MSSB Deal: A Win for Morgan Stanley

Morgan Stanley Smith Barney (MSSB) – the brokerage joint venture (JV) between Morgan Stanley (MS - Analyst Report) and Citigroup Inc. (C - Analyst Report) – has been valued at $13.5 billion. This signifies a clear victory for Morgan Stanley as it had valued the JV at $9 billion, while Citigroup valued it at $22.5 billion.

This also brings an end to the speculation surrounding the purchase price of 14% stake in MSSB. Now, Morgan Stanley will be paying about $1.9 billion for additional share in the JV, while no premium is required to be paid for the transfer of roughly $5.5 billion of deposits. Currently, the company holds 51% stake in the JV.

Further, both the companies have outlined steps that will allow Morgan Stanley to buy-out the entire JV. Under the terms of the amended JV agreement, the company will be acquiring the remaining 35% stake by June 1, 2015 at the same valuation of $13.5 billion.

As per the earlier JV terms, the company was supposed to purchase the entire JV by June 2014. Hence, the company is now getting extra time to arrange fund for the stake buy.

In the meantime, Morgan Stanley will be acquiring the next 15% stake by June 1, 2013, which is still subject to regulatory consent. Moreover, the company will not be required to pay any premium for the transfer of deposits.

MSSB History

Back in June 2009, Morgan Stanley and Citigroup entered into an agreement to form MSSB. The JV included Morgan Stanley's Global Wealth Management (GWM) Group and Citigroup's Smith Barney, Quilter in the UK, and Smith Barney Australia.

As per the terms of the deal, Morgan Stanley exchanged 100% of its Global Wealth Management business for 51% stake in the JV. Likewise, Citigroup exchanged 100% of its Smith Barney, Smith Barney Australia and Quilter units for a 49% interest in the JV and paid $2.75 billion to Morgan Stanley. The terms also stated that after three years, Morgan Stanley would have the option to purchase additional interest in the JV from Citigroup.

In January 2012, Morgan Stanley submitted its capital plans to the Federal Reserve for the stress test that included the purchase of an additional 14% stake in MSSB. This proposition by the company received the Fed’s approval in mid-March. Hence, in June, the company issued a notice that initiated a 90-day process to determine the purchase price.

Nevertheless, both the companies were unable to come to a common view regarding the price and required the help of an independent evaluator – Perella Weinberg Partners LP. However, the JV value calculated by Perella Weinberg was not satisfying. Therefore, Morgan Stanley and Citigroup commenced negotiations to reach the current price.

After Effects

The primary purpose of the JV is to stabilize Morgan Stanley’s earnings. However, the JV missed the profit targets set by the company on the back of a low interest rate environment and sluggish trading activities. Nevertheless, with nearly 17,000 wealth advisers and $1.7 trillion in assets under management, MSSB now accounts for the major portion of Morgan Stanley’s wealth management operations.

In the first half of 2012, Morgan Stanley’s GWM Group, which includes MSSB, recorded net revenue of $6.7 billion, making it the largest revenue contributing segment. The stake buy will lower the earnings volatility related to the company’s investment banking operations.

Further, rating agency Fitch considers Morgan Stanley’s stake buy a positive. The ratings agency stated that this will enable the company to diversify its revenue base and stabilize earnings. Additionally, the company will get incremental deposits related to MSSB, helping it to further broaden its funding base.

For Citigroup, divesting its stake in MSSB is a step closer towards improving its capital ratios and concentrating on its core operations, especially after its capital plan was rejected by the Fed. However, the company will have to take an after-tax charge of approximately $2.9 billion in the current quarter as a result of the agreed value of the JV.

Currently, Morgan Stanley retains its Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we also maintain our long-term Neutral recommendation on the stock.