ValueAct Capital Management, a $ 16 billion hedge fund with a penchant for high-profile turnaround stories, unveiled a $ 1.1 billion stake in Morgan Stanley on August 15 and, in a letter to the fund’s own investors, showed support for Gorman’s plan to move the bank away from risky activities like trading and into more stable areas like wealth management.
But if ValueAct CEO Jeffrey Ubben lauded the playbook, his view on the stock price shows there is more work to do on the execution of the plan. He said Morgan Stanley’s transformation hasn’t been well understood or valued by investors, and though he laid that blame at the feet of other investors, some still took it as subtle criticism of the firm’s salesmanship and a sign Gorman doesn’t have unlimited time to get the stock price rising.
“Should the company fall short of targets, we’d expect ValueAct to hold Morgan Stanley management accountable,” noted analysts with Keefe, Bruyette & Woods in a Tuesday note. Then, Ubben’s firm “may take a more activist role”.
While other activists often take aim at companies’ balance sheets, ValueAct is intently focused on senior management. Since its founding in 2000, it has joined boards of at least 16 companies that subsequently replaced their CEOs – on some occasions with input from ValueAct.
The firm often works behind the scenes with big investors to force change even at large companies. Before taking a stake in Microsoft in 2013, ValueAct privately rallied support for its agenda among Microsoft’s longer-term investors, The Wall Street Journal has reported. ValueAct executives told asset managers, for example, that they wanted a board seat at Microsoft and were prepared to take aim at then-CEO Steve Ballmer, who ValueAct believed had been slow to embrace new technologies. Ballmer eventually left as CEO.
It is unclear to what extent ValueAct has reached out to Morgan Stanley investors. And it doesn’t always shake up the corner office. Last year, it made a roughly $ 1 billion investment in American Express, only to sell it a few months later after it couldn’t come to terms with management on how to spur the company’s growth.
Activists have typically avoided big banks, partly because their ability to pay dividends and buy back stock – popular activist demands – is limited by the Federal Reserve. Mergers, which activists often encourage, have been effectively off limits for larger institutions since the crisis.
Gorman, a 58-year-old former McKinsey & Co. consultant who got the top Morgan Stanley job in 2010, made one of the bigger acquisitions since the financial crisis when he engineered Morgan Stanley’s multi-year purchase of Citigroup’s wealth management arm, Smith Barney.
He has “evolved the business mix more aggressively than any other large US bank. That’s a necessary but not sufficient recipe for success,” CLSA analyst Mike Mayo said. “Investors are getting ever more restless.”
ValueAct would support the bank expanding its wealth management business, if done by acquiring accounts that have sensible costs, one person familiar with the matter said.
The investor believes growth could come through technology expansion into lower-wealth accounts, organically growing the larger accounts or even acquisition, the person said.
Many banks have restructured in one way or another to become simpler and more stable due to new regulations and pressure from investors.
But shareholders haven’t had much to show for it. Five of the six biggest US banks have traded below their book value this year. Morgan Stanley’s stock price has trudged mostly sideways since 2009. Shares closed August 15 at $ 29.66, 13 cents below their close seven years ago. They rose 59 cents, or 2%, August 16 to $ 30.25.
Some things within Morgan Stanley’s control have improved. Its 2015 net income of $ 6.1 billion more than quadrupled its 2009 effort, while revenue rose about 50%.
Still, return on equity, a key profitability metric, has lagged far behind peers. In the fourth quarter of 2015, it was 4.4%, about the same level it hit at the end of 2009.
Wealth management accounted for 43% of Morgan Stanley’s revenue last year, up from 24% in 2007. The bank is pushing to squeeze higher profits from those clients, notably by opening up its checkbook for personal loans.
Its wealth management returns are almost freakishly steady. On 98% of days last year, the division booked between $ 50 million and $ 70 million in revenue, according to a recent investor presentation.
“Financials are really out of favour, and so the investor base is stuck looking backward and not looking forward given what has happened to Morgan Stanley’s business mix,” said Ricky Sandler, founder and CEO of Eminence Capital, a $ 6 billion hedge fund firm that took a new stake in Morgan Stanley last quarter.
Eminence has gone activist before – it launched a board fight at what was then Men’s Wearhouse in 2013 – but supports the management team and strategy at Morgan Stanley, which Sandler called “a healthy franchise getting healthier.”
Eminence owns about four million shares, Sandler said.
Ubben and ValueAct president G. Mason Morfit have said investors are undervaluing that stability and instead punishing the bank too harshly for weakness and inconsistent results in fixed-income trading, an important source of Wall Street profits.
Last quarter, after Morgan Stanley posted better-than-expected results for fixed income, Gorman said there was “a general overreaction to the underperformance” in the unit during the second half of 2015.
Its original foray into wealth management was rocky. Morgan Stanley bought Dean Witter in 1998, but the integration went poorly for the business and it was viewed as a second-tier player before Gorman was hired from Merrill Lynch to run it in 2006.
This article was published by The Wall Street Journal