The Dr. Jekyell and Mr. Hyde of Asset Managers

By Chad Henage - July 25, 2012 | Tickers: GS, JPM, NES.DL, STT | 0 Comments

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Having already looked at earnings reports from companies such as Goldman Sachs (NYSE: GS), JPMorgan Chase (NYSE: JPM), and State Street (NYSE: STT), I've been waiting to see what Morgan Stanley's (NYSE: MS) results would look like. Given that out of the four companies, Morgan Stanley sells at the least amount compared to its book value, I've suggested in the past that investors give serious consideration to this opportunity. After looking at the company's earnings report, my opinion has not changed.

While it's clear that Morgan Stanley has its challenges, I don't necessarily believe that the company should be valued at a tremendously lower multiple to book value versus its competition. From what I can see, the company essentially runs two huge divisions that determine its fate. One of its divisions, Institutional Services, is not doing well at all. However its other large division, Global Wealth Management, is putting up pretty decent numbers. Since these two divisions make up about 94% of Morgan Stanley's total revenue, let's take a look at what's going on with each half of the company.

The Bad Mr. Hyde:

There's no question that competitive pressure is hurting the Institutional Securities part of the business. Goldman Sachs for instance, has seen their more bond focused capabilities lead to trading services revenue up 11% in the most recent quarter. On the flip-side, asset managers like State Street, which specialize more in the equities market, saw the same measure drop by 18%. Morgan Stanley appears caught between a rock and a hard place as their trading services revenue dropped by over 38%. When one of your competitors does very well with debt instruments, and the other does very well with equities, it doesn't leave a lot of room for anyone else. Unlike in the past, Morgan Stanley doesn't just have to concern itself with traditional asset managers.

Large multinational banks such as JPMorgan Chase have also stepped up their offerings to compete in this field. In fact, JPMorgan outranks all 3 of their competitors in multiple categories. For instance, the bank ranks number one in global debt, equity, global long-term debt, and global investment banking fees. These are categories that would have been owned by either Goldman Sachs or Morgan Stanley in past years. In addition, it seems that JPMorgan is stealing asset management dollars from these other institutions. The company recently reported its 13^th consecutive quarter of positive net product flows.

However, with companies like State Street seeing assets under management drop 9%, Morgan Stanley is doing its part to move funds away from its competition. Though non-global asset management is not a huge area of focus for the company, Morgan Stanley did see over $13 billion in new assets in the last quarter alone. However, no amount of good news can offset the fact that the company's total revenue for this division dropped 37%, and pretax income plunged over 66%.

The Good Dr. Jekyell:

Even with all the negative numbers from Institutional Securities, Morgan Stanley managed to make a profit of over $500 million in the current quarter. The primary driver was the company's Global Wealth Management unit. Specifically, the company ranks number one in global IPOs, number two in global announced M&A, and number three in global equity. While the division's total revenues were down 4%, pretax income improved almost 24%. In addition, pretax margin increased to 12% versus 9% a year ago. The company's asset management fee revenue increased 5.56% as well. To get an idea of the size of Morgan Stanley's capabilities in the global arena, consider that total client assets were $1.7 trillion, and of this over $500 billion were in fee-based accounts. You can see that for almost every negative in Institutional Securities, there is an offsetting positive in Global Wealth Management. Knowing how these two divisions offset each other, the only remaining question is, can Morgan Stanley be a good value for investors?

Still Looks Cheap To Me:

One of the primary measures that I would draw investors attention to is, Morgan Stanley's tangible book value per common share of $27.70. With the stock trading at around $12.89, this means investors are paying just 53% of book value. By comparison, all three of the company's competitors sell for at least 70% of book value. While Morgan Stanley's current earnings did register a 30% miss versus analyst expectations, even if the company missed analyst expectations by 30% in the future, full-year earnings would come in around $.85 per share. With this as a sort of worse case scenario, the shares would sell for a P/E ratio of about 15 and expected growth is over 17%. The company's competition is expected to grow earnings by 10% to 14% over the next few years.

The company has been shoring up its balance sheet as well. Long-term debt has dropped from over $218 billion just over a year ago, to a current balance of about $167 billion. In addition, most analyst following the company expect much better earnings in 2013. With the current EPS estimate for full year 2013 at $2.10 per share, the stock trades for just over 6 times next year's earnings. In my eyes, this is a number that is just too cheap to ignore. Use this information as the starting point for your research, and determine if Morgan Stanley really is Dr. Jekyell or Mr. Hyde.

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