Morgan Stanley Acquires E-Trade

In this episode of Market Foolery, Chris Hill and Bill Barker talk about Morgan Stanley (MS 0.44%) buying E*Trade (ETFC). Domino's (DPZ -1.68%) continues to perform well and posted strong Q4 results. And after months of speculation of a possible spin-off, L Brands (BBWI 0.30%) sells the controlling stake of Victoria's Secret.

Also, this weekend is the 40th anniversary of the Miracle on Ice, when the American hockey team beat the former USSR in the 1980 Olympics. Bill Barker was there, and he shares his story.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Feb. 20, 2020.

Chris Hill: It's Thursday, February 20. Welcome to Market Foolery. I'm Chris Hill. With me in studio: Mr. Bill Barker. Thanks for being here.

Bill Barker: Thanks for having me.

Hill: The news fairy showed up. The news fairy was busy this morning. And we'll get to Domino's earnings, and holy cow! was that impressive. But let's start with the big deal of the day, and that is Morgan Stanley buying E*Trade. This is an all-stock deal; it is valued at $13 billion. And this shouldn't be super surprising, I guess, when you think about the ripple effects of last year, when Schwab said, "Yeah, we're going to cut our trading commissions to zero." And cut to however many months later, and E*Trade is, like, "Yeah, we'll let ourselves be acquired for that price."

Barker: Yeah, E*Trade has grown into a large company with plenty of money in it, and plenty of assets and accounts, but having really built its model around "take control of your finances by trading stocks." And you know that portion of the business being making money off of every single one of those trades gone, they needed a new business model to marry up to, and they found one.

Hill: I was a little surprised to see, right at the open this morning, shares of Morgan Stanley were down 4%, 5%. I just, in my limited analysis I thought, I'm not sure -- that's not a huge drop. And it has come back up from there, I think, right before we walked in the studio, I checked, it was like maybe only down 1.5%, but it seems like a good deal for Morgan Stanley. They think they can get $0.5 billion out of "synergies" over the next three years. And the resulting firm is going to have $3 trillion worth of assets. I mean, their ability to sort of use the deposits within E*Trade to help fund their lending operation. I don't know, it seems like a good deal for Morgan Stanley.

Barker: All right, well, up until recently the standard movement of stocks on an acquisition would be: the acquiring company went down and the acquired company went up. So I think that's one thing to remember is, that an acquirer having its stock go down is not all that unusual. And I think the implication from the market's initial reaction -- which, as you pointed out, might be more muted as the day goes along -- is that this was an acquisition of assets but maybe you paid more than you had to. It's not a jaw-dropping price, but I think Goldman Sachs has come out and sort of promoted themselves by saying that they built their own funnel of similar assets for Marcus, and that maybe Morgan Stanley is overpaying compared to what the market rate is for the pile of assets and a business and a platform as well that comes along with those assets.

But really the value seems to be that, whereas E*Trade, people fund their accounts, they leave a certain amount of money in cash and E*Trade pays them pretty little for that and invest that into largely mortgage-backed securities. And now that spread, which is pretty tight and going to remain tight in a low-interest-rate environment, they can bring that over to Morgan Stanley who need assets, because they like to lend to richer people that will end up paying a little bit more and are borrowing the money with a little bit more risk than the more mortgage-backed security market that E*Trade was getting all of its revenues from: basically the float, the spread on that.

Hill: You're absolutely right.

Barker: Thank you. Next topic. [laughs] Let's end that. There was a first.

Hill: No. I was going to say, you're absolutely right that all things being equal, the average deal of two public companies, the acquiring company, their stock drops a little bit. I was surprised at the amount that it had dropped, but you're right, no one should be surprised that it dropped a little bit. By the same token, no one should be surprised that Goldman Sachs -- a direct competitor of Morgan Stanley -- came out and said, "We think you overpaid for that, and by the way, here's our thing which we built ourselves." I mean, no disrespect to Goldman Sachs, but if they think that Marcus has better visibility and name identification than E*Trade, they're fooling themselves.

Barker: Well, there's about $50 billion in Marcus, according to what I've read, and so that's a little bit more than E*Trade. Okay, E*Trade has got the name recognition, it's got the brand, but people associate it with stock trading, which is now free. So where the brand goes is going to be interesting. Once upon a time, it was scaled around commercials of babies trading stocks.

Hill: [laughs] That's true.

Barker: For those that remember the "E*Trade baby" that was a focus of the company for years.

Hill: And a good advertising campaign. You just reminded me, the CEO from Morgan Stanley was being interviewed on CNBC this morning, and he was asked, "When did you first start having these conversations with E*Trade?" And he said, "Well, to be perfectly honest, back in 2002, when I was at Merrill Lynch." And I was impressed, and at that point, I just stopped listening to what he said because I was reminded like, "Oh, right, Merrill Lynch, that was a brand that used to exist." You know, to your point about E*Trade, we'll see where --

Barker: The brand still exists. Merrill Lynch. The brand exists.

Hill: I'm pretty sure BofA (Bank of America) is methodically eliminating the Merrill Lynch brand.

Barker: I'm just saying it exists. [laughs] There are Merrill Lynch accounts and billions of dollars there. Now, one of the reasons for that may be that you've got a generation that trusts the name Merrill, not that you're trying to draw new assets in, necessarily, under that, but you're not going to eliminate that brand as quickly as you might think, because there are piles of money there that are maybe not paying close attention but like the association that they have with that brand.

Hill: I don't think it's going away quickly; I just think it's going away. [laughs] And the evidence points to the fact that it's going away.

Let's move on to Domino's Pizza. Shares are up 25% this morning after a really strong fourth quarter report. Domino's same-store sales were up 3.4%; that's not a lot, but that is a good percentage point more than Wall Street was expecting. The last time Domino's Pizza had negative same-store sales, it was the spring of 2011. This thing has just been a machine for the past decade.

Barker: It's been a machine. It's taken a little breather as a stock about the last year and a half, but the bear case kind of crumbled today. And I was reading a fairly brave, I would say, Deutsche Bank report from back in December where the analyst had covered Domino's with a sell rating, which is pretty rare, and then the stock was about $290, they had a price target of $208. It's having a pretty tough day today, two months later, seeing the stock at $360. But the case, and as I say, fairly brave, they set out their rationale was that the comps would continue to decelerate, even though they'd had positive comps, the numbers were trending in the wrong way. And I think that today's announcement with a reiteration of the guidance for the next two years really has undermined that, obviously, that the stock is reacting that way. And I think a lot of people are probably covering short positions, because the performance today was not that out of line -- not 24% out of line with expectations. I think this is going to be a slightly short-fueled rally; short-covering fueled.

Hill: Rich Allison has been CEO for less than two years; he took over the summer of 2018 for Patrick Doyle. You like to say from time to time that one of the great things in life -- maybe the greatest thing in life -- is having an easy act to follow. Rich Allison had a really tough act to follow. And so far, he's doing pretty darn well following Patrick Doyle.

Barker: Yeah. Okay, there have been a few challenges recently with the expansion of other food delivery services and a lot of price-cutting and competition to try to get the food delivered for the lowest price possible and cut into the pizza business. I think there were some questions about whether that would be successful. Those questions today seem to be answered by pizza still having the largest and strongest share of the delivery food market. And so I think that some of the questions that have been out there have been answered today. Domino's has really been doing a phenomenal job of getting out there online, being in front of the competition and just having better metrics about its customers than the competition.

Hill: It really shows the value of the investments Domino's has made over the past decade in technology in its mobile ordering system. Also, Uber Eats is not its own separate company, DoorDash is not a public company, but if you are looking at DoorDash and the Uber Eats division of Uber and predicting great success for them, just know that on some small level, you're betting against pizza. And in America, historically, that hasn't been a bet that has paid off. Pizza, still really popular here in America.

Barker: No, nobody has ever made a fortune betting against pizza; [laughs] just the opposite. So they're continuing to grow. And to go back to the pain being felt by these Deutsche Bank analysts today, the sort of the thesis was, "Okay, the declining increased comps are going to result in a slowing down of the store count increase." And that is just not happening. You're seeing 500 openings over the last quarter globally, so that's about 130, 146 U.S., 380 around the rest of the globe... 500, a couple closed, but a net increase of almost 500, giving them 17,000 stores around the world. That's not McDonald's, but, boy! They're growing. They're growing at a healthy clip.

Hill: You used the word "brave" to describe the analyst note from the people at Deutsche Bank. Do you suppose the colleagues of -- and I don't know who wrote this report, but do you think -- I'm just going to assume it was a guy who wrote the report, just because the math suggests that there are -- doesn't even suggests, the math is that there are way more male analysts than female analysts, but do you suppose, like, like, "Chad, wow! what a brave call on your part."

Barker: Yeah, I don't want to compare the bravery here to say that of firefighters or police officers, the first responders, military --

Hill: No, we're not doing that, we're just saying in the context of analysts notes --

Barker: [laughs] In the extremely warped sense that one can be brave in the financial profession of Wall Street, this counts, because the path of least resistance is to issue buy reports, and the second-least-resistant path is a hold. And there are forces working against you not just of looking foolish when you're out there on your own and you've issued to sell, but investment banking interest that you're also jeopardizing when you issue a sell. Now, there's supposed to be a Chinese wall between the analysts and the investment bankers and -- you know, maybe there is, maybe there isn't. But today, that bravery is not translating into rewards. So I think that that will be another reason why the future analyst will continue to hug the buy and the hold as their top two choices by far.

Hill: I guarantee you that no one at Deutsche Bank is going by Chad's desk today and calling him brave. They're just walking by and they're like, "Thanks, Chad."

One quick thing before we move on to L Brands and the mystery that it continues to be L Brands.

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L Brands is the parent company of Victoria's Secret, Bath & Body Works and PINK. And for months, we've seen this report that L Brands is going to spin off Victoria's Secret; they're just going to sell it off. This morning, we get this report that L Brands is not going to spin-off Victoria's Secret or sell it outright, but they're going to sell a controlling stake of it to Sycamore Partners, which is a private equity firm. What is this? [laughs] Like, whatever case could have been made for buying shares of L Brands in the past, it seems like that case is a lot more complicated, because now a private equity firm is going to have a controlling stake of one part.

Barker: So let's quote the press release to start with assessing how much sense it makes, and here's the finished part:

We believe that as a private company Victoria's Secret will be better able to focus on longer term results. We are pleased that by retaining a significant ownership stake our shareholders will have the ability to meaningfully participate in the upside potential of these iconic brands.

And preceding that is a discussion of the focus and of the fresh eyes that Sycamore Partners will bring to it. And I think that -- OK, try to make the bull case for why this makes sense and why this is something that shareholders should like --

Hill: And I'll just interrupt by saying, at the moment, based on what's happening with L Brands stock, it doesn't appear that investors like this. It was down at the open, it's basically flat right now. There's no rush from Wall Street to say, "Holy cow! do we love this?"

Barker: Yeah, I think they were looking for a better price. And I think that Victoria's Secret, which has, I think, around $7 billion in annual sales, nevertheless only is being valued at $1 billion, and that is just not much and sort of underscores the problems that this brand is facing. Part of the release was that the same-store sales for Victoria's Secret were down 10% in the fourth quarter. And the other brand that L Brands has is Bath & Body Works, and that was up 10%. So this is not entirely attributable to, "Oh, mall traffic," or what are you doing online -- they both have online operations. Bath & Body Works doing very well: 10% comps, that's awfully good. And you know, Victoria's Secret down 10%; they just have completely blown it on the fashion, and they need a fresh pair of eyes to take this, I think, still-valuable brand and make it profitable. And that maybe has to come through somebody -- Sycamore has bought a number of other brands in the retail space. And so they are focused on this, but it is clear that L Brands was bringing Victoria's Secret in the wrong direction.

Hill: To your point about Sycamore; yeah, you look at the brands they have in their portfolio Nine West, Stuart Weitzman, Aeropostale. Yeah, so I suppose that's part of the bull case as well. So, now if I'm buying shares of L Brands, is it much more driven by the belief that Bath & Body Works is going to continue to put up -- maybe not 10% comps quarter after quarter, but positive comps? Because now L Brands becomes much more about Bath & Body Works.

Barker: Yeah. Well, before, you were buying Bath & Body Works and Victoria's Secret/PINK, and now you're buying half -- 45%, let's call it half of Victoria's Secret and Bath & Body Works. So, yeah, your relative investment is mostly into Bath & Body Works. And if all goes according to plan, what might go well for Victoria's Secret is the ability to take this thing private, make the cuts that are going to be necessary, and just be able to do it with a focus on the long term and not have to explain every quarter, "Okay, you know, when are comps going to turn around?" and to have that pressure on you. It they can take a long-term view of this that the public ownership of Victoria's Secret was not allowing, according to this logic, then, yeah, I think there is value in the brand name, and they need somebody else to figure out how to unlock that value, because they're not doing it.

They can blame the public ownership structure, and that's certainly true to a degree that quarterly results and annual results and guidance factor into your stock price, and you're answering to your shareholders, but ultimately this is a serious management mistake.

Hill: Before we wrap up on L Brands, I did spend a minute on the Bath & Body Works website checking out the new candle scents. And something occurred to me, because we have some fun -- over the years, we've had some fun with the names of the scented candles at Bath & Body Works, but here are three of the new scents. Daydream, Endless Weekend, and Blueberry Pie. And when I saw those three, I thought, "Oh, you know what, we make fun of names like, well, Endless Weekend or Sweater Weather or that sort of thing, but if I pick up a candle and it says "Blueberry Pie," I have a very clear sense of what that is supposed to smell like, and if it doesn't smell like what I think blueberry pie is supposed to smell like, I'm not buying that candle. Whereas Endless Weekend -- like it I looked at that and I thought, "Oh, it's actually brilliant," the other is like "Oh, it's Endless Weekend," "What does that smell like?" "Yeah, what do you want it to smell like?" Anything. It's a Rorschach test. Like, you pick up a candle called Daydream, and you're like, "Oh, sure."

Barker: Well, I think they've skewed more toward the Blueberry Pies of the world, from what I can tell, then the Endless Weekends, but hey, there's a market for both.

Hill: There absolutely is.

This weekend marks the 40th anniversary of the Miracle on Ice.

Barker: By the way, if you look at the press release for L Brands, it now just does feature Bath & Body Works as the picture surrounding the press release online. There is no mention of Victoria's Secret.

Hill: That's smart. They're already talking their own book.

This weekend is the 40the anniversary of Miracle on Ice, the 1980 Olympics when the U.S. amateur hockey team pulled the massive upset, maybe the greatest upset in sports, beating the USSR. And you were there.

Barker: I was there, yes.

Hill: You were in the building for this. I, like anyone else who or like almost everyone else who watched this game, I was watching at home on tape delay on my black-and-white television. [laughs] But you saw it live. What memories do you have of that game? Because I know that whatever memories you have are going to be authentic, because for some reason -- well, probably because you were there, you still haven't seen Miracle, which is the really, really well-done Disney movie from 2004.

Barker: That is true. And I think, although this wasn't intentional, going forward, it probably is going to be intentional to not watch the movie. That is, I have the actual memories, as fragmented as they are, after 40 years, and if I watch Miracle, I will remember it differently. And I might remember it more accurately, but it just will be a different experience than the actual memories I have, which are great. I mean, it's up there, you know, with the best memories one could have of being a lifelong sports fan and also lifelong American. Those two worked out very well that day.

Hill: They did.

Barker: That was the day we defeated communism.

Hill: [laughs] So, if I'm doing the math correctly, I think you were in your early 20s. And I'm wondering at what point during --

Barker: I was 6 or somewhere between 6 and early 20s, who can recall?

Hill: Who can recall? At what point during the game did you think, "I think we're going to win this"? Or was it really one of those things -- because I remember watching it at home. Spoiler alert. The U.S. takes the lead in the third period and the last 10 minutes of the game is just on the edge of your seat, like, holy cow! Is this actually going to happen? And it was relentless.

Barker: Couple of things. 1. The reason I was there is that my parents have a place in the Adirondacks, not too far from Lake Placid. And all property owners were basically able to order, from what I can recall, virtually however many tickets they wanted, to whatever events they wanted, about a year and year and a half before the actual Olympics.

Hill: Back when the Olympics was a quaint little business.

Barker: Lake Placid was the only site that applied to host the Olympics in 1980.

Hill: Wait! The only site in America or the only site on planet earth?

Barker: Globally. It was a competition of one. And for those that have been to Lake Placid, it's a tiny place. And so the Olympics have become much bigger, the Winter Olympics, by separating from the Summer Olympics year, have become bigger by being on that staggered two-year delay for the Summer Olympics. And I don't think you could host the Winter Olympics in Lake Placid anymore; it's too big. And so for some reason, we had two blocks of tickets and I switched seats to -- I can't remember why this was necessary, but I was in one seat for the first period, another seat for the second period, and then back to my original seat for the third period. And that coincided with the way the teams switched sides of the ice. And so I was always on the side with the U.S. end goalie Jim Craig, which I was disappointed about when we were scoring the goals, and I had a better view, I was, like, sort of blue line-ish. But the entire last part of the game, from what I recall, happened down on the U.S. goal side of the ice.

So when did I first think we might win? I don't know, with about 5 seconds left. Because it looked like it was inevitable that Russia was going to -- or as they called themselves at the time, Soviet Union, not everybody remembers that -- that just seemed inevitable that they were going to score five goals. Given how good they were and how relentless and how many shots on goal there seem to be.

Hill: And also the fact that not only had they, months earlier, played a team of professional all-stars from the United States and just destroyed them, they also played an exhibition game against the same U.S. amateur team right before the Olympics in Madison Square Garden and beat them, like, I don't know, 10 to 1 something like that, like, it wasn't even close.

Barker: Yeah. It was the first time that I can remember hearing the chant "U-S-A, U-S-A." I don't remember probably ever being at a sporting event where I was watching a U.S. team -- I was at other events for the Olympics and there weren't "U-S-A" chants for, you know, the U.S. downhill skier or anything like that --

Hill: The luge.

Barker: The luge. And if you're ever at the Winter Olympics, don't go to the bobsled or the luge; you see about a tenth-of-a-second of action and then you stand around freezing in the cold the rest of the time. You can't see -- I mean you would much rather watch that on TV than live.

Hill: The ski jump has got to be pretty good, though, live, wouldn't it?

Barker: Yeah, still cold, but, yes, you see the whole jump. You can't see the whole bobsled run or the whole luge run; that's the nature of the course.

Hill: It's the Winter Olympics; you know what you're signing up for with the cold. So you don't get to complain about -- if ever you're in a conversation with someone, and they're like, "I went to the Winter Olympics." And if they start complaining about the cold, you're legally allowed to slap.

Barker: All right. So, I remember the temperatures -- and you're from Maine, so you can tell me whether this is right or not -- as being in the -20s for that week. I mean, you grew up at or near the North Pole. Like, were those temperatures ones that you ever had: -20, -30?

Hill: Yeah. But I want to be very careful about this. You said, "That's what you remember," was that the actual temperature?

Barker: I believe it was in the -30s, but I pare it back, because it seems to me now, like, that can't be true. That isn't that like zero Kelvin, like can it get that cold? And you, being from Maine, this is why I'm turning to you -- what's the coldest you can remember it being?

Hill: Yeah, 30 below. Yeah, I remember a couple of times -- when I was a kid -- where it was 30 below and it was like "No, no, no it's really, like, don't spend a lot of time outside, it's really cold out there."

Barker: Yeah. So that's where -- you know, you could look it up, but I remember it being -30.

Hill: Oh, I'm absolutely going to look this up. [laughs] Not right now, because we got to get out of here, because we're well past the point of investing.

Bill Barker, thanks for being here.

Barker: Thank you.

Hill: Thanks for listening. Again, check out our free investing starter kit. Just go to fool.com/starterkit. I'll include the link in the description of the show.

As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

That's going to do it for this edition of Market Foolery. The show is mixed by Dan Boyd. I'm Chris Hill, thanks for listening. We'll see you next week.