Morgan Stanley Doesn’t Have Much To Worry About Even If Rosneft Deal Collapses

Last December, Morgan Stanley (NYSE:MS) announced its decision to sell its global oil merchandising unit to Rosneft, the state-controlled Russian oil producer. ^[1] The investment bank inked the deal in response to increasing pressure from the government on the country’s largest banks to exit the physical commodities business (see Regulator Pressure Causing Goldman, Morgan Stanley To Scale Back Physical Commodities Businesses). But doubts were raised about the deal earlier this year, when escalating political conditions in Ukraine led to a series of U.S. sanctions on Russia. ^[2]

While the deal is currently under review by the Committee on Foreign Investment in the United States (CFIUS), the increasing number of sanctions over recent months on Russia has led to the strong possibility of Rosneft backing out of the deal. ^[3] We believe that it might not be all that bad for Morgan Stanley if the deal falls through. As we detail in this article, it opens up several options which could work better for the bank.

We maintain a $38 price estimate for Morgan Stanley’s stock, which is about 10% ahead of the current market price.

See our full analysis of Morgan Stanley

The country’s largest banks took considerable heat from regulators over the second half of 2013, following allegations that these banks were manipulating the prices of commodities by creating an artificial shortage. A Senate committee hearing on the matter, and the Federal Reserve’s decision to draft a new set of guidelines restricting the involvement of investment banks in the physical commodities business, led to a series of divestment announcements beginning with JPMorgan’s (NYSE:JPM) decision to completely exit the business. Goldman Sachs (NYSE:GS) put its uranium trading unit on the block last November, and then its metals warehousing business in May. ^[4]

Morgan Stanley responded to the situation by agreeing to sell its Global Oil Merchanting unit to Rosneft last December. The sale included the bank’s oil terminal storage agreements, inventory, agreements pertaining to physical oil, oil-related equity investments and freight shipping contracts, and was estimated to bring the bank between $300-400 million in cash once it was finalized by the end of the year. But recent reports argue that Rosneft may no longer be able to complete the deal due to increased sanctions from the West on Russia. Although the Russian oil giant has enough cash to buy the unit, it is unlikely to secure the $30-40 billion in credit lines required to finance the unit’s day-to-day operations. ^[3] This will make the purchase extremely difficult for Rosneft given the current political situation.

There is a silver lining for Morgan Stanley even if the deal fails, though. Commodity prices have improved notably since Morgan Stanley entered into the agreement with Rosneft late last year – which could allow the bank to negotiate a higher price for the business with potential suitors. Also, as Morgan Stanley is one of just two U.S. banks (beside Goldman) legally allowed to own and run infrastructure for the manufacture, storage and operation of physical commodities, it may reconsider its decision to sell the unit itself – now that the scrutiny on banks over this issue has been quelled to a great extent. Either way, the improved commodity market conditions point to an increase in the bank’s FICC (fixed-income, currencies and commodities) trading yield in the near future.

1. Morgan Stanley to Sell Global Oil Merchanting Business to Rosneft, Morgan Stanley Press Releases, Dec 20 2013 [↩]
2. Morgan Stanley Rosneft Deal Seen in Limbo Amid Sanctions, Bloomberg, Apr 29 2014 [↩]
3. Rosneft may back out of Morgan Stanley oil unit deal, Reuters, Sept 25 2014 [↩] [↩]
4. Exclusive: Goldman puts Metro metals warehousing unit up for sale, Reuters, May 20 2014 [↩]