Even as negotiations about the valuation of the Smith Barney brokerage business continue between Morgan Stanley (NYSE:MS) and Citigroup (NYSE:C), the former seems intent on making its retail brokerage business more profitable. Recent reports indicate that Morgan Stanley, which currently holds a 51% stake in Smith Barney, is giving thought to the idea of closing quite a few brokerage offices and laying off support staff in an attempt to cut costs.  The move clearly seeks to unlock the synergies that exist from the merger of Morgan Stanley’s legacy brokerage operations with Smith Barney. Morgan Stanley is vying for an additional 14% stake in Smith Barney, and holds the option to acquire the remaining 35% over the next 2 years.
We have a $19 price estimate for Morgan Stanley’s stock, which is about 30% above current market prices – something we believe is because of significant pessimism among investors toward the financial sector in general and investment banks in particular.
The Retail Brokerage Business Hasn’t Been Very Profitable
Over the last two years, increased turmoil in capital markets clubbed with added regulatory pressure has forced Morgan Stanley to look for more stable alternatives to its money-minting trading business – like its wealth and asset management businesses. Since Morgan Stanley acquired the majority stake in Smith Barney from Citigroup in January 2009, the large brokerage business emerged as the best candidate to ensure a steady income for the investment bank.
However, Morgan Stanley has reported rather dismal margins for its overall brokerage business since 2009, with margins stuck at under 10% as seen in the chart below. With the slow economic conditions making it all the more difficult to generate revenues, the bank would clearly look to squeeze out whatever value it can from the business.
But There Seem To Be Some Cost-Cutting Options Available
This would explain Morgan Stanley’s decision to cut down on the number of operating regions from 16 to 12 last week – especially since the bank had already trimmed down on the 19 regions that existed just last year. A reduction in the number of regions eliminates corresponding manager jobs while creating opportunities for further job cuts among support functions like compliance and administration.
Notably, Morgan Stanley is not looking to cut its 16,900-member strong financial advisers base – which indicates that the bank only seeks to reduce overhead costs for its brokerage business while ensuring that the revenue potential is not adversely affected. The bank is also expected to save on recurring operating costs by its recent decision to move all its brokers on a single technology platform.
You can understand the impact of an improvement in operating margins for the business on Morgan Stanley’s value by making changes to the chart above.Notes:
- Morgan Stanley considers shutting offices, cutting staff: sources, Reuters, Aug 8 2012 [↩]