20080711-Citi-Merrill Lynch & Co Inc (MER)

Assets Sold, Risk Down, Book Value Up, No Dilutive Raise
 MER reported 2Q08 EPS of -$4.95 vs our est of -$3.95 (consensus -$1.91).
Ex-losses related to legacy assets, we estimate core annualized EPS of $5.00.
 The probability of a large dilutive common equity raise has declined
significantly. No dilutive equity raise is around the corner as Merrill sold $7b+
in non-core assets (and was rewarded with $1b+ in appreciation by not selling
BLK). Exposure to risky assets declined by $25b, core earnings ex-legacy
positions was $5.00 annualized, book value grew slightly and management still
has capital flexibility to sell more non core assets if necessary.
 Massive de-risking. Merrill exposure to residential mortgages, commercial real
estate and leveraged lending declined by $25b. About $12b or roughly half of
the reduction came from sales that were executed at or near where they were
marked. In addition, $11b of exposure to ABS CDOs was eliminated.
 We estimate that the remaining worst-case headwind from the $20b long ABS
CDO exposure (currently 0.38 cents on the dollar) is a very manageable $4b.
Furthermore, even including our worst case writedown estimate on the $16b
short exposure, the core earnings generation would be able to offset most of
any worst-case scenario decline (e.g. no equity capital raise necessary).
 Reiterate Buy as underlying earnings power remains intact. Merrill is trading at
book value. We view the massive de-risking and de-leveraging as good
catalysts to get the stock moving higher. While legacy asset exposure remains,
it’s manageable.