Here’s Why Morgan Stanley Is In A Hurry To Own 100% Of Smith Barney

by Trefis Team
Morgan Stanley
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Since the economic downturn of 2008, Morgan Stanley (NYSE:MS) has made some significant changes to its business model. It has become more cautious in its trading strategy (something we highlighted in our recent article Here’s How The Country’s Biggest Banks Stack Up When It Comes To Equities Trading) compared to rival Goldman Sachs (NYSE:GS), and has also worked hard towards reducing its exposure to sovereign debt in the peripheral European nations.

But Morgan Stanley’s biggest move towards reducing the overall risk portfolio of its business is undoubtedly the acquisition of a majority stake in Smith Barney from Citigroup (NYSE:C) in early 2009, and the subsequent increase in the stake to 65% in 2012. The importance of the acquisition was clearly demonstrated by Morgan Stanley as it prioritized acquiring the remaining 35% stake in its capital plan for this year. The global investment bank has been setting aside capital exclusively to increase its stake in Smith Barney over the last two years, even as competitors are distributing sizable cash to investors in the form of dividend hikes and share repurchase plans. In this article, we detail the main reasons behind Morgan Stanley’s urgency in fully acquiring Smith Barney.

We have a $24 price estimate for Morgan Stanley’s stock, which is near its current market price.

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Diversification Remains Morgan Stanley’s Biggest Priority In The Wake Of Tightening Regulations

Morgan Stanley purchased a 51% stake in Smith Barney from Citigroup in January 2009 primarily because of the flak its business model drew following the economic recession; the bank’s purely investment banking services were extremely sensitive to market conditions and were characterized by volatile revenue figures.

Before Morgan Stanley picked up the 51% stake in the Morgan Stanley-Smith Barney (MSSB) joint venture, its legacy wealth management business was but a fraction of its current size. In 2006, wealth management contributed less than 20% to the bank’s total revenues ($5.5 billion of a total $30 billion in revenues). But, as we can see from the chart below, which represents the assets under management in Morgan Stanley’s wealth management division since 2008, the portfolio jumped by nearly 200% in 2009 and has been uptick since then.

The resulting hike in revenues from the business is much more significant. For 2012, the wealth management business roped in $13.5 billion of Morgan Stanley’s total $26.1 billion revenues – contributing to well over 50% of the top-line.

Tighter regulations proposed under the Dodd-Frank Act, including the hotly debated Volcker Rule which seeks to clamp down on proprietary trading and investments, is already making revenue generation a difficult job for the pure investment banks and the situation will only get worse going forward. Morgan Stanley is looking to make up for all the lost revenues by strengthening its presence in the wealth management industry.

And Improving Margins At Morgan Stanley Wealth Management Will Inevitably Raise The Value Of Citigroup’s Stake

Last year, Morgan Stanley rechristened the MSSB unit as Morgan Stanley Wealth Management, with Citigroup’s stake in the business brought down to 35%. Over the recent quarters, the unit has made some notable improvements in performance – especially in margin figures which reached 17% in Q4 2012 from below 10% in the previous quarter (see Morgan Stanley Reaps Rich Rewards With Wealth Management Focus). With the once-ailing business showing signs of turning the corner, Citigroup could very well ask for a revaluation of its stake in the business before Morgan Stanley buys it out completely which is quite possible despite their agreement as it stands between them.

Such a revaluation would require Morgan Stanley to shell out more to acquire the final 35% stake.  It is therefore clearly in Morgan Stanley’s favor to close the deal as soon as possible.

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