deal to acquire
isn’t a steal. It still might prove to be a very good business decision.
The timing of the transaction is interesting: Morgan Stanley said it has been looking at this deal for several years, and Eaton Vance wasn’t trading at a huge discount to where it has been over that period of time—only 5% below its five-year average share price as of Wednesday.
But among things that have changed recently are some in Washington. For a long time running, an investor concern around Morgan Stanley was that the Federal Reserve’s shift to a new way of determining capital requirements would increase the bank’s required minimum. Instead, Morgan Stanley did relatively well in this year’s stress test, and its new requirements actually came in lower than many analysts had anticipated based on prior exams.
Meanwhile, Morgan Stanley and peers have halted share buybacks, initially by big banks’ own choice but now by Fed rules. The bank also has been generating capital through strong earnings across capital markets and investment management, bolstered by the Fed’s market interventions. The upshot is that the bank effectively has something like $10 billion in capital resources surplus to requirements.
James Gorman, Morgan Stanley’s chief executive, was quick to point out on a call with analysts that the bank’s decision to do the deal was based on a decade-plus strategic view, not just on recent capital developments. Still, even a key long-term rationale—bringing together Eaton Vance’s asset-management products and Morgan Stanley’s wealth-management distribution—is best served by acting now. Some of Morgan Stanley’s major wealth competitors are also banks, such as
Bank of America
Goldman Sachs Group,
with reasons to bolster their investment-management business at a tough time for more rate- and economy-sensitive banking activities.
At a roughly 40% premium to market value, Morgan Stanley isn’t getting Eaton Vance for nothing at $7 billion. It also isn’t anticipating a bonanza in the form of cost synergies—just a couple of percentage points. Asset management is a business that famously has trouble scaling its economics.
But using cash for this deal is still a potentially prudent way to utilize some of that capital cushion. Consider other options: Buybacks might be restricted or politically challenging for an uncertain period of time. Lending at rock-bottom rates isn’t terribly attractive and demand is low anyway. By contrast, asset management doesn’t add to the balance sheet and can reduce earnings volatility. Any future earnings accretion would come on top of that.
The deal will consume about one percentage point of Morgan Stanley’s excess capital, but the bank still expects to have a three-point surplus to the minimum. Given Morgan Stanley’s overall relatively limited credit-loss exposure and with even more revenue generated by the less-volatile investment-management business, the cushion remaining seems sufficient against future increases in capital minimums and still leaves room for buybacks and balance-sheet growth.
There are of course execution risks. Perhaps Morgan Stanley wealth customers around the world aren’t as interested in Eaton Vance’s Calvert ESG or quantitative Parametric products as anticipated. But that risk seems quite modest given the direction of investor appetites, and one well worth taking given other banking risks.
Investors are mostly being cautious, pushing Morgan Stanley shares up less than 1% on Thursday. Perhaps this reflects the dilution of the cash-and-stock deal. Coming on the heels of the closing of the E*Trade acquisition, though, this move only solidifies Morgan Stanley’s position as one of the better bets in banking.
Write to Telis Demos at [email protected]
Copyright ©2020 Dow Jones & Company, Inc. All Rights Reserved. 87990cbe856818d5eddac44c7b1cdeb8