Poacher to prey
An activist investor nibbles at a Wall Street giant
SINCE the 1930s Morgan Stanley has been dispensing advice to America’s most prominent companies. Now sound counsel may be needed at home. The Wall Street firm must ponder how to respond to a $1 billion investment by a hedge fund with a history of stirring up changes on boards and in executive suites.
The purchase, by ValueAct, a San Francisco fund, ought not to be a surprise. Judged on the measures often used as a first screen to identify takeover targets, Morgan Stanley has long looked vulnerable. A letter from ValueAct to its own investors early this month noted that the investment bank was trading at only 70% of book value, implying that a break-up could be lucrative. Since news of its investment emerged on August 15th, that has risen to 80%, providing an immediate return without undermining the thesis (see chart).
Predictably, Morgan Stanley said it welcomed its new shareholder (as it would any investor).
There may be at least some truth in this. ValueAct’s letter extolled Morgan Stanley’s virtues and its strategy. The fund has not demanded board seats or changes, as it has elsewhere.
This flattery may partly reflect Morgan Stanley’s position on Wall Street. It is about as inside the club as any firm could be. When ValueAct tries to shake up a board, Morgan Stanley will surely be on one side or the other. The fine words may also be sincere. In 2013 the bank acquired Citigroup’s vast brokerage operations for a song and has since integrated them into its own operations. In so doing it has slowly shifted away from businesses where risks and capital requirements were particularly high, notably fixed income. James Gorman, its chief executive, is broadly thought to have done a good job.
For all that, results remain barely adequate. Mr Gorman has set a target for return on equity of 9-11% in 2016, up from last year’s 8% but hardly stellar. It is much less than JPMorgan Chase and Wells Fargo, two universal banks, expect.
Ordinarily, that might prompt a possible bid. But no rival is faring brilliantly, and any takeover would be tricky. The logical domestic acquirer, Wells Fargo, could face antitrust objections: a merger would combine two of America’s three largest brokers. And the Federal Reserve is unlikely to allow a bank already considered too big to fail to become bigger still.
Mitsubishi UFJ of Japan already owns more than 20% of Morgan Stanley and could in theory buy the rest, but big cross-border bank deals have all but vanished. National regulators, considered the guarantors of institutions on their patch, are sceptical everywhere. America’s would surely be reluctant to approve a deal.
Any other buyer would need to be big: Morgan Stanley’s market valuation is $58 billion, and a takeover would require a premium. ValueAct says it has bought 2% of the firm. That is enough to draw attention, but no more. Regulatory restrictions would anyway limit the inclusion of leverage in any deal.
Still, a deal is not wholly unthinkable. Several private-equity firms are sitting on huge piles of cash and they like to think they can create new structures. That might even temper their habitual affection for debt. Morgan Stanley’s brokerage and advisory businesses surely could thrive as a privately owned business. Underwriting can be done with little capital. The trading business is shrinking.
ValueAct says in its letter that public shareholders do not understand or properly value the firm.
Perhaps others would.