Morgan Stanley under accumulation by hedge fund ValueAct

Activist hedge fund ValueAct has accumulated a two per cent stake in Wall Street investment (and since 2008) commercial bank Morgan Stanley. Jeff Ubben, who once took on the management of the Evil Empire of Redmond (aka Microsoft!) has invested $1 billion, making ValueAct the bank's eighth largest shareholder. The hedge fund has emphasised its support for CEO Jamie Gorman and has blessed his strategy of transforming the firm from a volatile fixed income trading powerhouse to the one of the largest recurrent fee income model of wealth managers in the world, thanks to his brilliant purchase of Smith Barney from Citigroup in the Vikram Pandit era, ValueAct's motivation for buying Morgan Stanley is exactly the same as my motivation for recommending it in this column. At 0.72 times tangible book value and 10 times earnings, Morgan Stanley seemed one of the true undervalued jewels of Wall Street relative to its potential earnings power and secular growth rate. This is no hostile takeover deal in the offing but a "friendly" activist hedge fund's quest for value in the bank's shares.
Morgan Stanley never truly really recovered from the trauma of the 2008 global financial crisis and Lehman's failure, which forced it to convert into a bank holding company to access the Bernanke Fed's discount window. John Mack's strategy to out Goldman Sachs with colossal bets on the proprietary fixed income desk backfired spectacularly once the debt markets seized up in 2008. Seven years into one of history's great bull markets, Morgan Stanley managed to earn only a miserable 6.5 per cent, far below the bank's cost of capital. In fact, it is now ten years since Morgan Stanley last delivered even a 10 per cent return shareholder equity.
Jamie Gorman, the Aussie ex McKinsey management consultant who reinvented Merrill Lynch's fabled global wealth management business (all for naught since the Thundering Herd paid for Stan O's epic blunders by being swallowed up by Bank of America), has slashed fixed income prop trading limits, payrolls and shed complex, capital intensive businesses, as was inevitable in the age of the Volcker Rule and Dodd Frank. However, 2016 was tough for the bank's wealth management business, due to a flatter US Treasury yield curve, a bloodbath in the energy/high yield debt market and, above all, the fallout from Brexit and the higher central bank mandated capital surcharges.
The Chinese yuan depreciation in January 2016 and the angst over contagion risk from the Italian banking system all helped to trigger a bear market in Morgan Stanley shares from 40 to 24, though they have now recovered to 29. This is the reason Morgan Stanley's beta is among the highest among its US money center banking peers, far above J.P. Morgan Chase and Wells Fargo. This means this puppy can go "risk off" in a moment, as it did in 2008 (Lehman), 2010 (Greece) and 2015 (China).
Morgan Stanley's fixed income, currencies and commodities (FICC) division delivered $1.3 billion in the second quarter, while the equities division earned $2 billion. Yet from revenues were still lower by seven per cent to $8.9 billion, though better than the Street whisper number, the reason the shares rallied since mid July. It is entirely possible that Morgan Stanley earns $3 EPS in 2016 and its shares rerate to 12 times earnings. This means that the bank's shares can rise to $35 at least (my prior target) or more, if ValueAct raises the decibel count on Gorman's strategic transformation.
There are significant headwinds to higher profit growth at Morgan Stanley. Gorman has not remotely achieved his 9 to 11 per cent return on equity (ROE) targets despite epic job cuts. After all, Gorman fired one fourth of Morgan Stanley's global fixed income division in 2015. Equities revenues fell despite a surge in global mergers and acquisitions deals. Morgan Stanley needs to leverage its asset/wealth management and deal advisory businesses worldwide to produce sustainable profitability growth metrics to merit a potential valuation rerating on the shares. ValueAct can hopefully help Gorman achieve the holy grail of a double digit return on equity, a target that proved so elusive in the past six years he has led the firms. Are McKinsey management consultants, after all, glorified bean counters? - business@khaleejtimes.com