An Old-Fashioned Mexican Standoff
How much is Smith Barney worth,
and why should advisors and their clients care?
If Smith Barney-parent Citigroup
and acquirer Morgan Stanley can’t reconcile a roughly $15 billion disagreement
about price, advisors and their clients are likely to experience the fallout in
the form of smaller recruiting checks and/or a less satisfying client experience.
It’s ironic that the retail
brokerage made famous by commercials from the curmudgeonly John Houseman, “Smith
Barney – they make money the old-fashioned way,” is caught up in an
old-fashioned valuation dispute that may have significant adverse consequences.
The price that Morgan Stanley
will pay for 14% of Smith Barney will be established by what can only be
described as a byzantine process.
The first step was for
Citigroup to declare a selling price for Smith Barney. The Citi number came in
at $24 billion for 14% of the brokerage.
Morgan Stanley then had an opportunity to counter. It came in with a
price of $9 billion for 14% of the firm.
I’m sure the investment bankers
who devised this tortured process predicted a Mexican Standoff when they came
up with this “resolution”
plan. The sheriff who will resolve it will be a third-party
that determines a fair value for Smith Barney.
There are two ways to value a
retail brokerage. One is based on a
percentage of total client assets. The other is a multiple of normalized
earnings.
David Trone, a highly regarded
research analyst at JMP
Securities in San Francisco, arrived at a $24 billion valuation using
both methodologies on Feb. 22, 2012. The
math is straightforward: 1.5% of $1.65 trillion of client assets, or 15 times
normalized earnings of $1.6 billion, equals $24 billion.
Looks like Citi’s valuation is
closer to the true market value than Morgan Stanley’s.
The price resolution is particularly
important for Morgan Stanley, which is facing intense pressure from
shareholders. The firm has stated publically that wealth management is a key
part of CEO James Gorman’s strategy to revitalize earnings.
Why
Advisors Should Care?
If Citi is correct and the
value is close to $24 billion, Morgan Stanley will have to make significant
expense reductions. If Morgan Stanley’s
$9 billion figure is correct, the expense reductions will be out of the
brokers’ pocketbook.
Either way, there will be ramifications
for everyone. The two most immediate impacts are that advisor
recruiting checks are likely to shrink, and the client experience
is likely to suffer.
To increase profits, it’s likely
that Morgan Stanley will implement plans to increase margins. Historically, firms have manufactured complicated
investment “solutions” to increase margins. But as the financial crisis showed,
those “solutions” don’t necessarily result in higher investment performance for
clients.
Additionally, Morgan Stanley is
likely to pare back technology investments, since there could be less capital available after the deal.
Technology
Quagmire?
In fact, that technology
conversion for Smith Barney clients has already been difficult.
A senior manager at the firm
recently told a Morgan Stanley branch office that the firm is well aware that its
integration of the Smith Barney platform
into Morgan Stanley was not perfect, but had to be done.
One Smith Barney advisor recently
summed up the experience thus far: “It feels like I’ve switched firms, but
without the recruiting check.”
What happens next in Wall
Street’s latest valuation drama remains to be seen for both clients and
advisors.
That is, of course, unless
Smith Barney advisors or their clients decide to break away and realize the
certain technology upgrade and other benefits of working
with an independent firm.
Let the cuts begin!
ReplyDeletehttp://www.onwallstreet.com/news/mssb-weighs-brokerage-changes-2680296-1.html?ET=onwallstreet:e9239:24012a:&st=email&utm_source=editorial&utm_medium=email&utm_campaign=OWS_Daily__081012
The valuation deadline has been extended!
ReplyDeletehttp://www.onwallstreet.com/news/Morgan-Stanley-Citigroup-Joint-Venture-Value-Deadline-Extended-2680603-1.html?ET=onwallstreet:e11357:24012a:&st=email
The most informative article I have read on the subject.
ReplyDeletehttp://www.bloomberg.com/news/2012-08-27/morgan-stanley-win-on-brokerage-would-be-pyrrhic-victory.html
Looks like the brokers fired the first shot.
ReplyDeleteMorgan Stanley lives do brokers die?
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