(Bloomberg News) A win for Morgan Stanley in a fight with Citigroup Inc. over the value of their brokerage joint venture could show the firm is playing a losing hand.
Morgan Stanley, which has staked much of its pitch to investors on the stable earnings of its wealth-management business, is arguing that the brokerage is worth less than half what Citigroup says as it adds a 14 percent stake to the 51 percent the investment bank currently owns. Morgan Stanley's $9 billion valuation implies the joint venture's profit could shrink by as much as 12 percent annually over the long term, according to Goldman Sachs Group Inc. analysts.
The $13 billion gap between the two firms' valuations raises the stakes for the sale and stokes a debate on Wall Street about the future of retail brokerages. Investment bank Perella Weinberg Partners LP will provide its assessment of the outlook when it sets a valuation this week.
"If you're bullish on Morgan Stanley, the lower amount they pay the better," said David Konrad, an analyst at KBW Inc. in New York. "However, then you take a step back and say, this is supposed to be one of your best businesses, and you're saying it's not worth very much. It's a fine line they're walking."
While analysts including Konrad said much of the gap resulted from negotiating tactics, the Morgan Stanley valuation contradicts the bullish targets it has laid out to investors. Greg Fleming, who runs the wealth-management unit that includes the brokerage, has said it will reach a "mid-teens" pretax margin by the middle of 2013, requiring at least a 25 percent jump in earnings from last quarter.
Gorman Goal
Morgan Stanley shares are down 51 percent since the end of 2009 and trade at less than half of book value. Part of the reason for the discount is the low profits at the brokerage amid a trading slump and global economic weakness, said Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York. Morgan Stanley Smith Barney is the world's largest brokerage by number of financial advisors, with 16,934 as of June 30.
Chief Executive Officer James Gorman, 54, set a 20 percent pretax-margin goal for the unit soon after he took the New York-based firm's top job at the start of 2010. The margin hasn't exceeded 12 percent in any quarter since the joint venture was created in 2009, when Citigroup sold 51 percent of the business. Morgan Stanley also got the right to buy the rest of the brokerage over time, with 14 percent available this year, 15 percent next year and the final 20 percent in 2014.
Conflicting Valuations
The failure to reach targets may explain the difference between valuations, Hintz said.
"Citi negotiated the original deal knowing the value was going to go up over time and the future pieces would be more expensive," Hintz said. "That explains almost everything in terms of the differences. One guy is saying, 'Look at what your plan was,' and the other guy's saying 'Well, that wasn't the way it worked out.'"