Analysis: Morgan Stanley’s Smith Barney experiment at a boil

By Joseph A. Giannone

NEW YORK (Reuters) – Almost two years into its Smith Barney takeover, Morgan Stanley is still wrestling with how to absorb a rival brokerage without alienating the money-making advisers who are key to its revival.

James Gorman, a former McKinsey consultant and Morgan Stanley’s chief executive, is the only major Wall Street leader to stake so much of his firm’s future on selling investments and financial advice to wealthy individuals and families.

Morgan Stanley doubled the size of its brokerage business by merging with Citigroup’s Smith Barney in June 2009, paying $2.7 billion for a 51 percent stake and the right to own the whole venture by 2014. It’s a bet that brokerage and a still-mending asset management unit will stabilize a firm built on volatile investment banking and trading.

The strategy made sense after massive mortgage trading-related losses in 2008 sapped investors’ confidence in Morgan Stanley. Gorman, who ran Merrill Lynch’s retail brokerage business for five years, is now at a crucial turn in executing his vision.

Morgan Stanley pursued Smith Barney for its loyal sales force — a former Morgan Stanley executive says they were the hardest brokers to recruit — and their drive for selling packaged investment products that generate steady fees.

Now Morgan Stanley Smith Barney is weighing a branding change that risks offending those brokers. The company recently polled clients about a new name for the division, and none includes Smith Barney, according to a Dow Jones report.

“For some, it may be the last straw,” said Jerry Eberhardt, a 40-year Smith Barney veteran who left in 2009 as head of its western division.

Spokespeople at Morgan Stanley declined to comment on the branding issue or make executives available.


A branding change would follow substantive changes Morgan Stanley has already made in the individual investor business.

It said in January that Charles Johnston, the former Smith Barney boss who kept the president’s title at the joint venture, will retire this year at age 57. He’s been replaced by Greg Fleming, a 47-year-old former investment banker who Gorman recruited in late 2009 to oversee Morgan Stanley’s investment management business.

The pair were colleagues at Merrill, where Fleming focused on financial service firm mergers and for a short time served as president before the company’s sale to Bank of America Corp in 2009. He has never managed a retail brokerage business.

His challenge now is to keep an eye over two divisions, with his wealth management focus on lifting productivity among the firm’s 18,000 brokers. Morgan Stanley has about 2,500 more advisers and $100 billion more client assets than archrival Merrill Lynch, but lags it in revenue and productivity.


He also has to execute Gorman’s promise to wrench significant savings from the merger by consolidating technology and closing overlapping branches. That’s led to the departure of scores of branch managers, primarily from Smith Barney.

Gorman has told investors he expects wealth management to produce profit margins of more than 20 percent, a significant jump over last year’s 9 percent result. He did not give a timeframe for his goal.

As the world’s largest retail broker, Morgan Stanley remains formidable. It generated nearly $13 billion of revenue and 40 percent of Morgan Stanley’s total income in 2010.

Its brokers generated nearly $15 billion of net new U.S. assets in the second half of 2010, almost reversing outflows of $19 billion in the joint venture’s first five quarters.

The company also appears to be stemming unwanted defections by Smith Barney brokers, more than 2,000 of whom left between announcement of the joint venture and closing of the deal.


Progress may slow this quarter, however. Richard Staite, an analyst at Atlantic Equities, estimates that wealth management profit in the current quarter is off about 10 percent from the previous three months while profit margin likely edged up to a still low 12 percent.

The retail push hasn’t engaged investors. Shares of Morgan Stanley have climbed 27 percent since the deal closed, but trade at a discount to book value and lag the 53 percent advance by Goldman Sachs Group Inc. in that time period.

Gorman has long preached that execution will be the key to the merger’s success. Consolidating technology platforms and cutting overhead costs will generate $1.1 billion of savings, he promised, but some advisers see delays in the key work of integrating the two firms’brokerage platforms.

“They have big execution issues, and they’ve given no timeframe for achieving their profit margin target,” said Michael Mayo, an analyst at Credit Agricole Securities. “We feel that progress is likely, but the jury remains out on the degree of improvement.”

Christine Pollak, a Morgan Stanley spokeswoman, said integration is on plan, and insisted that platform efficiencies “will continue to attract the industry’s most accomplished financial advisers.” She declined further comment.

The rebranding decision, meanwhile, looms over a firm that knows it can have significant consequences.

Brad Hintz, an analyst at Sanford Bernstein, said Morgan Stanley’s former reputation as a valuable adviser to very wealthy individuals was damaged irreparably when Morgan Stanley merged with the downscale Dean Witter in 1997.

“The cachet was gone and Morgan Stanley’s high-net-worth business has never recovered from becoming a Sears,” he said in an email, referring to Dean Witter’s former owner.

What’s more crucial than keeping Smith Barney on the door, others say, is keeping advisers focused on results.

“Gorman is a smart guy, but ultimately good advisers come to work every day to arbitrage the firm for the good of the client,” said Thomas Matthews, chief executive of Smith Barney from 2002 until he retired in 2004.

(Reporting by Joseph A. Giannone, editing by Jed Horowitz)

Analysis: Morgan Stanley’s Smith Barney experiment at a boil