Smith Barney Math

I'm trying to work out the mathematics of the proposed joint venture between Citigroup (C) and Morgan Stanley (MS), and what it does for Citi's balance sheet, using stories from the FT and Bloomberg.

According to the FT, Citigroup has 15,500 brokers; according to Bloomberg, the companies have 22,000 brokers between them. Let's be charitable to Citigroup and assume that Citi's brokers are worth just as much, on a per-broker basis, as Morgan Stanley's. And let's further assume that the FT is right and Morgan Stanley is going to pay Citi $2.5 billion for a 51% stake in the joint venture. How could that correspond to the $10 billion gain Bloomberg says that Citi would book?

If the joint venture simply merged on an all-brokers-are-equal basis, then Morgan Stanley would own 6,500/22,000 or 29.5% of the joint venture. So if it ends up with 51%, or 11,220 brokers, that means it's essentially buying 4,720 brokers from Citigroup for $2.5 billion. Which values each broker at about $530,000.

At that valuation, the entire joint venture would be worth $530,000 times 22,000, or $11.65 billion. Citi will have received $2.5 billion in cash, and would own 49% of the joint venture, worth another $5.7 billion, for a total of $8.2 billion.

If that's the case, how on earth can Citi gain $10 billion "from writing up the value of Citigroup's Smith Barney brokerage unit to the new price set by the deal"? Smith Barney might not be worth a lot on Citi's balance sheet right now, but it's surely worth more than $0.

And this puzzles me, too:

The gain of $5 billion to $6 billion after taxes would flow into Citigroup's capital...

After taxes? What taxes? I thought that Citi had managed to lose so much money of late that it has enormous tax losses which essentially mean it's not going to pay any taxes for the foreseeable future. But now Bloomberg's implying that 40% to 50% of the $10 billion gain on Smith Barney will have to be paid in taxes -- which seems like a ludicriously high tax rate at the best of times.

Is there something I'm missing here? Are Smith Barney brokers actually worth more than Morgan Stanley brokers? Are some of the numbers wrong? Or is this just a case of journalists getting different numbers from different sources, and not stopping to ask whether they play nice with each other?

Update: A reader points out that the Bloomberg article does talk about "a $20 billion joint venture", and only "as much as" $10 billion in Citigroup gains. So maybe we can work backwards from the $20 billion number? That would value the joint venture at about $900,000 per broker, on average.

But let's say that the Citi brokers are worth only $800,000 each, while the Morgan Stanley brokers are worth $1.2 million apiece.

In that case, the joint venture before any cash payment would be worth $800,000 times 15,500 on the Citi side, or $12.4 billion, and $1.2 million times 6,500 on the Morgan Stanley side, or $7.8 billion. Total: just over $20 billion, with Morgan Stanley having a 39% stake. In order to raise its stake to 51%, Morgan Stanley would need to buy another 12%, and 12% of $20 billion is $2.5 billion.

That would explain the $2.5 billion. After receiving the cash, Citigroup would also have 49% of a $20 billion joint venture, worth $9.8 billion. So altogether it would have $12.3 billion, and depending on the current book value of Smith Barney, a large chunk of that might find its way into write-ups.

Comments

[Moon Kil Woong:]

Let's see 900,000 per broker would need around $180 million in capital at .5% in earnings for Smith Barney to value them as such. Righhhttt.

Ummmm next, and assuming they have this base to work with the odds that all 4,720 brokers move all that money $849,600 billion with them with no cash loss is what percentage?

Are the analysts on crack or something or just getting paid to lie to investors once again. And if you tell me that they will make more than .5% on these large deposits I think they won't have such big clients for very much longer.

By the way, the odds Citibank had this much cash under brokerage management still is very suspect in and of itself. After all, who would give them this much cash. Not I.

Jan 12 01:11 PM

[Obama is Bu...:]

The biggest problem facing banks right now is trust / credibility.

If 51% of Smith Barney is worth $2.5 billion, than the whole is presumably worth around $5 billion.

Citi CEO Pandit wants us to believe that $5 billion is equal to $10billion -- and somehow he doesn't understand why no one trusts the numbers on his balance sheet.

I am not trying to pick on Mr Pandit -- basic algebra skills seem to be eluding all the bank CEOs lately, and Hank Paulson too.

Jan 12 01:26 PM

[Obama is Bu...:]

BTW -- yes, I understood your thinking behind the value of each broker and an estimated "worth" of $8.6 billion... the problem with this thinking is that the most valuable asset of a brokerage walks out the door each night.

Morgan Stanley brokers are not going to tolerate a Citi brokerage culture -- anymore than Merril brokers are going to tolerate the bureaucracy of Bank of America.

In a "produce or perish" rain maker culture like Morgan Stanley, many of Citi's brokers are a liability... someone will have to pay for the severance costs.

If the MS/C venture adopts a "nice" culture, than the rain makers might just walk out the door -- which will cost a lot more.

In all these bank acquisitions, analysts who try to place values on the "new" company always seem to forget to subtract the costs of merging corporate cultures. Ask Morgan Stanley how much fun it was to merge with Dean Witter.

Jan 12 01:54 PM

[Pent up demand:]

So basically this is the big bank equivalent of pawning your clothes then?

Jan 12 02:47 PM

[Smarty_Pants:]

How does the combined balance sheet look if you subtract the TARP funds and mark all the level 3 assets to market?

Just wondering. Seems like debating where to put the deck chairs on the Titanic. And the band played on ...

Jan 13 09:21 AM

[Honey:]

Frankly speaking, in my opinion my broker at Smith Barney is worth maybe $50,000. That's all I'm saying.

Jan 13 12:57 PM

[Bob4More_or...:]

My Smith Barney broker is worth about approximately -$<font color=red><b>... to me, based upon 2008 performance. And I'm just one client/customer/patsy.

Jan 16 04:41 AM