Brokerage firms were once the bread and butter of Wall Street. Still, a recent spat between Morgan Stanley and Citigroup has exposed just how hard it is for even the experts in the business to quantify the value of such operations.
During Morgan Stanley's earnings call last Thursday, its chief executive, James P. Gorman, trumpeted the strengths of its brokerage unit, saying it was an important business for the bank. Yet just a few days earlier, as part of deal negotiations with Citigroup, Morgan Stanley placed a surprisingly low valuation on that very same unit.
That apparent disconnect reveals the high stakes that exist as Morgan Stanley wrangles with Citigroup over acquiring a bigger slice of the unit they jointly own, Morgan Stanley Smith Barney. The unit â€" formed of the union of Citigroup's Smith Barney side and Morgan Stanley's brokerage businesses - manages the assets of wealthy individuals and is headed by Gregory J. Fleming. Mr. Gorman has said that he wants it to play a big role in Morgan Stanley's future.
On a conference call last Thursday, Mr. Gorman was enthusiastic about Morgan Stanley Smith Barney. “Our wealth management business will considerably increase its value to our clients and financial advisers through superior functionality and to our shareholders through enhanced and stable earnings,†he said.
The bank bought a 51 percent stake in Morgan Stanley Smith Barney from Citigroup in 2009, and the current talks are over the price it should pay for an additional 14 percent of the unit.
In a financial filing last Thursday about the deal talks, Citigroup implied that Morgan Stanley had come to the table with a bid that places the value of all of the operations of Morgan Stanley Smith Barney at around $9 billion. Citigroup, however, says it's worth about $23 billion. Because of the distance between the bids, both banks now have to call in a third-party appraiser, the investment bank Perella Weinberg Partners.
Executives from Morgan Stanley Smith Barney will give an overview of the business to Perella Weinberg, in a meeting scheduled for Thursday at Morgan Stanley's offices in Purchase, N.Y., according to people briefed on the talks but not authorized to speak on the record because the discussions are private.
Officials from Citigroup and Morgan Stanley will also be in attendance at that first meeting with the appraisers, these people said. Representatives for both companies declined to comment on the meeting.
Then, next week, Citigroup and Morgan Stanley will individually make their case to Perella Weinberg.
The gap between both valuations is likely driven in part by negotiating tactics. Morgan Stanley wants to have full control over the business for as low a price as possible. Meanwhile, Citigroup is likely to want it to be worth more; if it's worth less than Citigroup estimates, the bank, under accounting rules, will be forced to make a write-down on its balance sheet. That could lead to a large and possibly embarrassing charge against earnings and capital.
If Perella Weinberg comes up with a valuation that is far off both banks' bids, it could call into question the accuracy of their balance sheets.
According to a recent filing, Citigroup's balance sheet gives Morgan Stanley Smith Barney a value of around $22 billion, which is comparable to what it has told Morgan Stanley it is worth.
Morgan Stanley hasn't stated the precise value its balance sheet places on the unit, but filings suggest it could be $10 billion to $14 billion. The upper end of that range is far off the $9 billion implied in its bid for the 14 percent stake.Citigroup may have most to lose if the appraisal comes far from its valuation.
Wall Street analysts value Morgan Stanley Smith Barney around $15 billion. But that would be $7 billion below Citigroup's valuation. In such a case, Citigroup would book a loss, thoug h only on its stake, so it would be less than $3.5 billion. That would hurt some important measures of capital, but not others. Any hit to capital would not escape the notice of regulators, like the Federal Reserve, which earlier this year rejected Citigroup's request to return more capital to its shareholders.
But Morgan Stanley may also face some questions on its decision to emphasize its wealth management business. Morgan Stanley's trading businesses are underperforming right now, so it is even more dependent on its wealth management unit.
If Perella Weinberg ends up attaching a value on the low side, close to $9 billion, analysts say it could lead Morgan Stanley shareholders to have doubts about the wealth management business, too.
