Mellon's Strategy
Insights into the bank's recent moves

by Brian Graney (TMFPanic@aol.com)

ALEXANDRIA, VA (Nov. 5, 1998) -- Some interesting news has been coming out of Mellon Bank (NYSE: MEL) over the last week, so we're going to put the discussion about our upcoming oil and gas industry study on hold for today and take a closer look at the financial services world instead.

Boo-hoo.

Don't cry too much, though. We'll be back with more thoughts on the oil and gas sector tomorrow. We're not trying to stall or anything. Honest. Just ask Jeff... Oh wait, he's hanging out at the Starbucks down the street, so I guess you can't ask him. Anyway, keep posting your ideas and suggestions on the Drip Companies message boards and we will resume our regularly scheduled programming tomorrow.

Back to Mellon...

As Jeff mentioned earlier this week, Pittsburgh's favorite bank (at least from our vantage point here in Virginia) recently signed a strategic agreement with ABN AMRO Bank NV of the Netherlands, combining the two companies' custody services businesses. The "custody" here does not refer to the police or divorce court lawyers. For investors, it refers to a company which offers to keep physical possession of stock certificates and provides some extra services to make life simpler for stockholders.

I talked with Mellon's investor relations chief, Don MacCleod, about the custody agreement, which he said makes sense for the company on a couple of different levels.

First, offering custody services is attractive to customers because it allows them to have a single source for all of their personal investment-related information. If a person makes quite a few trades (this is most unFoolish, yet it still does happen), Mellon will have all of the pertinent records in one place. This makes life a lot easier for the customer when they need to find that information down the road, such as when tax time rolls around.

Custody makes sense from Mellon's point of view because they are one of the five or six big firms dominating the business and the return on equity is very high. This situation is unlikely to change, since there are very high barriers to entry into the business, which MacCleod explained are a by-product of the large-scale technology outlays needed to keep track of investment data for a large number of people. Given Mellon's emphasis on technology, the company seems well-positioned to lead the way in this area.

Mellon currently has $2 trillion of assets under its custody, making it one of the biggest custody players around. State Street Corp. (NYSE: STT) and Northern Trust Corp. (Nasdaq: NTRS) are examples of other sizable competitors in the custody world, although MacCleod feels Mellon has an edge over both firms in the customer service area. ABN AMRO brings an additional $550 billion in assets under custody to the table, along with its established network of 1,900 offices in more than 70 countries around the globe. So, Mellon is bulking up quite a bit and will be able to leverage its scale in the custody biz all over the world.

The situation was exactly the reverse for Mellon in the credit card processing realm, which the company decided to exit last week with the sale of its merchant processing unit to Paymentech (NYSE: PTI). While the business handled about $5.3 billion in annual card sales volume, that figure (as staggering as it may seem at first) was only about 2% of the market.

"We didn't have the scale to compete with the big players," MacCleod explained, so the company decided to bail. Right now, the top five companies in the processing sector control about 75% of the market. Since Mellon was not one of the top five, it made sense to get out of that business and focus on other areas where it does have scale advantages, such as its custody operations.

This way of corporate thinking -- exit businesses where the firm doesn't have an advantage, bulk-up in areas where it does have an advantage -- is the stuff that endears shareholders to their companies over the long-term. Mellon appears to be very focused on its strategy for growing the company down the road, unlike some of its competitors which have their hands in lots of business but are lacking an over-arching gameplan for the future.

Mellon's strategy is simple: Focus on high-return businesses where the company already has an edge and execute. This line of thinking is probably best illustrated in how the company views its asset management business, which offers higher returns than any of Mellon's other business lines.

As MacCleod explained, Mellon views its mutual fund business both from a manufacturing and from a distribution point of view. On the manufacturing side, which refers to the actual "construction" of the fund business, Mellon feels pretty secure about its position. MacCleod doesn't see any more acquisitions in this area, outside of a few possible purchases to "fill things in here and there." With a mutual fund stable that already includes Dreyfus, Founders Asset Management, and The Boston Co., adding another big fund family would probably result in too many overlapping offerings. Plus, as Dale Wettlaufer informed me recently, U.S. mutual fund companies are not exactly cheap right now.

On the distribution end of things, Mellon is currently "well represented" but would like to expand its international presence, especially in Europe. In fact, the company is doing just that. Recently, Mellon acquired a 75% stake in British fund manager Newton Investment Management for $210 million. The deal with ABN AMRO will also help further the company's international reach. And as MacCleod intimated, if any area of the mutual fund business will see more growth in the near future, the distribution end is the most likely candidate.

We'll be keeping a close eye on this investment of course, just as we intend to keep tabs on all of our holdings. But with Mellon executing its strategy so well, you can probably expect our occasional updates to be the kind that our editors love: short and sweet.

Finally, this is the last night to post your favorite oil and gas companies (also post your knowledge). To do so, please click here.

FoolWatch -- It's what's going on at the Fool today.


11/05/98 Close

Stock Close Change JNJ 81 11/16 -3/16 INTC 94 -13/16 CPB 56 1/2 -7/16 MEL 63 11/16 +11/16
Day Month Year History Drip 0.12% 4.09% 21.34% 3.34% S&P 500 1.36% 3.20% 16.84% 19.18% Nasdaq 0.74% 3.71% 16.99% 15.26% Last Rec'd Total # Security In At Current 09/02/98 8.027 CPB $52.867 $56.500 09/01/98 9.727 INTC $80.238 $94.000 10/07/98 7.850 JNJ $71.405 $81.688 10/07/98 1.000 MEL $48.560 $63.688 Last Rec'd Total # Security In At Value Change 09/02/98 8.027 CPB $424.36 $453.53 $29.17 09/01/98 9.727 INTC $780.50 $914.37 $133.87 10/07/98 7.850 JNJ $560.53 $641.25 $80.72 10/07/98 1.000 MEL $48.56 $63.69 $15.13 Base: $2100.00 Cash: $237.52** Total: $2310.35

The Drip Portfolio has been divided into 89.430 shares with an average purchase price of $23.482 per share.

The portfolio began with $500 on July 28, 1997, adds $100 on the 1st of every month, and the goal is to have $150,000 in stock by August of the year 2017.

**Transactions in progress:
09/21/98: Sent $77 to buy/enroll in MEL.
10/24/98: Sent $40 to buy more INTC.
10/26/98: Sending $60 to buy more JNJ.