Morgan Stanley: Back from the brink
Investors are cheering reports of Morgan Stanley's deal for Citi's Smith Barney. But is the worst really behind the Wall Street giant?
NEW YORK (CNNMoney.com) -- Financial stocks got pummeled Monday as investors brace for another round of terrible quarterly results.
JPMorgan Chase (JPM, Fortune 500) fell more than 4%. Goldman Sachs (GS, Fortune 500) slipped 7%. Bank of America (BAC, Fortune 500) was down 12%. And Citigroup (C, Fortune 500) plunged almost 20%.
But one well-known financial firm bucked the trend -- at least for part of the day.
So, in the parlance of Sesame Street, which one of these stocks is is not like the others?
Morgan Stanley (MS, Fortune 500) shot up nearly 4% early Monday morning on reports that it is nearing a deal to merge its brokerage business with Citigroup's Smith Barney unit. By the end of the day though, Morgan joined fellow banks in the red and was down about 1.5%
A source has confirmed to CNN that, as part of the deal, Morgan Stanley would take a 51% stake in the combined entity and have the option to buy the remainder of the joint venture over the next few years.
At one point early Monday, Morgan Stanley's stock hit about $20 a share. While that's still a far cry from its 52-week high of $52, it's more than triple the low of $6.71 that the stock hit back in October. At that time, many on Wall Street feared that the firm might suffer the same fate as bankrupt Lehman Brothers.
But since then, Morgan Stanley has received a $10 billion investment from the Treasury Department as part of the government's controversial Troubled Asset Relief Program, or TARP. In addition, Japanese financial services giant Mitsubishi UFJ (MTU) closed a deal to invest $9 billion in Morgan Stanley.
So does Morgan Stanley CEO John Mack have his mojo back?
On the one hand, part of the bounce for Morgan Stanley may simply be just a recognition that it's probably no longer at death's door.
"The fear of failure has diminished, which helps," said Jeffery Harte, an analyst with Sandler O'Neill & Partners. "In hindsight, there was extreme pessimism. The market was concerned about Morgan's survival six to eight weeks ago."
Experts also seem to think that a deal for Smith Barney would be a huge plus for Morgan Stanley. In a report Monday, Barclays analyst Roger Freeman wrote that an acquisition "would be a positive strategic development from the perspective of a MS shareholder."
He argues that the speculated price tag of about $2.5 billion to Citigroup for the majority stake in Smith Barney would be a "compelling price" for what he dubbed an "attractive property."
Frank Barkocy, director of research with Mendon Capital Advisors, a money management firm that invests primarily in financial stocks and owns stakes in both Morgan Stanley and Citigroup, agreed that it sounds like Morgan Stanley may be getting a very fair deal.
"It's not a distressed sale, but if Citi sold Smith Barney earlier, it probably could have received more for the entity," he said.
But what really seems to be exciting investors is the fact that a deal for Smith Barney could help Morgan Stanley to become less reliant on risky leveraged businesses like trading, real estate investing and prime brokerage, the unit that caters to hedge funds.
"Smith Barney would give Morgan Stanley better balance and lessen its dependence on trading and other riskier operations," Barkocy said.
And in a report Monday, Fox-Pitt Cochran Caronia Waller analyst David Trone pointed out that combining Smith Barney with Morgan Stanley's brokerage business could lead to "huge" cost savings that could help boost cash flow at Morgan Stanley.
But Harte, who has a "hold" on the stock, said it may be premature to say that happy days are here again. He said the company still faces a tough environment as it and other banks will likely need to keep writing down the value of mortgage-related assets for quarters to come.
That's likely to keep a lid on earnings at Morgan Stanley for the foreseeable future. Currently, analysts expect Morgan Stanley to report steep profit declines for its next two quarters. And analysts' estimates for those quarters have come down sharply over the past month.
So while Mack appears to be making some smart moves to reduce risk at Morgan Stanley -- the company has also been beefing up its efforts to boost deposits after it was granted approval by the Federal Reserve to become a bank holding company last September -- Morgan Stanley certainly isn't out of the woods just yet.
For this reason, it shouldn't be a huge surprise that Morgan Stanley wasn't able to hold on to its gains Monday.
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