Analyst: Morgan Stanley Smith Barney Joint Venture Has an "Embarrassing History"

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Morgan Stanley and Citigropu haggle over the value of the MS Smith Barney JV. "The wide difference between the firms' valuations for the JV has been "somewhat humiliating for Morgan," says Bernstein Research.

Brad Hintz, financial services senior analyst for Bernstein Research, rates shares of Morgan Stanley an “outperform,” yet pulls no punches in his comments on the MS’ deal with Citigroup. For example, Hintz says, “MS has fabulously disappointed investors with the execution of its integration plans.”

(Of course, in MS’ defense, the technological integration is a pretty huge job and very complicated, too.)

As everyone knows, James Gorman is making a big bet on the retail financial advisory business, and now owns 51% of the Morgan Stanley Smith Barney joint venture and ended up haggling over the price of another 14% stake. This is not news, of course, the announcement was made yesterday. A third-party had to come in to arbitrate the dispute and put the value of the JV at $13.5 billion. That’s slightly lower than consensus expectations of about $15 billion.

Hintz says: “So ends another chapter in the long, embarrassing history of the MSSB JV.”

What I find interesting is Hintz and his team’s thoughts on the bickering over price. Citigroup says had valued the business at $22 billion; Morgan Stanley valued it at $9 billion. (Also, $5.5 billion in bank deposits will be transferred.)

Some of Hintz and team’s thoughts:

“According to the original agreement, the two owners were supposed to determine the valuation of the retail business by analyzing the operating profit, AUM and the equity market omparables. So the relatively wide difference between the two valuations has been somewhat humiliating for Morgan Stanley. After all, MSSB has been pitched to investors as the future of the 'new' Morgan Stanley and the low valuation implies that the prospects of the retail business may not be as bright as they were when the JV was formed in 2009.”

And here are some other choice thoughts:

“But perhaps this conclusion is true. While the nearly 17,000 MSSB advisers roughly match the size of Merrill's thundering herd and its $1.71 trillion in assets under management put it at the top of the retail brokerage charts, MS has fabulously disappointed investors with the execution of its integration plans. The principal problem has been technology; Morgan Stanley told the analyst community in January 2009 that the JV would consolidate on either the Dean Witter or Citi technology platform. MS management stated that 'much of the technology that exists here at Smith Barney is outstanding… One thing we've both done is made the right [technology] investments over the last several years. So we are well-positioned to move aggressively forward here.' [emphasis original]

“It didn’t happen. Neither the Dean Witter nor the Smith Barney platforms were acceptable to MS management. And this meant a costly new system had to be designed, built and implemented. Plans to consolidate office space, middle management, the municipal desk, compliance and back office were all put off. The JV stumbled coming out of the gate – generating only a 10% pre-tax margin for two years. Finally, MS management moved the target pretax margin for MSSB from 20% to a mid-teens figure.

“Last quarter, the global wealth management (GWM) segment's operating margin was 12%, on relatively soft GWM revenues of $3.3 billion. Like all the full service and discount brokers, the segment suffered from weak trading and commissions revenues and disappointing investment banking numbers. Integration costs at GWM were $80 million. Financial advisor count fell 2% QoQ and annualized revenue per MSSB FA declined by 2%. And while the company proudly announced that the long delayed MSSB integration was completed during the quarter, the press continues to report FA complaints about the new technology platform.”

Stating that at about $15.51 a share, “the stock is trading slightly above the bottom 10% of its historic P/TBV [tangible book valuation] range.”

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