Strategic Report
Jason T. Hathaway Matthew Lubman Brendan Springstubb April 20, 2005
Morgan Stanley
SageGroup, LLC. 2
Table of Contents
Company History 3 Competitive Analysis 6 Internal Rivalry 6 Entry 8 Substitutes and Complements 8 Supplier Power 9 Buyer Power 10 Financial Analysis 11 Company Analysis 12 Competitive Environment 14 Discounted Cash Flow Analysis 17 Key Issues and Solutions 18 Conclusion 22 References 23
Morgan Stanley
SageGroup, LLC. 3
Company History
Morgan Stanley is one of the largest financial service firms in the
world, offering financial products and services to investors and corporations
worldwide. In 2003, Morgan Stanley ranked first in Global Equity Trading
among the major financial service firms, second in announced Global Mergers
and Acquisitions, third in Global Equity Underwriting, and fourth in Global
Debt Underwriting. Morgan Stanley’s current standing as a leader in the
Diversified Financial Services Industry (the “Industry”) stems from the 1997
merger between Morgan Stanley Group, Inc. and Dean Witter, Discover & Co.
The history of Morgan Stanley can be traced back to the opening of the
first Dean Witter brokerage office in San Francisco, California, in 1924.
During the late 1920s and early 1930s, Dean Witter steadily grew its
brokerage business, becoming one of the nation’s leading financial service
firms. In 1938, Dean Witter became one of the first financial services firms
to establish a National Research Department. Only seven years later, in
1945, the Company became the first financial services firm to formally train
account executives. Throughout the 1950s and early 1960s, Dean Witter
continued to grow by acquiring a number of smaller brokerage firms. Also,
the Company’s growth during the 1950s and 1960s can be traced to Dean
Witter’s integration of new computer technology with its growing brokerage
business. In 1961, Dean Witter became the first securities firm to use
electronic data processing.
Dean Witter first went public in 1972. Six years later, in 1978, the
Company merged with Reynolds & Co. in the largest securities merger to
date. And in 1979, Dean Witter became the first brokerage firm to hold
offices in all 50 states and the District of Columbia. In 1981, however, the
Company was acquired by Sears, Roebuck, & Co. Five years after being
purchased, Dean Witter expanded its business to include credit services with
the launching of its Discover Card unit in 1986. In 1993, Sears, Roebuck, &
Co. opted to spin off Dean Witter Discover to public shareholders. Then, in
1996, just one year before its merger with Morgan Stanley, Dean Witter
Morgan Stanley
SageGroup, LLC. 4
created an electronic system that enabled clients to make banking and
securities transactions via the Internet.
In 1935, Morgan Stanley opened its first office in New York. Following
the Glass Steagall Banking Act in 1933, which forced firms to choose
between their commercial banking and investment banking businesses,
Henry S. Morgan, Harold Stanley, and a select group of other finance
professionals left J.P. Morgan & Co. and Drexel & Co. to form the investment
banking firm of Morgan Stanley & Co., Inc. One year after its inception,
Morgan Stanley had achieved 24% market share among public offerings. In
1941, the Company joined the New York Stock Exchange (NYSE) and
reorganized itself as a partnership. Morgan Stanley continued to grow its
business throughout the 1950s, with its most notable transaction being the
Company’s co-management of the World Bank bond offering in 1952.
Throughout the 1960s, Morgan Stanley entered a period of growth and
expansion that continued through the 1997 merger with Dean Witter. In
1967, the Company opened Morgan Stanley & CIE. International in Paris and
London in an effort to pursue the growing international securities market.
Also, in 1969, Morgan Stanley expanded its business model to include real
estate financing and advisory services. In 1971, Morgan Stanley entered the
sales and trading business and established its Mergers and Acquisitions
Group. By 1975, the Company had expanded its business through its
addition of institutional investors, making Morgan Stanley a full service
financial firm. Only two years later, in 1977, the Company formed Morgan
Stanley Realty, Inc. and Morgan Stanley Private Wealth Management.
Throughout the 1980s and 1990s, Morgan Stanley continued to expand, with
the two most notable transactions being its establishment of the Novus credit
card network and the Company’s acquisition of Van Kampen American Capital
Mutual Fund Family.
In 1997, Morgan Stanley Group, Inc. and Dean Witter, Discover & Co.
merged to form the modern Morgan Stanley, a global market leader in
securities, asset management, and credit services. Only a year later, Morgan
Stanley raised $4.4 billion for Dupont’s spin off of Conoco, which was the
Morgan Stanley
SageGroup, LLC. 5
largest initial public offering in the United States to date. In the following
five years, Morgan Stanley continued to grow through a series of
acquisitions. In 1999, the Company acquired AB Asesores, Spain’s largest
financial service firm. In the same year, Morgan Stanley purchased the
private wealth management firm, Graystone Partners, LP, and also joined
with Sanwa Bank in an attempt to provide investment products to Japan. In
2000, the Company purchased Ansett Worldwide Aviation Services to become
one of the largest financial owners of aircraft. In the following years, the
Company serviced some of the largest financial transactions to date in the
United States. Most notably, in 2001, Morgan Stanley served as the
underwriter for the $4.1 billion public offering of Agere Systems, the largest
initial public offering to date in the United States.
Morgan Stanley
SageGroup, LLC. 6
Competitive Analysis
Any analysis of the Diversified Financial Services Industry requires an
initial definition of the product and geographic markets in which firms
compete. The products offered by firms in the Industry include institutional
securities, private wealth management, asset management, and for some
firms, credit services. For most firms in the Industry, however, credit
services comprise only a small fraction of total revenues, implying that the
main product markets in the Industry are simply institutional securities,
private wealth management, and asset management. Hence, Morgan
Stanley’s main competitors are Bear Sterns, Citigroup, Credit Suisse First
Boston, Goldman Sachs, JP Morgan Chase, Lehman Brothers, Merrill Lynch,
and UBS. Since all of the major firms in the Industry offer financial services
throughout the world, geographic considerations are of relatively little
importance to defining the market. That is, all firms in the Industry complete
in the global marketplace. While there are a number of other firms, such as
Charles Schwab, American Express, and Bank of America, that compete in
specific product markets, our five forces analysis focuses primarily on the
major financial services firms identified above.
Internal Rivalry
The Diversified Financial Services Industry is extremely competitive.
At the core of competition in the market is the vast number of firms offering
wide varieties of financial services to consumers. The intense competition
within the Industry is easily justified by the fact that there are at least nine
major firms competing within the Industry’s main product markets. In
addition to the primary competitors identified above, firms in the Industry
must also compete with smaller, more regionally focused firms such as
Wachovia, Wells Fargo, and American Express, all of which offer financial
services to individuals and corporate clients.
Competition in the Industry is also heightened by the fact that
financial products are relatively undifferentiated. For example, if a consumer
firm is considering launching an IPO, any number of the nine main firms in
Morgan Stanley
SageGroup, LLC. 7
the Industry, plus other banking firms outside of the well-defined Industry,
may be in direct competition to be hired to underwrite the transaction. With
all of investment banks in the Industry offering nearly identical products,
competition to provide investment banking services is extremely intense.
Internal rivalry is further augmented by low switching costs incurred by
buyers. Using the example above, it is easy to see that the consumer firm
contemplating an IPO incurs minimal costs in choosing Morgan Stanley over
say, Goldman Sachs. The lack of product differentiation and low switching
costs that increase internal rivalry extend beyond investment banking. On
the asset management side, products are essentially undifferentiated;
individual investors and private wealth managers can choose to allocate
funds to any number of asset management firms. Switching costs for these
buyers are also low, as they have the freedom to transfer/remove funds
essentially without penalty. Of the three main products offered by firms in
the Industry, private wealth management is perhaps the most differentiated
and has the highest switching costs to buyers. Buyers may develop loyalties
to private wealth managers over time, increasing the implicit cost of hiring a
new financial advisor. Barring individual loyalties among investors, buyers
can costlessly hire and fire financial advisors.
Finally, internal rivalry in the Industry results from the relative size of
particular transactions. In investment banking, one or two large transactions
can launch firms to the top of the Industry rankings. For example, Proctor &
Gamble’s $57 billion purchase of Gillette substantially altered the rankings for
top merger advisors to date in 2005, landing Goldman Sachs, Merrill Lynch,
and UBS in the top three in the Industry. Prior to the merger, UBS had
never been included among the top three in merger advisory services. Thus,
we see that large transactions, such as the Proctor & Gamble/Gillette merger,
increase internal rivalry as firms attempt to capitalize on rare, high-revenue
transactions. Once again, the same trend is observed in the asset
management and private wealth management product markets. Firms in the
Industry compete aggressively for large individual and institutional accounts
that bolster fees and commissions.
Morgan Stanley
SageGroup, LLC. 8
Entry
There is a relatively low threat of entry to the Diversified Financial
Services Industry. Due to the size of the firms in the Industry and the
maturity of the market, it would be, for all practical purposes, impossible for
any start-up financial services firm to ever enter the market or compete
effectively with Morgan Stanley or any other firm in the Industry. Thus, the
most significant threat of entry is the possibility that a middle-market firm,
such as Lazard or CIBC World Markets, could grow its business fast enough
to enter the market and steal market share from existing firms. Such
prominent middle-market firms are already viewed as peripherally
competitive to the established firms in the Industry with respect to specific
product groups, such as investment banking. However, there is still
relatively little threat that any middle-market firm would be able to enter the
market and steal significant market share from existing firms. Reputation is
an extremely important firm quality in the Industry, and hence, it is unlikely
that any new firm would have the ability to steal substantial market share
from existing, highly reputable firms. Furthermore, the experience curve in
the Industry also limits entry. Implicitly, firms such as Goldman Sachs, who
have a great deal of transaction experience in every product market are
more likely to be hired to conduct similar transactions in the future. Entry is
also deterred by certain economies of scale possessed by larger firms; such
economies include research costs, Industry experience, administrative costs,
technical efficiency, etc.
Substitutes and Complements
The primary substitute to Diversified Financial Services is for buyers to
diversify their financial purchases independently. For example, individual
investors can choose not to hire private wealth managers, but instead to
handle their investments personally through an independent account. They
may choose to individually buy stocks and/or mutual funds, based on their
own research or gained knowledge. Investors can choose to substitute away
Morgan Stanley
SageGroup, LLC. 9
from securities in general by investing in real estate, hedge funds, or
alternative investments.
Buyers also have a wide range of asset management services from
which to choose beyond those offered by firms in the Diversified Financial
Services Industry. For example, buyers can substitute away from services
offered by Merrill Lynch or Morgan Stanley by once again investing their
funds independently in mutual funds or other asset management firms.
Examples include Fidelity, Van Kampen, and Janus.
With respect to investment banking, buyers have the ability to
substitute away from the Diversified Financial Services Industry by hiring an
investment bank not explicitly included in the Industry; for example, buyers
may choose a boutique investment bank, such as Barrington Associates, for
mergers and acquisitions advisory, or a hedge fund or private equity firm as
a source of capital-raising.
For those firms in the Industry that offer credit services, buyers have
the option of opening an account with a credit services firm not already in
the Industry, such as American Express. Ultimately, however, the threat of
buyers substituting away from firms in the Industry is relatively small due to
the number of buyers in the market.
Supplier Power
Firms in the Industry face very little supplier power. Diversified
Financial Services firms have two groups of suppliers: (1) capital providers,
including mutual funds, hedge funds, and institutional buyers of equity and
debt financing, and (2) employees. In the case of capital providers, firms in
the Industry are not subject to either direct or indirect supplier power. That
is, suppliers of capital have very little pricing power over firms in the
Industry due to the large number of suppliers; in other words, the supply
market for firms in the Industry is not very concentrated. Employees have
low to medium supplier power in commanding a higher wage. In each
division of Diversified Financial Services firms, there are usually a few top
finance professionals at the executive level, called “rainmakers.” These
Morgan Stanley
SageGroup, LLC. 10
rainmakers generate large amounts of business for their respective firms.
For example, in private wealth management, a rainmaker may be a financial
advisor who has an extremely large amount of assets under management.
Seemingly, these rainmakers have at least some supplier power over their
respective firms because they have the ability to take their talents to a
competing firm. The same is true for top investment bankers and asset
managers.
Buyer Power
Buyers include individuals and institutions that purchase financial
services from firms in the Industry. With respect to investment banking,
buyers include corporations seeking to finance projects and/or undertake
mergers or acquisitions. Other buyers include wealthy individual investors
purchasing the services of a private wealth manager, and a money manager
purchasing asset management services. Buyers in the Industry are
essentially price-takers. That is, they have little power to alter purchase
prices from sellers due to low concentrations of buyers in the market. As a
result of the large number of buyers in the market, no single buyer can
significantly alter the price it pays for financial services. A summary of our
five forces analysis is shown in the following table:
Five Forces Analysis
Internal
Rivalry Entry
Substitutes and
Complements Supplier Power
Buyer
Power
High Low Low to Medium Low to Medium Low
Morgan Stanley
SageGroup, LLC. 11
Financial Analysis
As a diversified financial services firm, Morgan Stanley operates in four
primary lines of business: (1) Institutional Securities, which includes
investment banking, sales, trading, financing, and market-making activities,
(2) the Individual Investor Group, which manages assets for wealthy private
individuals, (3) Investment Management, whose services include asset
management and private equity activities, and (4) Credit Services, led by the
Company’s Discover Financial Services unit. In 2004, Morgan Stanley
reported total revenues of $39,549 million and net income of $4,486 million.
Of the $39,549 million, Institutional Securities earned $9,378 million in 2004,
or 23.7% of total revenues. The Individual Investor Group accounted for
8.25% of the Company’s total revenues, posting revenues of $3,264 million.
The Company’s Investment Management unit earned $4,412 million
(11.16%), while Credit Services accounted for $1,318 million (3.33%). The
Company’s largest source of revenue, however, came in the form of dividend
and interest income, stemming from aggregate financing and investing
activities. Dividend and interest income accounted for 47% of the
Company’s revenues, or $18,590 million. The composition of Morgan
Stanley’s 2004 revenues is shown in Figure 1 below:
Figure 1
24%
8%
11%
3%
47%
7%
InvestmentBankingIndividualInvestor GroupInvestmentManagementCredit Services
Interest andDivident IncomeOther Income
Morgan Stanley
SageGroup, LLC. 12
Company Analysis
Morgan Stanley’s current share price is $56.95, which implies a market
capitalization of $61.41 billion. Since the collapse of the Internet bubble in
2000 and the events of September 11th in 2001, Morgan Stanley has
successfully increased its market capitalization by and average of 8.3%
between 2002 and 2004. During the 3-year period, the Company’s market
capitalization grew from just over $48 billion in 2002 to $61.41 billion at the
end of 2004. The Company’s revenues grew 10% in 2004, well above its 5-
year average of 2.3%, but moderately lower than its 10-year average
revenue growth rate of 14.3%. Furthermore, net income increased by 18%
in 2004, above both the Company’s 5-year average of 2.2% and its 10-year
average of 17%. Morgan Stanley’s return on equity was 15.9% in 2004, up
from 15.23% in 2003 and 13.65% in 2002. The observed growth in the
Company’s return on equity can be directly traced to its increased
profitability, as its net profit margin improved steadily in each of the past
three years. In 2004, Morgan Stanley reported a profit margin of 11.34%, a
moderate increase from the 10.84% and 9.21% reported in 2003 and 2002,
respectively. The 3-year increase in return on equity is also linked to the
significant increase in the amount of assets held by the Company. In 2004,
the Company reported an increase of $234 million in long-term investments,
resulting from recovering financial markets and improved economic
conditions. As a result, Morgan Stanley was able to increase its asset-base
from roughly $530 billion in 2002 to over $774 billion at the end of 2004.
Also, the significant increase in the asset value boosted the Company’s
financial leverage. In 2002, Morgan Stanley had an asset-to-equity ratio of
24.19; however, by the end of 2004, the Company had increased its financial
leverage to 27.49. Using DuPont Analysis, Figure 2 illustrates the increase in
the Company’s return on equity due to increases in both profitability and
financial leverage between 2002 and 2004:
Morgan Stanley
SageGroup, LLC. 13
Figure 2
Year Profit Margin Asset Turnover
Financial
Leverage
Return on
Equity
2004 11.34% 5.10% 27.49 15.90%
2003 10.84% 5.80% 24.24 15.23%
2002 9.21% 6.13% 24.19 13.65%
Morgan Stanley’s ability to increase both profitability and the value of
its assets over the past three years has been fully reflected in its share price.
At the end of 2002, shares were trading on the New York Stock Exchange at
$39.92. By the end of 2004, however, shares were trading at $56.95, up an
average of 12.57% per year. Of course, the increase in share price in the
period between 2002 and 2004 reflects the Company’s recovery from the
collapse of the technology bubble and the events of September 11th, both of
which had devastating effects on Morgan Stanley due to the Company’s
sensitivity to overall market conditions. Figure 3 illustrates the Company’s
share price over the last five years compared to the performance of the S&P
500:
Figure 3
Morgan Stanley
SageGroup, LLC. 14
As evidenced by Figure 3, both Morgan Stanley and the S&P 500
suffered substantial losses in share price as a result of the collapse of the
Internet boom and the subsequent attacks of September 11th. It is clear,
however, that Morgan Stanley’s share price suffered significantly larger
declines in value than the S&P 500. Such phenomenon may not only be
explained qualitatively by Morgan Stanley’s dependence on financial markets,
but is also justified quantitatively by the Company’s high beta value. Morgan
Stanley has a beta of 1.956, which is high for any industry, including
Diversified Financial Services. In short, the large risk premium required by
equity holders due to Morgan Stanley’s exposure to changes in the overall
economy makes the Company’s share price more volatile with respect to
changing market conditions.
Competitive Environment
While there are many financial services firms, Morgan Stanley’s
primary competitors in the Diversified Financial Services Industry are
Citigroup, Merrill Lynch, and Goldman Sachs. It is difficult at times to
accurately assess the competitive environment in the Diversified Financial
Services Industry as a result of the size of Citigroup’s assets and its overall
dominance in the Credit Services Market. For example, at the end of 2004,
Citigroup’s asset-base was over 1.264 trillion, more than 60% larger than the
next firm in the Industry. In 2004, Citigroup’s market capitalization was over
$248 billion, more than four-times that of the second largest firm. Figure 4
illustrates the size of each firm relative to its competitors:
Morgan Stanley
SageGroup, LLC. 15
Figure 4
Company
Morgan
Stanley Citigroup
Goldman
Sachs
Merrill
Lynch Industry
Market Value (billions) 61.41 248.49 52.97 55.65 104.63
Assets (millions) 775,410 1,264,032 531,379 494,518 766,335
Revenues (millions) 39,549 108,276 29,839 27,745 51,352
Net Income (millions) 4,486 17,046 4,553 3,988 7,518
As evidenced by Figure 4, Citigroup is the largest firm in the Industry.
Citigroup’s market capitalization, asset-base, revenues, and net income are
so large that, from a monetary perspective, it appears to be in a league of its
own. It is also evident from Figure 4, however, that Morgan Stanley appears
to be well positioned in the Industry in terms of market value, assets,
revenues and net income, as the Company is second only to Citigroup in
three of the four categories. To better assess Morgan Stanley’s competitive
position in the Industry, it is necessary to analyze the profitability of each
company and the Industry as a whole. Figure 5 illustrates, through the use
of DuPont Analysis, the profitability of each company in the Industry
compared to the Industry average:
Figure 5
Company
Morgan
Stanley Citigroup
Goldman
Sachs Merrill Lynch Industry
Net Profit Margin 11.34% 15.74% 15.26% 14.37% 14.18%
Asset Turnover 5.10% 8.57% 5.62% 5.61% 6.22%
Financial Leverage 27.49 12.90 21.19 17.88 19.86
Return on Equity 15.90% 17.39% 18.15% 14.42% 16.47%
Return on Assets 0.58% 1.35% 0.86% 0.81% 0.90%
As demonstrated by the financial leverage ratio of each company,
Morgan Stanley is the most levered, with an assets-to-equity ratio of 27.49.
Morgan Stanley’s high leverage ratio is consistent with its high beta value.
In general, the more levered a firm is, the more risky it will be viewed by
investors, and hence, the higher the required rate of return used to discount
Morgan Stanley
SageGroup, LLC. 16
future cash flows. Thus, while Morgan Stanley’s profit margin is well below
the industry average of 14.18%, the Company’s return on equity is still
relatively competitive as a result of its leverage. Finally, Morgan Stanley’s
return on assets of .58% is well below the Industry average of .90%.
From an equity pricing perspective, it is vital for an investor to be
aware of average prices, multiples, and levels of risk within the Industry.
Figure 6 illustrates the share price, price-to-earnings multiple, and beta value
for each company in the Diversified Financials Industry, along with the
Industry average:
Figure 6
Company
Morgan
Stanley Citigroup
Goldman
Sachs Merrill Lynch Industry
P/E 13.96 15.19 12.34 14.19 13.92
Share Price ($) 56.95 47.88 110.02 59.93 68.70
Beta 1.96 1.33 1.63 1.61 1.63
The most important statistic given in Figure 6 appears to be the beta
values for each of the four firms. Morgan Stanley has the largest beta in the
Industry, which implies that the Company is more risky than any of the other
three firms. As would be expected from the size of its assets, Citigroup has
the smallest beta, which implies that it is less risky than the other firms in
the Industry. Both Goldman Sachs and Merrill Lynch have beta values nearly
equal to the Industry average. Figure 7 graphically illustrates share price
performance for each firm in the Industry, along with the S&P 500:
Morgan Stanley
SageGroup, LLC. 17
Figure 7
Discounted Cash Flow Analysis
Assuming a risk-free rate of return on a ten-year Treasury note of
4.36% (the current yield), a constant beta value of 1.956, and an expected
market return of 7% in the future, Morgan Stanley would have to maintain
5.5% growth for the next ten years and 3% thereafter in order to justify its
current share price of $56.95. Given these assumptions, it is difficult to
determine whether Morgan Stanley is currently undervalued. There appears
to be insufficient evidence to support a “BUY”, “STRONG BUY”, or “SELL”
rating at this time. Ultimately, discounted cash flow analysis yields a “HOLD”
rating on Morgan Stanley’s common stock, the same rating currently given
by Standard and Poor’s.
Morgan Stanley
SageGroup, LLC. 18
Evaluation of Key Issues
Issue 1: Discover Financial Services: Sell or Spin Off?
On April 4, 2005, Morgan Stanley announced that the Company’s
board had approved for management to pursue a spin off of its Discover
Financial Services unit. The announcement appears to stem from recent
attacks by eight former executives on the job performance of current
Chairman and Chief Executive Officer, Phillip J. Purcell. The group of former
executives currently own 11 million shares, or approximately one percent of
shares outstanding. Morgan Stanley must currently decide whether a sale of
the unit to another credit card company will increase shareholder value (in
both the short-run and the long-run) more than spinning off Discover into its
own separate entity through the issuance of Discover stock to current
Morgan shareholders. Nearly all Industry analysts value the Discover unit at
somewhere between $9-15 billion, with most agreeing that a spin off would
be valued at approximately $11 billion. Possible buyers that may be
interested in acquiring Discover include JP Morgan Chase, Bank of America,
American Express, MBNA & Co., and Capital One Financial Corp., among
others.
Solution: Sell Discover
We recommend that Morgan Stanley capitalize on the current market
for its Discover Financial Services unit. Even if the Company is able to fetch
a spin off price at the upper end of analysts’ estimates (say, $11 billion, or
even more optimistically, $12 billion), very little, if any, shareholder value
will be created directly from the spin off. Furthermore, it is possible that the
spin off could dilute shareholder value if the spin off does not fetch a market
price equal to that which is currently embedded in the value of Morgan
Stanley. That is, it is possible that the unit may be viewed by investors as
less valuable on its own than it is under the umbrella of Morgan Stanley.
Even if such a result is unlikely, it is still a risk borne by existing shareholders
since equity offerings do not always live up to the expectations of Wall Street
analysts. True, the spin off could prove to be successful in the long run
Morgan Stanley
SageGroup, LLC. 19
under new management; however, Discover is peripheral to Morgan’s core
securities business. In order to do what’s best for shareholders in both the
short- and long-run, Morgan should refocus its strategy on growing its core
securities business.
If Morgan Stanley chooses to sell Discover to an existing credit card
company, it will almost assuredly be able to fetch a price that is substantially
higher than its spin off value. One possible reason for this is that existing
credit card companies will value Discover more highly as a result of possible
synergies, existing management effectiveness, etc. If Discover simply
becomes an independent entity, there is no guarantee that, even under new
and/or better management, it will be more profitable in the future than
expected, a result needed in order to increase shareholder value. Thus,
Morgan Stanley should allow shareholders to “cash out” of Discover because
the price it receives for the unit can be used to grow Morgan Stanley’s core
securities business, a strategy that is less risky and has a higher probability
of increasing shareholder value. The price obtained by Morgan Stanley for its
Discover unit will enable the Company to allocate funds to help grow its
Institutional Securities, Asset Management, and Individual Investor Groups.
Moreover, the immediate increase in shareholder wealth resulting from the
acquisition announcement (assuming the tender price is above the market
value) may serve to mitigate the current pressure of Phillip Purcell to resign.
If nothing else, an immediate increase in shareholder wealth will buy Mr.
Purcell some time to prove that he can operate Morgan Stanley’s core
securities business profitably.
Issue 2: Underperformance of Asset Management
The asset management division of Morgan Stanley has grown its
revenues by an average of 4% over the past three years; however, the unit’s
five-year average annual growth rate is slightly less than zero. These
returns, while subject to conditions in the market, reflect an under
performance based on the expectations of Wall Street analysts.
Furthermore, Morgan Stanley is subject to the growing trend of talented
Morgan Stanley
SageGroup, LLC. 20
asset managers fleeing large investment banks to join hedge funds or other
asset management firms, which may possess greater compensation
schedules.
Solutions: Acquisitions and Lateral Hires
With the sale of its Discover unit, Morgan Stanley will have the cash
needed to re-vitalize its asset management unit, which has recently under
performed and subsequently hurt shareholder value. Improvement within
the asset management division of the Company can be done in a number of
ways. First, and most likely, Morgan Stanley could seek to acquire an
existing asset management firm as a means of adding value to its existing
asset management division. That is, we feel that Morgan Stanley should use
the money from its sale of Discover to grow its core securities business by
locating and acquiring an existing asset management firm(s). While Morgan
has come under scrutiny over past acquisitions, shareholders would likely
approve the acquisition of an existing asset management firm since it
represents an investment in the Company’s core securities business. Thus,
we feel that Morgan may find it beneficial to explore possible acquisitions in
the asset management market.
Secondly, we recommend that Morgan Stanley take additional
measures to improve the quality of finance professionals in its asset
management division. For example, Morgan could seek to laterally hire
successful asset managers who are currently employed at other firms.
Morgan Stanley’s corporate culture and reputation make it an attractive work
environment for finance professionals. Morgan could play this card as a
means of attracting new, talented asset managers, particularly those working
at smaller, lesser-known firms. It is also possible that incentive packages
could be created to laterally hire asset managers from Morgan’s direct
competitors (i.e., Merrill Lynch, Citigroup, etc.), though such a strategy may
prove problematic if it causes “wage wars” between competing firms. One
possibility to avoid such a problem would be to set contracts for a specific
length of time, thus ensuring that a “rainmaker” does not simply leave
Morgan Stanley
SageGroup, LLC. 21
Morgan after receiving an incentive package. Fixed-length contracts would
most likely increase profitability, especially if the Company can laterally hire
a few of the top finance professionals in the Industry. But Morgan’s culture
could prove to be the most powerful tool in recruiting lateral hires,
particularly those who have shown persistent success at smaller asset
management firms and/or hedge funds. A similar process could also be used
to attract successful financial advisors from other firms to Morgan’s
Individual Investor Group.
Morgan Stanley
SageGroup, LLC. 22
Conclusion
In summary, our analysis suggests that Morgan Stanley adopt a “back
to basics” approach to its corporate strategy. In particular, the company
should sell its Discover unit and pump the proceeds back into its three core
lines of business: Institutional Securities, Individual Investor Group, and
Asset Management. Given current market conditions, we are confident that
Discover will sell to another credit card company at a price much higher than
it would as a spin off. Furthermore, the sell off will not only increase
shareholder value, but will also likely relieve, at least to some degree, the
current pressure being put on Mr. Purcell by former Morgan executives.
Finally, the sell off will provide the capital needed to restore Morgan’s core
business units to prosperity, particularly its asset management division.
Morgan Stanley
SageGroup, LLC. 23
References
The Wall Street Journal
Yahoo! Finance
Morgan Stanley Corporate Website
Hoovers Online
Standard and Poor’s
Morgan Stanley 10-K