The much awaited news regarding Morgan Stanley’s (MS) stake buy from Citigroup Inc. (C) in their brokerage joint venture (:JV) has finally arrived. The company intends to give a notice regarding the exercise of its right to purchase additional 14% stake in Morgan Stanley Smith Barney Holdings LLC (:MSSB), the joint venture. The issuance of notice would start a 90-day process to determine the purchase price.
Under the JV terms, Morgan Stanley and Citigroup would be independently valuing MSSB’s fair value. The companies would be submitting their valuation within 45 days. If both the figures are within 10% of each other, then the 14% stake would be sold at an average of these. However, if the valuation difference is more than 10%, then the third-party appraisal will be conducted, which would be completed by August-end. We believe that the earliest completion date for the stake buy would be somewhere near the end of third quarter.
Apart from the fair value of the 14% stake, Morgan Stanley will also be required to pay a premium for $5.4 billion deposits, which are currently held by Citigroup. At present, Morgan Stanley has 51% interest in MSSB and the remaining is held by Citigroup. With this stake buy, Morgan Stanley would control 65% of the JV.
The Background Story
Way back in June 2009, Morgan Stanley and Citigroup had entered in to an agreement to form MSSB. The JV included Morgan Stanley's Global Wealth Management (:GWM) Group and Citigroup's Smith Barney, Quilter in the UK, and Smith Barney Australia.
As per the terms of the deal, Morgan Stanley exchanged 100% of its Global Wealth Management business for 51% stake in the JV. Likewise, Citigroup exchanged 100% of its Smith Barney, Smith Barney Australia and Quilter units for a 49% interest in the JV and paid $2.75 billion to Morgan Stanley.
The terms also stated that after three years, Morgan Stanley would have options to purchase additional interest in the JV from Citigroup. However, Citigroup would continue to hold a significant interest in the JV till 2014.
In January 2012, Morgan Stanley had submitted its capital plans to the Federal Reserve for the stress test that included buying of additional 14% stake in MSSB. This proposition of the company received the Fed’s approval during mid-March.
The announcement for stake buy comes at the time when both Morgan Stanley and Citigroup are facing ratings downgrade from Moody’s Investor Service, the rating arm of Moody's Corp. (MCO). Moody's is weighing a probable three-notch rating downgrade for Morgan Stanley while Citigroup faces a ratings downgrade of up to two notches.
In the first quarter, Morgan Stanley’s GWM Group, which includes MSSB, recorded net revenue of $3.4 billion, making it the largest revenue contributing segment. Further, the stake buy would also reduce the earnings volatility related to the company’s investment banking operations. For Citigroup, divesting its stake in MSSB is a step towards improving its capital ratios and concentrating on its core operations, especially after its capital plan was rejected by the Fed.
Currently, Morgan Stanley retains its Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we also maintain our long-term ‘Neutral’ recommendation on the stock.
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