07/14/97 IT'S NOT TOO LATE TO GET IN ON FINANCIAL MERGER MANIA

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IT'S NOT TOO LATE TO GET IN ON FINANCIAL MERGER MANIA

It's wedding season for financial-services firms. Barely a day passes without some announcement of a betrothal. There's Bankers Trust buying Alex. Brown, Zurich Insurance Group of Switzerland taking majority control of investment manager Scudder, Stevens & Clark, NationsBank buying San Francisco high-tech investment boutique Montgomery Securities. There have even been rumors of a megaton merger between Citicorp and American Express.
The price-earnings ratios of the financial-services indexes and funds, with their heavy dominance by banks, have been running 12 to 13 times estimated 1998 earnings compared with 19 times for the Standard & Poor's 500. The NASDAQ Bank Index is up 262% since July 1992, while the S&P Financial Index, a grouping of diversified, large-capitalization financial companies, is up 248% for the same period. The s&p 500, meanwhile, has risen 145%.
BREAKDOWN. Amid such gains for financial services, is it too late for investors to get in on the action? The answer depends in part on how you feel about the overall direction of the U.S. economy and stock market. If you believe that low inflation and strong growth can continue, then the market probably can go higher. And the same dynamics that are behind the economy--new technology, global competition, and consolidation--are at work in the financial-services arena.
Couple that with the continuing breakdown of Depression-era legal restrictions on what commercial and investment banks can do and own, and you have the recipe for more dealmaking among financial firms. ''There's a mad scramble by all kinds of players,'' says George Salem, an analyst at investment firm Gerard Klauer Mattison.
One way to exploit the scramble is to find a mutual fund that has been concentrating on America's financial restructuring. For example, manager James Schmidt amassed a stellar track record at the John Hancock Regional Bank fund, which is up 112% over the past three years. That fund is closed to new investors. But Schmidt is still welcoming investors to his Financial Industries fund, which is up 14.2% so far this year. Schmidt, who has 320 companies in his fund, likes several Tennessee banks such as Union Planters and First Tennessee, as well as New York's GreenPoint Financial, which specializes in low-documentation mortgages. And David Ellison, a former Fidelity fund manager who runs the FBR Financial Services fund, favors banks and thrifts such as Astoria Financial and First Chicago as well as such insurers as SunAmerica and Torchmark.
If funds are not your game, you might want to try to pick the next takeover target yourself. That's a dicey business, especially since the stock prices of many rumored target companies already reflect a takeover premium. ''You've got companies trading at levels beyond what the fundamentals would support,'' cautions Sanford C. Bernstein brokerage analyst Sallie Krawcheck. Perhaps a better strategy might be to focus on the buyers.
First and foremost in this group is Travelers Group. ''It gives you a call on consolidation in many industries,'' says Krawcheck, who terms the stock ''a core financial holding.'' Under the aggressive leadership of Sanford Weill, Travelers has pulled off large acquisitions in the brokerage industry, consumer finance, and insurance. Weill's empire includes Shearson, Commercial Credit, and Aetna's property casualty units, which have added to Travelers' earnings. The takeover titan has made no secret of his desire to do more deals, and Krawcheck thinks the stock, now at 64 5/8, could rise 20% to 30%.
But if you're really determined to prospect for takeover stocks, do it with care. In the past, all you had to do was buy the stock of a midsize bank in a state such as Florida or North Carolina and wait for one of the grand acquisitors, like NationsBank or Barnett Banks, to come along and make a premium offer. That can still be the path to instant riches: The stock of Central Fidelity Banks soared 18% on June 23, after North Carolina's Wachovia agreed to buy the Richmond-based bank.
The Midwest also looks ripe for action. Analysts favor banks such as Mercantile Bancorp of St. Louis, which has been a successful acquirer but could be the right fit for a larger bank seeking even more geographic mass. ''Banking consolidation in the U.S. has several years to go,'' says J. Christopher Flowers, managing director at Salomon Brothers.
But with many of the so-called ''superregional'' banks now close to becoming national franchises, the appetites of these consolidators are changing. Banks are the most likely acquirers across the financial-services industry because they have the capital, are enjoying record profitability, and have years of experience at acquisitions. But large commercial banks are moving away from bank-to-bank marriages. Taking advantage of the liberalization of rules limiting the percentage of income a bank can get from underwriting, they are now acquiring investment companies, regional brokerages, and full-service firms to round out the range of products they can offer retail and corporate clients.
International banks are also obvious buyers. Many have global aspirations but lack a strong franchise in the U.S., whose economy is among the most dynamic in terms of raising capital. The Dutch banks ING Barings and ABN Amro have been active in the U.S., with ABN Amro picking up Midwestern lenders and thrifts and ING rumored to have looked at Oppenheimer. Other notable foreign banks with an acquisitive eye include Deutsche Bank and Swiss Bank, which recently bought investment bank Dillon, Read.
RESTRICTIONS. Some analysts believe that international banks will pay more for entry into the U.S. market and also may not face the same legal restrictions. That makes them possible acquirers for investment banks with a merchant banking presence such as Donaldson, Lufkin & Jenrette. DLJ's stock is double what it was a year ago, with most of the gains occurring this year.
Another favorite takeover target for banks, insurers, and securities firms alike are mutual-fund operators, which have been at the epicenter of the greatest bull market in history. That explains why white-shoe banker J.P. Morgan is eyeing the American Century family of funds and why Mellon Bank bought out Dreyfus. It also goes a long way to explain the perennial rumors surrounding American Express, which has a valuable property in its financial-planning and advisory unit. It's also the reason General Electric's acquisitive Capital Services unit has been snapping up asset-management firms with abandon.
With more than 12,000 banks, thrifts, insurers, and brokerages in business, there's no shortage of investment candidates. As long as the overall market and economy remain healthy, it's likely that financial-services stocks will continue their ride for a while longer.
Tim Smart
EDITED BY EDWARD C. BAIG

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