Morgan Stanley, Citigroup agree to extension to deadline for brokerage evaluation
Lauren Tara LaCapra
Morgan Stanley and Citigroup have agreed to give an arbitrator additional time to evaluate the price tag for their Morgan Stanley Smith Barney brokerage joint venture, the banks said on Tuesday.
The extension of about a week was granted because the original August 30 deadline did not provide the arbitrator, Perella Weinberg Partners, enough time to perform a complete analysis of the business, a source familiar with the matter said.
The original timeline -- set when Citi and Morgan Stanley agreed to combine their retail brokerage businesses back in 2009 -- also runs up against a holiday weekend in the US and likely would have left all three parties scrambling to file appropriate paperwork late on Friday evening, said the source, who spoke on condition of anonymity.
Morgan Stanley and Citi were forced to call in an arbitrator in July after they were unable to agree on a price for Morgan Stanley to buy another 15 per cent stake in the business.
Morgan Stanley now owns 51 per cent of Morgan Stanley Smith Barney and has operating control, but has the option to buy the business in full in three smaller portions through 2014.
Under terms of their joint venture agreement, the banks are supposed to value Morgan Stanley Smith Barney using factors like operating profit, assets under management and the stock prices of other brokerage firms.
But the two banks’ valuations were still wide apart, with Morgan Stanley offering a bid that would value the overall business at US$9 billion -- less than half of the roughly US3 billion valuation that Citi had assigned to Morgan Stanley Smith Barney.
The argument for a higher valuation relies on the size and long-term earnings potential of the business: Morgan Stanley Smith Barney is the largest US brokerage business, with nearly 17,000 advisers and US$1.71 trillion in assets under management at June 30.
On the other hand, the business has failed to reach profit targets set by Morgan Stanley management, even after the target was lowered, due to low interest rates, weak trading activity and a costly merger process.
Some of those issues -- including merger expenses -- are expected to fade away soon, but stock-market prices of competing brokerage firms suggest that investors view the long-term profit potential as dim.
Because Morgan Stanley and Citi could not settle the valuation dispute on their own, they were required to call an independent party to settle the matter in an unusual arbitration process set out by the original terms of their agreement.
If Perella Weinberg comes up with a figure in the middle third of the two banks’ values, its valuation will hold. In that scenario, both banks would have to give a little: Citi would likely have to take a noncash writedown on the business, and Morgan Stanley would have to pay more than its initial bid.
But if Perella Weinberg’s value falls within the lowest third or highest third of the range, the price is set at half-way between that value and the value of the winning appraisal -- leaving both banks at risk for being excessive with their valuation figures.
The structure was meant to encourage both parties to come to a similar valuation or meet in the middle, but it did not work out that way.
The result has left Morgan Stanley in the uncomfortable position of placing a low value on a business that management is betting the company’s future on, since analysts generally hew toward a higher valuation. Citi is also at risk of embarrassment and a potentially hefty accounting charge.
Perella Weinberg Partners was expected to finish its analysis by the end of August, and the banks said they expected the transaction to close by September 7. The evaluation and payment period has been extended to September 10.