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AllianceBernstein Holding LP
Morgan Stanley (MS) is fighting with Citigroup (C) over the value of their brokerage joint venture. A win for Morgan Stanley could show the bank is stepping up its commitment to a struggling business.
Photograph by Simon Dawson/Bloomberg
Morgan Stanley, which owns 51 percent of brokerage Smith Barney, is exercising its right to buy an additional 14 percent stake. Citigroup estimated in a July filing that the total value of the business is about $22 billion, and that Morgan Stanley’s bid was 40 percent of that, which would mean the two banks’ estimates of the total value are about $13 billion apart. The question will be resolved by investment bank Perella Weinberg Partners, which will determine a valuation by Sept. 10. Spokesmen for Morgan Stanley, Citigroup, and Perella Weinberg declined to comment.
Morgan Stanley’s bid runs counter to the bank’s high expectations for the business. According to Goldman Sachs Group (GS) analysts, the valuation implies that the brokerage’s profit could shrink by as much as 12 percent annually over the long term. David Konrad, an analyst at Keefe, Bruyette & Woods (KBW), says that if you’re a Morgan Stanley shareholder, you want the bank to pay as little as possible. “However, then you take a step back and say, ‘This is supposed to be one of your best businesses, and you’re saying it’s not worth very much,’ ” he says. “It’s a fine line they’re walking.”
Morgan Stanley Smith Barney is the world’s largest brokerage by number of financial advisers, with 16,934 as of June 30. Morgan Stanley has the right to buy the rest of the brokerage from Citigroup over time, with 14 percent available this year, 15 percent next year, and the final 20 percent in 2014. Morgan Stanley has become increasingly dependent on wealth management. Revenue from that division accounted for 41 percent of the bank’s total in 2011, up from 16 percent in 2006. Morgan Stanley shares are down 51 percent since the end of 2009, partly because of low profits at the brokerage amid a trading slump and global economic weakness, says Brad Hintz, an analyst at Sanford C. Bernstein (AB).
While Morgan Stanley’s low bid may be a negotiating tactic, it contradicts the bullish targets the bank laid out to investors as recently as June. Gregory Fleming, who runs the wealth management unit that includes the brokerage, has said the pretax profit margin at the unit will reach the “mid-teens” by the middle of 2013; that will require at least a 25 percent jump in earnings above last quarter’s level. Chief Executive Officer James Gorman set a 20 percent pretax-margin goal for the unit soon after he took the top job at the start of 2010. The margin hasn’t exceeded 12 percent in any quarter since the joint venture was created in 2009. A low valuation for the unit would also be a blow to Citigroup, forcing it to write down the value of the stake it still holds.
The failure of the unit to reach its profit-margin targets could explain the difference between Citigroup’s and Morgan Stanley’s valuations, according to Hintz. “Citi negotiated the original deal knowing the value was going to go up over time,” he says. “One guy is saying, ‘Look at what your plan was,’ and the other guy’s saying, ‘Well, that wasn’t the way it worked out.’ ”
The bottom line: Morgan Stanley Smith Barney is worth $22 billion, according to Citigroup; Morgan Stanley says the value is more like $9 billion.