March 28, 2024

DealBook: Morgan Stanley to Take Over Smith Barney, With Citigroup’s Blessing

James Gorman, chief executive of Morgan Stanley.Peter Foley/Bloomberg NewsJames Gorman, chief executive of Morgan Stanley.

9:16 p.m. | Updated

Morgan Stanley has reached an agreement to take full control of the Smith Barney retail brokerage joint venture, a business that it has called a crucial part of its future.

The deal announced on Tuesday, ending a wrangle of some months between the company and its partner, Citigroup, was a coup for Morgan Stanley. Now the challenge will be whether the business of advising wealthy customers on their investments can help lift Morgan Stanley’s sagging fortunes as its core investment banking and trading operations contend with difficult markets and a heavier regulatory burden.

After negotiations that stretched well into Monday night, Morgan Stanley and Citigroup agreed to value the brokerage operation at $13.5 billion. That figure was significantly closer to Morgan Stanley’s estimate of the unit’s worth, letting it buy the rest of the enterprise at a lower price. Citigroup said it would take a $2.9 billion after-tax write-down from the transaction.

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The two companies outlined steps that would allow Morgan Stanley to buy the 49 percent of the business that it did not already own within three years. That will begin with the purchase of a 14 percent stake that will close by the end of September. Morgan Stanley will buy an additional 15 percent by next June.

That will fulfill a major part of the turnaround effort undertaken by Morgan Stanley’s chief, James Gorman. In a statement, he described the agreement as “a significant milestone for Morgan Stanley in the implementation of our strategy.”

The joint venture, Morgan Stanley Smith Barney, was born in 2009, forged from Citigroup’s Smith Barney unit and Morgan Stanley’s counterpart, as a way to benefit both companies. For Citigroup, which had long identified the brokerage as a nonessential asset to be sold off to free up capital, the deal will speed up its own rehabilitation plan.

“As we have shown, the more we put the past behind us, the more we can focus on our future, which is in the core businesses in Citicorp,” Vikram Pandit, Citigroup’s chief, said in a statement.

Howard Chen, an analyst at Credit Suisse, called the settlement a win for both firms, allowing them to more quickly achieve their objectives. “It’s a point of progress in capital management and increases the potential for capital return to shareholders,” he said.

Shares of Morgan Stanley jumped nearly 4 percent on Tuesday, to $17.25, while those in Citigroup rose 2.6 percent, to $32.66.

The retail brokerage business is one that Mr. Gorman knows well, having overseen both Merrill Lynch’s and Morgan Stanley’s units. Analysts say that it is an operation that requires relatively little capital for the company, while its most successful wealth advisers can bring in millions of dollars in revenue.

And Morgan Stanley Smith Barney is one of the biggest such businesses around. It accounts for the bulk of its Morgan Stanley’s wealth management business, which has nearly 17,000 wealth advisers and $1.7 trillion in assets under management.

Roughly 74 percent of the overall division’s clients have entrusted more than $1 million in assets to the firm’s wealth advisers.

The unit reported a $418 million profit for the first half of the year, up 15 percent from the year-ago period. Its revenue slipped 4 percent, however, to $5.9 billion.

But Mr. Gorman’s strategy isn’t without risk. The most productive advisers are constantly being poached by rival brokerages, or can choose to set up shop on their own. And when those individuals leave, they nearly always take their entire roster of clients, draining their former employers of millions of dollars in assets to manage.

Morgan Stanley Smith Barney’s own brokers have complained that the integration of the two firms’ operations has been anything but smooth, marred by technology issues. And rivals like Bank of America’s Merrill Lynch and Wells Fargo have been competing fiercely for clients.

While a clearly drawn path to Morgan Stanley’s eventual takeover of the brokerage has existed for years, getting there was difficult. In July, the two companies brought in an independent appraiser, Perella Weinberg Partners, to value the brokerage operation after each provided vastly different estimates of its worth. Morgan Stanley estimated its worth at a little over $9 billion, while Citigroup said it was worth closer to $23 billion.

While some of the disparity between the two estimates could be attributed to tactical posturing, both sides had substantive disagreements over how to value the brokerage and related assets like tax benefits, according to a person involved in the talks.

That prompted senior executives at both firms to plead their case. Besides Mr. Gorman, Morgan Stanley called upon Robert Kindler, the firm’s head of global mergers and acquisitions, and Gary Shedlin, a specialist in financial institutions. And Citigroup drew upon Edward J. Kelly, the chairman of its institutional clients group and a top dealmaker, and David Head, a co-head of financial institutions investment banking.

An e-mail from Perella Weinberg with the firm’s appraisal — less than $13.5 billion — reached Mr. Gorman and Mr. Pandit in their Midtown Manhattan offices shortly after 4 p.m., according to people briefed on the matter.

Because of rules set by both firms governing the appraisal process, the low figure meant that Morgan Stanley Smith Barney could have valued the business at more than $10 billion below Citigroup’s estimates. That could have led to a significant accounting charge for the bank.

And because Perella Weinberg’s appraisal covered only the 14 percent stake that Morgan Stanley is seeking to buy at the moment, further haggling over the brokerage’s value loomed.

Both firms then decided to negotiate an all-encompassing settlement that would obviate the need for additional drama. Senior negotiators for Citigroup arrived at Morgan Stanley’s offices off Times Square early Monday evening, for talks that stretched long into the night.

What emerged was Tuesday’s deal — and a looming end to the Smith Barney name, coined from the 1938 merger of Charles D. Barney Company and Edward B. Smith. The unit will be re-christened Morgan Stanley Wealth Management.


This post has been revised to reflect the following correction:

Correction: September 11, 2012

An earlier version of this article misstated the role played by the investment bank Perella Weinberg Partners, While the bank did provide an appraisal of the Smith Barney brokerage business, it was Morgan Stanley and Citigroup that came up with the $13.5 billion valuation of the business.

Article source: http://dealbook.nytimes.com/2012/09/11/morgan-stanley-smith-barney-is-valued-at-13-5-billion/?partner=rss&emc=rss

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