Updated from 8:57 a.m. EST

After

Merrill Lynch

(MER)

laid off 14,600 people and consolidated worldwide offices in the U.S., Asia and Europe in 2001, the bulk of its cost-cutting effort was finished.

But expense reduction alone won't bring it the 40% earnings growth currently estimated for 2002. Analysts polled by First Call say the brokerage will have to come up with $21.9 billion in revenues next year to achieve its current earnings goals, about the same as in 2001. But with the company's revenues in a downward spiral for almost a year, flat revenues for 2002 imply a sharp pickup in business by the second half of this year.

Executives on the company's conference call noted that even if Merrill's revenues are unchanged in the first quarter from the fourth, they'll be running about 15% below the average quarterly rate of 2001.

"We really need revenue growth before the story can turn around," said Reilly Tierney, analyst at Fox-Pitt, Kelton. Tierney estimates that by the fourth quarter of 2002, Merrill will have to be boosting its year-over-year revenues by about 60% to hit its targets. "Investors want to see more than cost savings in terms of margin growth," he added.

Top Line

Including an after-tax charge of $1.7 billion for job cuts and other cost-cutting measures, as well as $30 million in expenses related to Sept. 11, Merrill Lynch posted a net loss of $1.26 billion, or $1.51 a share, in the fourth quarter. It was the company's first quarterly loss since 1998. In the year-earlier period, Merrill earned $877 million, or 93 cents a share.

Excluding the charge and including Sept. 11-related expenses, fourth-quarter earnings came in at 48 cents a share, in line with the average analyst estimate, according to Thomson Financial/First Call. For the full year, the company earned $2.41 per share, excluding the charge and including Sept. 11-related expenses. Analysts currently expect full-year 2002 earnings to jump to $3.33 per share.

Merrill's shares have slipped since early January, but are still up a hefty 53% to $55 a share since Sept. 20, on expectations for a stronger 2002. Other shares in the sector have also posted solid gains, including

Goldman Sachs

(GS) - Get Report

, up 33% to $87.40, and

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Morgan Stanley Dean Witter

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, which has jumped 48% to $55.63.

"There was a view that there was a tremendous bottom in 2001 and that business can't get worse, and that so much cost-cutting gave them lots of leverage," said Tierney about what is driving optimistic estimates. "But there are not a lot of signs of life in the pipeline."

Vital Signs

There are at least some encouraging signs. Merrill said Wednesday that it expects some improvement in its underwriting business this year, judging by activity in its own mergers and acquisitions pipeline. But considering the dismal levels of activity witnessed last year, it would be hard for conditions to get any worse, analysts said. Meanwhile, other companies are better positioned to reap the benefits of such an increase.

"They talked about a growing mergers and acquisitions pipeline, but that's growing from a very low base," said Brad Hintz, analyst at Sanford Bernstein. "While seeing transaction volumes rising in investment banking is good news, it's very, very good news for

Goldman Sachs

(GS) - Get Report

, which is the best leveraged to a recovery of IPO and mergers and acquisitions activity."

Indeed, Merrill is highly dependent on its retail operations, where business remains weak. The company netted $1.2 billion in commission revenues and $586 million in principal-transaction revenue in the fourth quarter, versus $538 million on underwriting, which includes mergers and acquisitions and IPOs.

"Merrill is the most linked to retail business on the street," says Hintz.

Meanwhile, debt-underwriting revenue, one of the sole areas of revenue growth in 2001 for the securities industry, may disappear in 2002, Merrill said. A string of rate cuts by the

Federal Reserve

led to a surge in new debt offerings last year. Some 11,269 bonds were issued in the U.S., totaling a record $2.61 trillion, according to Thomson Financial/First Call. That was up 51% from the prior year as a year of tumbling interest rates made the cost of debt more attractive.

That party would appear close to over, given how little room rates have left to fall.