James Gorman needs to take some responsibility for a multi-billion dollar mistake he has made and resign. He has been at the helm for 2 years, and the stockholders of Morgan Stanley have suffered enough. I have written earlier about how Gorman may be an empire builder at shareholder expense, and this is a follow up to that assertion.
On May 31st 2012, Morgan Stanley (MS) informed Citigroup (C) of its intention to purchase an additional 14% in their brokerage joint venture, Morgan Stanley Smith Barney (MSSB). On the day that MS exercised this option, the stock closed at $13.36/share. Today the stock is in the same place, and earnings recently reported were very weak.
Morgan Stanley Valuation
Morgan Stanley currently is trading at approximately 50% of tangible book value (TBV). The company has a market capitalization of approximately $26bn, and is trading at around 11 times 2012 earnings estimates and less than 7 times 2013 estimates. It just reported a terrible quarter with the top line down 25% year over year. However, it was still solidly profitable and reported the highest Basel 3 Tier one capital level (around 8.5%) of all the big banks. The firm is de-risked but not making much money.
The value of MSSB is somewhere in the neighborhood of $9-$22bn. Preliminary indications indicate that MS is valuing MSSB from $9bn, while C is valuing it at $22bn. Under the terms of their contract, MS and C have just recently exchanged their valuation estimates. If it is 10% apart or less, then the valuation will be an average of the two. If not, an independent advisor will determine the value and the transaction will close on approximately September 7th. The 14% stake will cost MS between $1.26-$3.08bn.
Use of Capital for Buybacks
MS has gotten approval from regulators to spend the money to purchase 14% of MSSB from Citigroup, which will likely cost between $1.26-3.08bn. This cost could approach 10% of the market cap of MS, a stock that is trading at 50% of book value. It is just not a prudent use of capital to pay a price that could approach book value for MSSB, when MS can buy back its shares at a significant discount to TBV. The Board of MS should not have exercised this option and should have applied to regulators to use the capital for stock buybacks.
MS Stock Price is Unacceptable
The Board of Morgan Stanley needs to address the fact that the stock price is trading at crisis levels. The market has completely lost confidence in the company. For a company like MS to be trading at 50% of TBV is hugely damaging to the franchise. The damage that is being done far outweighs the upside that the company will get through purchasing 14% of MSSB at this stage. The stock is trading at levels where the solvency of the firm may be questioned and clients will take their business elsewhere. The $1.26-$3.08 billion could have put a floor under the stock, protecting the company from a panic plunge in share price. I have repeatedly advocated the financial firms use a Warren Buffet style buyback to stabilize their stock prices. If buybacks are done with a floor price that is set significantly below TBV, then the buybacks are highly accretive and no brainer.
By using this $1.26-$3.08bn to buy 14% of MSSB instead of buying back stock, the Board of MS has put shareholders and employees at an unacceptable risk associated with a plummeting stock price. A change of leadership is necessary to re-establish credibility before it is too late.