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MARCH 21, 2005
Phil Purcell's Credibility Crisis Investors want Morgan Stanley's chief to beef up weak businesses -- or dump them For years, Morgan Stanley (MWD ) Chief Executive Philip J. Purcell seemed invincible. The bank's return on equity and profits soared past most of its peers'. So did the stock price, which reached 109 on Sept. 11, 2000. Wall Street adored its one-stop-shop model, created when Dean Witter -- with its retail brokerage network and Discover credit-card operation -- bought Morgan Stanley and its storied investment bank in 1997. Everything was going Purcell's way. No longer. Today, Purcell is under fire. Integrating the two firms has proven much tougher than many investors expected. That might be O.K. if the different segments were stellar stand-alone businesses. But while the investment bank remains a star, the former Dean Witter operations are laggards as Morgan plays catch-up with rivals who have bigger and more profitable retail brokerage and credit-card outfits. Almost eight years into the merger, the investment bank is still doing the heavy lifting, accounting for 62% of operating earnings. The brokerage contributes just 6%. Investors are not pleased. At 60 on Mar. 9, the company's stock price has been flat the past year, underperforming many of its rivals, though it has risen 18% since Nov. 30. The weak performance has revived tensions brought on by the merger in part because Morgan's senior bankers get about one third of their compensation in stock. Some investors worry that if the stock doesn't recover sharply, unhappy bankers could walk. As Morgan's Mar. 15 annual meeting in Chicago nears, investors, analysts, and even some employees are calling on Purcell to fix the problem by selling the firm's mediocre businesses. At the very least, they believe he should shake up the management at some of the units. Scott Sipprelle, a former Morgan Stanley managing director who's now a hedge-fund manager, sent a letter to Purcell and the board arguing that the merger was a mistake. In a recent meeting with a senior executive, he took direct aim at what he says is the firm's ill-fitting mix of businesses, poor regulatory record, and cozy board of directors. Five of the 11 board members, including Purcell, once worked for consultant McKinsey & Co. "This is really a non-issue," says a Morgan spokesman. "Some director overlap is inevitable when shareholders demand the highest-caliber directors for their board." Morgan also says it has put a lot of effort into improving its regulatory record. Purcell declined to be interviewed. The attacks are part of an open season on Purcell. On Internet message boards, investors poke fun at Purcell about everything from his niece's job as Discover's general counsel and his son's cheap mortgage deal last year to the board's recommendation against a shareholder proposal to cap CEO pay. Morgan says the niece was a crucial member of Discover's antitrust fight against Visa and MasterCard, and the terms of the son's mortgage were available to anyone qualified. Institutional Shareholder Services is also recommending investors vote against the pay-cap proposal because it is arbitrary. Some insiders complain that the New York-based company shelled out $467,142 last year for Purcell's personal travel by corporate jet. The board says the expense is justified because Purcell has to use the jet for security reasons. WAL-MART CARD DEAL Purcell has acknowledged publicly since last November that Morgan Stanley's returns have sunk to "the middle of the pack." Although 2004 net income jumped 18%, to $4.5 billion, the firm lagged far behind Goldman Sachs Group's (GS ) 52% profit leap and Lehman Brothers Inc.'s (LEH ) 39% rise. But Purcell refuses to take the drastic actions demanded by critics. In meetings with both investors and employees, he insists that the best course is not to draw up some radical plan, but merely to execute better -- raising his critics' ire even more. Whether he eventually succeeds or not, Purcell seems likely to remain standing for now. He is backed by a board that recently gave him a 47% pay raise even as the company's shares were falling, though he is still paid less than all except one other top Wall Street chief. And some investors, who believe Purcell will keep the firm's retail brokerage and credit-card operations, want to own the stock anyway as merger activity picks up. "The real selling point of the stock today is the top-notch investment bank," says Bob Maneri, a managing director at Victory Capital Management in Cleveland, which bought 755,000 shares for one fund last fall after Morgan announced disappointing earnings and the stock dropped. Still, Morgan Stanley is in a strategic box. Selling the businesses that don't fit would appear obvious, but it's not that easy. Sure, Morgan Stanley might quickly pocket about $10 billion if it sold Discover. Its image as a blue-collar card has been difficult to shake, and it doesn't have the global heft to compete with the big boys for marketing deals and customers. Some investors believe a logical buyer would be Citigroup (C ), Bank of America (BAC ), or JPMorgan Chase & Co. But though it's not growing, Discover still churns out cash, supplying 19% of earnings. Analysts say it has a higher return on equity than many other divisions. "They can't sell it, because they can't easily replace the earnings hole," says UBS (UBS ) financial-services analyst Glenn Schorr. Purcell has told investors that a U.S. Supreme Court antitrust ruling last fall forbidding Visa and MasterCard from restricting banks from issuing other cards will give Discover a new lease on life. One strategy is to focus on the fastest-growing part of the market, debit cards. In November, the firm bought debit-transaction processor PULSE EFT Assn., which will allow Discover to issue debit cards to its 40 million card holders. It also struck a deal to issue Wal-Mart Stores Inc. (WMT )-branded cards, financed by General Electric Co. (GE ) and processed by the Discover network. The cards will have all three brand names on them. "But there's growth and then there's growth," cautions David Robertson, publisher of The Nilson Report, a credit-card industry newsletter. "If Discover issues a credit card [instead of just putting its name on one], that's far more profitable." In January, Purcell conceded to investors that he will "reassess" selling Discover if it doesn't start to deliver sufficient growth. However, he said he wouldn't make a decision for at least two years, and he didn't reveal specific growth targets. Guy Moszkowski, financial-services analyst at Merrill Lynch & Co. (MER ), says Morgan has "articulated a growth strategy, and because they're pursuing it, I don't see them spinning off the business anytime soon." COMPLETE CONTROL Purcell's challenge with retail brokerage is equally tricky. Rivals such as Merrill Lynch have a roster of wealthier clients, analysts say. Merrill also has raced ahead of Morgan in segmenting customers and offering them tailored advice. It shows in the numbers: The operating profit margin of Morgan's retail brokerage business was 10% in 2004, excluding litigation costs, vs. 19% at Merrill, estimates Fox-Pitt Kelton. After wringing out costs over the past year, Purcell argues that the brokerage is now in a better position to compete. He doesn't see selling it as an option because it's crucial to his strategy of building a diversified bank based on the fastest-growing services. The criticism Purcell is facing is especially stinging because he has been in complete control of the firm. Since former President John J. Mack left in 2001, every division now reports directly to Purcell. What's more, the underperforming units were part of Dean Witter, where Purcell served as CEO when he engineered the $10 billion takeover of Morgan. The firm's lackluster share price has even sparked speculation that Purcell might some day be forced to sell Morgan Stanley to JPMorgan, Bank of America, or HSBC, though most bankers dismiss such talk. In effect, one of Wall Street's master salesmen now faces one of his toughest selling jobs. Few chiefs have been better at talking people into seeing things their way -- and gained as much power from it -- as Purcell. Whether he was persuading one of the Street's most venerable investment banks to agree to a takeover in 1997 or courting top executives to stay after Mack's departure, Purcell has usually prevailed. Purcell repeatedly tries to demonstrate to investors that the mediocre results trouble him and that he's on top of the problem. He has emphasized to groups of investors in two investor conferences over the past five months that once again producing premium returns is his top priority. He recently flew to Boston to meet with the company's third-largest shareholder, Fidelity Investments, whose funds sold 13% of their Morgan stock in the last quarter of 2004. While critics focus on recent results, Morgan prefers to highlight the long term. Morgan's chief administrative officer, Stephen S. Crawford says the firm's average return on equity over the past eight years was 22%, which is one-fifth higher than its peers. Morgan Stanley needs to get its mojo back or it risks becoming nothing special. And for now, the firm's fate is in Purcell's hands. During a Jan. 27 investors' meeting, he told people that although he was unhappy with the firm's returns, he was pleased with progress made in every one of Morgan Stanley's businesses. One person asked Purcell if the firm did so well last year, what hurt its returns? Purcell suggested that if he could have just changed "a few things," the firm would have come out ahead, though he did not go into specifics. Now it's time for him to deliver.  By Emily Thornton in New York, with Stanley Reed in London and Aaron Pressman in Boston
BW MALL
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