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 commercialsfrom 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.
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.