what if merrill lynch went belly up

there are rumours that there is far more to come in the way of bad news for these guys, imagine the carnage if that happens?? see below:

Sovereign Funds Beat Buffett With Stakes in Citigroup, Merrill

By Aaron Kirchfeld

Jan. 22 (Bloomberg) -- Citigroup Inc. and Merrill Lynch & Co. shareholders, who've held on to the stocks through a 50 percent decline in value, now face having their stakes diluted as sovereign wealth funds snap up convertible preferred shares at terms unheard of 20 years ago.

The last time the biggest U.S. securities firms went hat in hand to outside investors was in 1987 when New York-based Salomon Inc. turned to Warren Buffett, the world's most successful stock- picker, for $700 million to fend off an unwanted takeover.

Even billionaire Buffett didn't earn a fraction of the premium that state-managed funds in Kuwait, Abu Dhabi, Korea and Singapore negotiated for the more than $21 billion they invested in New York-based Citigroup and Merrill, let alone the equity they'll get in about three years' time. Buffett was paid a 9 percent dividend, 1.75 percentage points more than the U.S. Federal Reserve's overnight lending rate. By contrast, the 11 percent that some of today's investors are pocketing represents a spread of 6.5 percentage points.

``The dilution could be huge,'' said Peter Hahn, a former managing director at Citigroup and fellow in corporate finance and government at London-based City University's Cass Business School. The sovereign funds ``have a claim on ownership; they are in a privileged position to get the dividend and they bought in at a lower price than most shareholders.''

Record Losses

Citigroup, the biggest U.S. bank by assets, and Merrill, the No. 1 brokerage, both reported the largest quarterly losses in their history last week, as a combined $34.7 billion of writedowns for subprime-infected assets depleted income and the capital they need to do business. In all, seven of the world's biggest banks have attracted about $59 billion since July by offering sweetheart deals to outside investors.

Fueled by record oil prices and rising currency reserves, sovereign funds have ballooned to $3.2 trillion in assets and analysts at Frankfurt-based Deutsche Bank AG estimate the figure will climb to more than $5 trillion in the next five years.

Morgan Stanley, UBS AG, Bear Stearns Cos., Barclays Plc and Canadian Imperial Bank of Commerce also have reached out to sovereign funds or state-controlled investment authorities in Asia for money after bad investments depressed profits.

``Sovereign funds are a lot like Buffett, the quintessential investor with a whole lot of money,'' said Anthony Sabino, a business-law professor at St. John's University in New York. ``It goes to show there are Warren Buffetts all over the world.''

Cash Infusions

Citigroup received a cash infusion of $7.5 billion two months ago from Abu Dhabi Investment Authority, the world's biggest sovereign fund with about $875 billion of assets, and followed that up last week by raising $15.4 billion from a group including the governments of Singapore and Kuwait, former Chief Executive Sanford ``Sandy'' Weill and Saudi Prince Alwaleed bin Talal.

Alwaleed became Citigroup's biggest individual shareholder in the early 1990s, when loan losses in Latin America and a collapse in U.S. property prices left corporate predecessor Citicorp short of capital. Then-CEO John Reed sold Alwaleed $590 million of convertible preferred stock, and the Saudi billionaire stuck with the investment following Citicorp's merger in 1998 with Travelers Group Inc.

Merrill got a commitment for as much as $6.2 billion last month from Singapore's Temasek Holdings Pte. and U.S. money manager Davis Selected Advisers LP, and another $6.6 billion last week from a group led by Kuwait Investment Authority, Korea Investment Corp. and Tokyo-based Mizuho Financial Group Inc.

`Refocus on Earnings'

None of the investors will have a say in management.

Merrill Chief Executive Officer John Thain said in a Jan. 15 statement that the transactions ``make certain'' the company is ``well-capitalized.'' Citigroup CEO Vikram Pandit said the same day that the investment ``will allow us to refocus on earnings and earnings growth.''

Shannon Bell, a Citigroup spokeswoman, and Merrill spokesman Bill Halldin declined to comment beyond the statements.

The companies and shareholders are paying a high price for the cash by selling convertible securities with dividends as high as 11 percent, said Oppenheimer & Co. analyst Meredith Whitney. The investments may reduce earnings per share at Citigroup by close to 20 percent and at Merrill by at least 20 percent as the securities are turned into stock, she estimates.

``At first blush, these capital infusions seem to shore up Citi's capital base for the near term, albeit at a high cost in our opinion,'' Whitney wrote in a Jan. 16 note to clients. The New York-based analyst predicted on Oct. 31 Citigroup may cut its dividend, which it did on Jan. 15 by 41 percent.

Buffett Investment Trails

Still, as Buffett's 10-year investment in Salomon shows, patience, and a 9 percent dividend, don't ensure market-beating returns. When Travelers Group, the company that became Citigroup after the merger with Citicorp, acquired Salomon in 1997, it got Buffett out of one of his poorest performers.

During the decade that Buffett's Omaha, Nebraska-based Berkshire Hathaway Inc. owned a piece of Salomon, the securities firm's stock trailed every U.S. stock index. Even the dividend didn't make up for Salomon's performance. The Standard & Poor's 500 Index more than tripled and Coca-Cola Co. rose 10-fold during the 10-year period, while Salomon climbed 138 percent.

The so-called mandatory convertible offering bought by Abu Dhabi has a yield of 11 percent, almost double the rate that Citigroup offers bond investors. Abu Dhabi will be able to swap the securities for as many as 235.6 million common shares starting in 2010 at a maximum conversion price of $31.83, the bank said on Jan. 17 in a statement. Citigroup fell 2 percent to $24.45 in New York Stock Exchange composite trading on Jan. 18.

Citigroup Terms

The locked-in payout of 11 percent was sweetened after the bank lowered its dividend, which paid out the equivalent of a 7.1 percent yield on common stock.

With the purchase of a 4.9 percent stake, Abu Dhabi, the capital of the United Arab Emirates, would rank among Citigroup's largest shareholders alongside Alwaleed and Los Angeles-based Capital Group Cos.

By keeping holdings below 5 percent, investors avoid a review of the transaction by U.S. banking regulators under the Bank Holding Company Act.

The $12.5 billion of convertible preferred securities that Citigroup sold last week to the group, led by Government of Singapore Investment Corp., pay a lower yield of 7 percent, as they can be turned into shares at $31.62 and investors have the option of waiting until Citigroup's stock rises before choosing to convert.

Kuwait, Korea, Mizuho

Merrill's securities held by Kuwait Investment Authority, Korea Investment and Mizuho Financial will have an annual dividend yield of 9 percent until automatically turning into as much as an 11 percent stake in 2010 based on the share price range given by the firm.

KIA, which manages an estimated $250 billion for Kuwait, alone invested $2 billion in Merrill as well as $3 billion in Citigroup.

The group of investors will get fewer shares if Merrill's stock price climbs above $61.31 and more if it drops below $52.40, terms of the agreement show. Merrill rose 4.9 percent to $51.87 in New York trading on Jan. 18.

Merrill's latest capital infusion diluted 2008 earnings by 9 percent after the first transaction's dilution of more than 10 percent, New York-based analyst Charles Peabody of Portales Partners LLC said.

`Double Dipping'

``Double-dipping clearly turned out to be painful for Merrill Lynch,'' Peabody said in a note to investors on Jan. 15. It was ``a very steep price to pay for securities losses, suggesting a desperate need to clean up the company's troubled past.''

Temasek will pay $4.4 billion for new Merrill shares at $48 apiece and has an option to buy an additional $600 million of stock by March 28, according to the term sheet. The stake will stay below 10 percent at all times, according to Merrill. It's currently about 9.4 percent.

Davis Advisers, which will invest $1.2 billion, also paid $48 euros a share, which is a 14 percent discount to Merrill's Dec. 21 stock price.

If Temasek exercises its option, then the cash infusion may be 13 percent dilutive to shareholders, according to estimates from analysts at New York-based Sanford C. Bernstein & Co.

``The dilution to existing shareholders is probably not on the first page of concerns for management,'' said Bruce Foerster, a former Lehman Brothers Holdings Inc. executive who's now president of Miami-based advisory firm South Beach Capital Markets. ``The firms are evidently in such a dire situation.''