Morgan Stanley's (MS 3.81%) acquisition of Eaton Vance (EV) is the bank's second big move of 2020, after it acquired E*Trade earlier in the year. Morgan Stanley has spent $20 billion combined on both deals as it looks to transition from a longtime investment banking powerhouse into a more diversified company with stronger earnings power in any kind of economy. Here are four things the Eaton Vance acquisition taught us about Morgan Stanley.
Image source: Morgan Stanley.
1. It's more than an investment bank
Morgan Stanley is one of the largest investment banks in the world. But it wants to be much more, and with the acquisition of Eaton Vance, you can't say the company is just an investment bank anymore.
Most large banks in today's regulatory environment see revenue diversity and creating a "fortress balance sheet" as necessities so they can perform well at all points of the economic cycle: expansion, recession, and calmer periods. Morgan Stanley actually had its best earnings quarter ever in the second quarter of this year, reporting a nearly $3.2 billion profit. That's because investment banking has shined this year as a result of lots of trading activity in the volatile markets, and because the bank has underwritten many initial public offerings.
But Morgan Stanley CEO James Gorman has long been working to transition the company so it can perform as competitively as possible without having to rely too heavily on its institutional securities division, which encompasses investment banking and sales and trading. This process really began in 2013 when Morgan Stanley purchased all of Smith Barney from Citigroup. In 2019, the bank's institutional securities business made up 49% of the bank's total annual revenue. With the acquisition of Eaton Vance and E*Trade, Morgan Stanley expects to derive roughly 58% of its revenue from wealth and asset management on a pro forma basis, and will have $4.4 trillion of assets under management.
Image source: Morgan Stanley investor presentation.
2. Morgan Stanley wants to be rerated
The E*Trade and Eaton Vance acquisitions have essentially transformed Morgan Stanley, and now Gorman wants a new stock price and valuation to go with it.
Gorman believes investors are looking at Morgan Stanley the wrong way. On a conference call Oct. 8 discussing the acquisition, he pointed out that while Charles Schwab, one of the company's most direct competitors, was trading at around 20 times earnings, Morgan Stanley was only valued at 10 times earnings, as if it was purely a trading business. But that's clearly not the case anymore. If Morgan Stanley, could trade at 14 times or 15 times earnings, he said, the stock would go for $100 per share (it closed Monday at $50.74). "It makes absolutely no sense," he said. "There will be a rerating of this stock. I hope it happens in my career, let alone in my lifetime. I know its happening now."
3. The deal is about revenue synergies
These days, a lot of acquisitions in the financials sector are about cost synergies, or cutting expenses. Morgan Stanley expects to save $150 million in expenses, or roughly 4% of combined expenses at Eaton Vance and the investment management division of Morgan Stanley. But as one analyst pointed out on the earnings call, this is toward the lower end because most deals in the space have been realizing cost savings between 6% and 14%. Morgan Stanley executives, however, say the Eaton Vance deal is all about strategy and growth. The plan is not to change the way anyone at Eaton Vance operates -- or even their compensation structure -- but rather to feed off each other's strengths. The companies have very little product overlap. Rather, the plan is for Eaton Vance to capitalize on Morgan Stanley's international distribution channels and Morgan Stanley to capitalize on Eaton Vance's domestic distribution to cross-sell.
4. Customization is the future
One word Morgan Stanley executives used a lot on the conference call when talking about asset management was "customization." One of the subsidiaries that comes with Eaton Vance is Parametrics, a company that provides customer portfolio solutions. It gives clients the power to tailor their investment exposure. So, a client could have the power to customize their investment strategy around taxable solutions, a single stock, a group of stocks, or a theme such as environmental, social, and governance (ESG) investing. And Morgan Stanley execs think this kind of product, the personalized and separately managed account, is going to be more in demand than the mutual fund vehicle going forward. Eaton Vance CEO Tom Faust said on the conference call that he thinks "custom indexing was in second inning of development."
