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A few months back I published an article recommending shares of Morgan Stanley (MS). At the time, the stock traded below $16 per share. Since then, it has rallied better than 25% to around $20. In that article I noted that, thanks to the Tier 1 capital boost occasioned by its settlement with MBIA, Morgan would be free to exercise a May call option allowing it to purchase an additional 14% in the Morgan Stanley-Smith Barney brokerage unit it runs with Citigroup (C). The additional 14% would boost MS' stake to 65% from 51%. It appears however, that Morgan wants to buy the entirety of the business now, as opposed to buying the remaining stake in installments over the next three years.
As I noted previously, the brokerage unit is valuable: it delivered to MS a record $3.3 billion in revenue during the third quarter of 2011 and margins have increased steadily over the last three years. If the market continues to climb and economic data continue to improve, the wealth management business will only get better. As Forbes notes, "the firm makes much more in fees from wealth management customers when they move out of safer investments and into equities." This could prove to be key as many analysts believe that the retail investor, still jaded from the heartbreak of the financial crisis, has not yet moved off the sidelines. If the recent move above Dow 13,000 creates some level of conviction in the minds of retail investors, they could come to market in droves, dumping safe-haven Treasury bonds (which are likely to fall over the next few years as rates rise) for riskier stocks, resulting in hefty profits for Morgan's wealth management operations. This is also a reason to get the deal done now if you're Morgan Stanley, as, according to Reuters, "the joint venture['s] profit headwinds, including high integration costs, low interest rates, and volatile market conditions ...are expected to fade in the coming years" driving up the price Citi is able to demand for the remainder of the stake. It is also worth mentioning that, thanks to "the Fed's decision to reject Citi's request to return capital to shareholders in 2012," the bank may take a lower price for its 49% share in order to "give it more flexibility to pay higher dividends."
All of this bodes well for Morgan. There is some ambiguity regarding just how an outright purchase of the remaining stake would affect Morgan's credit rating, however. There is an argument to be made that the deal would be a positive development in that "it would reduce Morgan's reliance on capital market activities," possibly helping the firm avoid a three-notch downgrade by Moody's. On the other hand, If MS is forced to use debt-financing to get the purposed $10 billion deal done, it could accelerate a downgrade.
Here is my take away: Wealth management generated 33% of Morgan's total revenue last quarter. Now, the firm has an opportunity to buy the remaining stake in the brokerage unit at a depressed price, from a seller eager to raise capital, at a time when wealth management fees are likely to begin to rise thanks to improving economic and financial market conditions. This seems like a particularly savvy move that will benefit the firm tremendously in the long run. In the short run, there are significant headwinds regarding MS' credit rating and exposure to European sovereign debt, so I wouldn't be loading up on call options ahead of any deal Morgan and Citi are able to strike. If you're looking to buy and hold however, Morgan's purchase of the remaining 49% of Morgan Stanley-Smith Barney looks like a good move. If you're hesitant to get in now, note that MS still trades at just 75% of tangible book, so even if it falls in the short term, the shares should close 2012 significantly higher.

Source: Morgan Stanley To Benefit Long Term From Purchase Of Citi's Stake In Joint Venture