corporate finance, Warburg’s investment banking operation is making no money and has serious problems.

In its latest half-year results, Warburg made $97.54 million, of which $88.96 million came from Mercury.

“Without the asset management, Warburg becomes a much less valuable property,” Sanford Bernstein’s Moszkowski said.

Mercury’s managers know this and are playing off it in their demands, he said. But, he added, “There are limits.”

Said one arbitrager who asked not to be named: “The cultures of the two firms are very different. There wasn’t a compelling need in terms of adding new businesses or geographic expansion. They overlap to some degree.

“This to me was a recipe for a thing blowing up in a few days.”

Yet, the strategic fit between Morgan and Warburg may be good enough to lure the two back to the table, said Marty Wasmer, principal of First International Asset Management.

“Our feeling is that Morgan will find a way to get it done,” he said. “It may be dead for now, but we feel it might be revisited.”

Morgan shares closed down 37.5 cents to $61 on the New York Stock Exchange. Warburg and Mercury both closed sharply off in London.