Abigail Hofman: Morgan Stanley’s worrying slide

By:
Abigail Hofman
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The received wisdom is that if Morgan Stanley gets into too much trouble, Mitsubishi will step in to save it. Will that still be the case now that Nomura’s grandiose international project has ended with a whimper?

Could the same be said of US broker Morgan Stanley? Don’t forget that Japanese financial institution Mitsubishi UFJ has a 20% stake in Stanley. The received wisdom is that if Morgan Stanley gets into too much trouble, Mitsubishi will step in to save it. Will that still be the case now that Nomura’s grandiose international project has ended with a whimper?

Morgan Stanley’s second-quarter results were disappointing verging on the dreadful, depending on how charitable you are feeling. Net income fell more than 50% from the previous year. Net revenue in fixed income and commodities fell to $770 million in the period – down some 60% year on year.

The firm is trying to reduce risk-weighted assets and build market share in this area. The two aims might not be compatible. Stanley blamed the poor results on the threat of a Moody’s double downgrade that hovered Damacles-like over them during the period.

The excuse seems a little glib and I worry about the Good Ship Gorman. Indeed I have been worrying for a while. Eighteen months ago, in my March 2011 column, I wrote that CEO James Gorman might face "exile" if the firm could not produce consistent results.

Gorman continues to hold out the promised land of wealth management nirvana. In other words, he wants to increase earnings from the supposedly steady retail brokerage operation to balance the more volatile investment banking revenues.

I have never been convinced that the income stream from wealth management is inherently more reliable than other investment banking earnings. As far as I remember, everything went down together with a resounding thud in 2008.

But let’s park that debate on one side for a moment. I am intrigued about the current negotiations whereby Morgan Stanley is seeking to purchase 14% more of the Smith Barney unit. It would appear that Morgan Stanley values the stake at $9 billion while Citi prizes the asset at some $22 billion.

This was the summer when many of the chickens that the Abigail with attitude column has been husbanding came home to roost
This was the summer when many of the chickens that the Abigail with attitude column has been husbanding came home to roost
Some of this difference in valuation might be a result of tough negotiating and arcane game theory. But isn’t it a bit odd that Gorman claims the Smith Barney platform will be transformational for the firm yet values the asset so much lower than his joint-venture partner? An independent arbiter, Perella Weinberg, will adjudicate shortly in mid-September. The valuation will have important ramifications for both Morgan Stanley and Citi – which, by the way, is run by a former Morgan Stanley investment banker, Vikram Pandit.


Readers will remember that I also fulminated about Facebook. In my June column, I wrote that Morgan Stanley, the lead underwriter, had managed to pluck disaster from the jaws of victory and that the Facebook IPO could end up damaging the firm’s technology franchise.

In my July column, with Facebook shares trading at around $30, or some 20% below the issue price, my stance had hardened. I criticized the pricing at the top of the indicated range as well as the hefty valuation accorded to the company (some 75 times projected 2012 earnings).

In late May, James Gorman went on CNBC to defend Morgan Stanley’s handling of the deal. This was a mistake. Although it was admirable to want to stare down the wolves howling for blood and the interview showed that he had an understanding of the nuts and bolts of the deal, Gorman effectively gave a hostage to fortune and publicly associated himself with a murky episode in the firm’s history.

Whoever advised Gorman to do the interview should be chastised. As I write at the beginning of September, Facebook’s shares are languishing at around $18. So a retail investor who purchased shares at the IPO in mid-May would have lost more than 50% of his money less than four months later. However, during this period, the overall Nasdaq composite index has risen.

Obviously anyone investing in stocks should know that their value can go down as well as up. But I do think Facebook will have a deleterious effect on Stanley’s retail franchise. I can imagine the anguished calls that the firm’s brokers must be receiving every day about the transaction.

Readers might dub me an unrepentant socialist but I do believe the sophisticated money slithered out of the deal as the retail ingénues stumbled in. News that legendary venture capitalist Peter Thiel, one of the founding investors in the company and a board member, sold most of his holding in the company in August reinforces this belief.

Individuals should be responsible for their actions and this tenet has to apply to highly paid investment bankers. The Facebook IPO has been a disaster. It was mispriced and mishandled from the outset – shouldn’t someone at Morgan Stanley, closely involved with the deal, do the decent thing and tender their resignation?