Thursday, April 21, 2005

And the Winner is…..Not Phillip Purcell

White-shoe investment bank Morgan Stanley and its CEO Phillip Purcell have made headlines recently due to the public campaign of a group of shareholders whose mission is to force out Purcell. Calling themselves the “grumpy old men”, these former Morgan Stanley investment bankers claim that Purcell is aloof with employees and simply not maximizing shareholder value. Since they have made their campaign public, several top employees from the institutional side of the business have left or been fired. Vikram
Pandit, former president of Institutional Securities, and Joseph Perella, a top investment banker, are no longer working at Morgan. This campaign, however, is about much more than disgruntled ex-employees and their former boss. The main issue at hand is the lack of a defined business culture since Dean Witter acquired Morgan Stanley, and the strategic moves that are required to maximize shareholder value.

One of the most prominent investment banks, Morgan Stanley ranks No 1 in stock underwriting, and No 2 in global securities underwriting, it also advised on 7 of 10 of the biggest takeovers in the world this year. Clearly, Morgan Stanley knows how to get business. Despite these revenues, they are not growing profits. Morgan Stanley’s five year earnings growth is -2.1%, while its peers at Goldman Sachs grew earnings 7.7% and Citigroup grew earnings 11.1% during the same period. Why aren’t they making money? “Costs” say most analysts. Jennifer Chien, analyst at PNC Advisors, says Morgan Stanley has a “bloated cost structure”. More specifically, Morgan’s revenue per broker, at $462,000 is well below peers’ Merrill Lynch, $740,000, and Citigroup, $540,000. One might conclude that a possible solution would be to cut the least efficient brokers and their associated costs. This is exactly what Phillip Purcell seems unwilling to do.

In 1997 Dean Witter merged with Morgan Stanley and brought Dean Witter’s legion of retail brokers together with Morgan Stanley’s elite investment bankers. Mr. Purcell was the head of Dean Witter and became CEO of the combined Morgan Stanley Dean Witter. He has protected the brokers he brought with him, and consolidated power brilliantly around former Dean Witter executives. After 8 years, many insiders feel that the two firms haven’t been blended well and that the firm lacks a clear vision of what market niche it should occupy. This is a primary complaint of the “grumpy old men” who feel the company hasn’t formed a blended culture. They want to divest from Discover credit card and many retail services associated with Dean Witter in order to concentrate on the upscale institutional securities sector which brought in 54% of the revenue and 62% of the profits last year. This approach would position Morgan Stanley as a boutique bank, like Goldman Sachs, who has grown profits much faster than Morgan over the past five years. Purcell has recently agreed to spin-off Discover credit card to existing shareholders, possibly as a sign of appeasement. Another possible business approach mentioned would be to emulate Citigroup and its financial supermarket structure. This would entail selling everything from credit cards to merger advice, in an attempt to gain synergies from cross-selling and cost savings as a one-stop shop. Morgan Stanley management considered such an idea through a merger with Wachovia or Bank of America at a meeting last summer, however, Purcell’s team decided to grow internally and not pursue a merger.

Becoming a financial supermarket simply doesn’t seem like a viable option for Morgan Stanley. They already have a bloated cost structure and many inefficient brokers. The individual investor group has some of the lowest margins at the firm, at around 8%. This is substantially lower than institutional securities which are near 30%. Morgan Stanley has not shown the ability to properly blend the cultures of the two firms and there is a clear distinction between Morgan Stanley employees and Dean Witter employees eight years after the merger. If management can’t blend cultures in an eight year-old merger, there is no reason to believe it will be able to successfully do so for what could be an even bigger merger with a prominent commercial bank. And if they can’t blend cultures in a new merger, it seems unlikely that they will be able to achieve the synergies and cost savings associated with the financial supermarket model, thus negating the purpose of model.

Adopting the financial boutique model seems a much better option for Morgan Stanley. Already very prominent in equities underwriting, mergers, as well as the growing commodity business, Morgan wouldn’t have to grow these businesses as they are a proven entity. They should spin retail and credit card services (already planned) to current investors and let them decide the value of the new companies. Analysts sometimes claim that the steady cash flows of retail business add to stock valuation over the uncertainty of a boutiques trading desk. Morgan already has a similar P/E ratio to Goldman Sachs of 10-12, so it is not seeing this benefit from its retail business. Valuations would probably improve as investors have a clearer idea of the business model.

Whatever path the firm takes, Phillip Purcell is in a very unenviable position. He doesn’t want to call the merger a failure or eliminate Dean Witter employees. Thus, he probably won’t follow the boutique strategy. Whatever changes he does make will look like they were forced on him by others. One positive for Mr. Purcell, the board seems unlikely to find a different CEO who will make these changes. The board is dominated by the CEO’s former colleagues and he has consolidated power very intelligently since the beginning of his tenure as CEO. They are squarely in his camp.

If Mr. Purcell doesn’t make changes quickly the departures of top institutional money makers will continue. He won’t have the personnel to pursue a viable boutique strategy and may have no choice but to ‘go big’ and become a financial supermarket. If he doesn’t move fast, all he will have left are a lot of brokers who aren’t making a lot of money.

Lorena Kurtjian

Jason Oberheide

James Quinn


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