As long as Philip Purcell was running things, it was clear that Morgan Stanley's struggling retail brokerage would remain intact. Even as he fought off the so-called Group of Eight — dissident shareholders who demanded his resignation and divestiture of the former Dean Witter — Purcell assured advisors and the public that the investment bank would keep its 10,000-broker retail unit. After all, it was Purcell who engineered the merger of the Main Street broker network and the white-shoe bank and pushed out old Morgan Stanley management.
Now that Purcell has given up (he announced in mid-June that he'll be gone by next March), the future of the old Dean Witter organization is in question. Miles Marsh, Morgan Stanley's lead independent director, says the board believes that the combination of investment banking, trading and retail brokerage is still the right formula for the firm. “And it would take quite a lot to persuade us it is not,” he says.
Still, Morgan Stanley remains under pressure to improve profitability and its stock price. Its retail brokerage, known as the Individual Investor Group (IIG), has seriously lagged behind peers such as Merrill Lynch and Smith Barney in revenue per rep and profitability. For example, IIG advisors produced an average of $421,000 in revenue as of year-end 2004, according to Merrill Lynch estimates. While that's a 10-percent improvement over the prior year, it's still 30 percent to 60 percent below what advisors at rival firms Smith Barney, Merrill Lynch and Wachovia Securities produce, says a Credit Suisse First Boston report. (Morgan argues that its numbers are depressed by the large number of trainees it hires.)
IIG's pretax margins have also improved — they were 15 percent in the first quarter, vs. 14 percent in the first quarter of 2004. But they are still way off the 20-percent pace of its peers. Meanwhile, IIG generated about 19 percent of Morgan Stanley's revenue, but just under 6 percent of pretax profits in 2004. Merrill's retail group, by contrast, generated 45 percent of revenues and 32 percent of pretax profits.
What Next?
For now, Morgan reps are sizing up their options. “A letter we got internally continued to echo the statement that the board and people in charge of hiring the new CEO are in favor of an integrated financial services firm that includes retail,” says a Morgan rep who asks not to be identified. “But nothing anybody [on the board] has said has happened.”
Morgan reps have good reason to be skeptical. With the company's stock languishing at around $52 a share, down from a high of more than $100 in 2000, Morgan Stanley has to do something to appease angry investors. Days after Purcell announced his plan to retire, a group of investors launched another attack on the board. Banc of America analyst Michael Hecht predicts that Purcell's replacement is likely to accelerate the timing of a “value-unlocking event.” A sum-of-parts analysis by Punk Ziegel analyst Richard Bové shows that spinning off all three Dean Witter businesses — credit, asset management and retail — would boost Morgan Stanley's valuation by 37 percent.
In the meantime, a sale of the Discover credit-card business, which Purcell had committed to, has been thrown into doubt by reports citing insiders at the company.
Playing Catch-Up
Despite the assurances by top management that a sale of IIG is not a serious option, the strategy upon which the Dean Witter-Morgan Stanley merger was based — pushing proprietary institutional and retail products through a vast broker sales force — is no longer viable. At one point, say several brokers, Morgan required that 75 percent of a broker's sales be house-brand product.
For a while this strategy proved extremely profitable. But new disclosure regulations — which Morgan agreed to after paying a $50 million fine — have put the kibosh on the proprietary model. Meanwhile, Morgan Stanley has fallen far behind Merrill, Smith Barney and UBS in courting high-net-worth investors with open-architecture platforms, fee-based services and sophisticated wealth management strategies.
The firm is making a big push to catch up. It's ramping up the number of third-party products on its platform. And some 800 reps have gone through “wealth advisor” training and another 400 will do so by year-end. Morgan is also encouraging advisors to do more fee-based business, which accounted for 27 percent of the total in the first quarter of 2005, up from 24 percent a year ago.
Yet the firm is still struggling to attract big accounts. IIG says that half of its $518 billion under management is from households with greater than $1 million of liquid assets. This compares to two-thirds of Merrill's client assets in accounts with over $1 million of investable assets.
Still, one senior broker is optimistic. “I think in the last year they have really started to embrace wealth management,” she says. “For the first time Morgan Stanley is listening to its troops.” But even if there is a spinoff, she figures that any buyer would be crazy not to offer “some really big golden handcuffs” to keep an attractive book like hers.
