Saturday, May 07, 2005

Morgan Stanley's blues

The temporary lull in the action at Morgan Stanley has helped me realize that the terms of the debate are off point.

Purcell and the gang of eight are fighting over who best can increase the price of
Morgan Stanley’s stock – which has declined 14% since the beginning of their imbroglio -- but they should be debating how to increase its value. Neither party has proposed compelling answers to the question of how to increase the stock price. And this is the key challenge facing Morgan Stanley’s CEO – regardless of who occupies the position.

Purcell has made several management mistakes. The biggest was merging his Dean Witter with Morgan Stanley. The companies served two very different groups of customers with very different kinds of employees. Dean Witter’s blue collar stock brokers sold stocks and mutual funds to the middle class. Morgan Stanley’s pedigreed blue bloods delivered investment banking to blue chip corporations and private banking to their executives. There was no way for the blue collars and the blue bloods to coexist.

Having executed a merger based on a flawed concept, Purcell compounded the mistake by creating a management structure in which his blue collar loyalists replaced the blue bloods from Morgan Stanley. By turning away Morgan Stanley’s talent, Purcell was securing his power at the expense of the company’s profit potential and shareholder value.

Purcell should do two things to increase shareholder value. First, he should analyze Morgan Stanley’s business units based on their profit potential and competitive position. Morgan Stanley should dispose of businesses with weak profit potential and lagging competitive position. Second, he should identify the businesses with the greatest profit potential and strongest competitive position and invest in them through strategic hiring and acquisitions.

My guess is that one way to increase Morgan Stanley’s stock price would be to return the company to its roots by making the following corporate strategy changes:


  • Individual Investor. This stock brokerage business – with 10,962 brokers and 525 expensive offices -- earns a paltry 8% pretax operating margin – well below the 28% pretax margin for the overall company. Prospects for this business look terrible with retail investors staying away from stocks in a year when the S&P 500 is down 5%. Morgan Stanley should sell it.
  • Credit Services. The Discover credit card business’s 46.2 million customers earn Morgan Stanley a 35% pretax margin – the highest earner in Morgan Stanley’s portfolio. I question the logic of spinning off to shareholders what looks to me like Morgan Stanley’s crown jewels. But this decision has already been made. However, if Morgan Stanley gets paid enough money for the business and can reinvest the cash wisely, the spinoff might end up making sense.


  • Institutional Securities. This corporate finance powerhouse earns a respectable 31% pretax margin. Unfortunately, Morgan Stanley is being forced to pay higher compensation to replace the bankers who have left and retain the ones that competitors are trying to poach. Higher pay will cut Morgan Stanley’s profit margins – particularly in segments such as Mergers & Acquisitions – where its market rank slipped from 2nd to 4th between 2002 and 2004. If Morgan Stanley gets the $9 billion in proceeds it expects from the Discover spin-off it should use the cash to bolster its position – particularly in its industry leading equity issuance business.
  • Investment Management. With $424 billion under management and 30% pretax margins, this business looks like it would be ripe for growth through acquisition. There are several asset managers which could be acquired to bolster Morgan Stanley’s position in this attractive industry which is likely to benefit from 77 million baby boomers making a last ditch effort to save money before they hit 65.

While I would like to refine this proposed change with better data, I believe that a debate over Morgan Stanley’s corporate strategy would be more fruitful for shareholders than the one about whose blood is bluer.


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