By Harvey George, Chiara Fulvi, Jonathan Fuchs (London School of Economics), Marcus Falck, and Elsa Henriksson (Stockholm School of Economics) | 08/03/2020
Overview of the deal
Acquirer: Morgan Stanley
Estimated value: $13 billion
Announcement date: 20/02/2020
Acquirer Advisors: Morgan Stanley
Target Advisors: JP Morgan
Morgan Stanley announced that it will merge its full-service, financial-advisor-driven business model with E-Trade’s digital brokerage and banking business in an all-stock transaction valued at approximately $13 billion. Under the terms of the agreement, E-Trade stockholders will receive 1.0432 Morgan Stanley shares for each E-Trade share, which represents per share consideration of $58.74 based on the closing price of Morgan Stanley common stock on February 19, 2020. The purchase, which is the biggest takeover by a U.S. bank since the 2008 financial crisis, underpins the trend among U.S. investment banks to claim a larger piece of the wealth management and consumer-facing services space, partly due to the lower cyclicality of the sector. Morgan Stanley will be better positioned to generate attractive financial returns through increased scale, improved efficiency, higher margins, stronger returns on tangible common equity, and long-term earnings accretion.
“E-Trade’s products, innovation in technology, and established brand will help position Morgan Stanley as a top player across all three channels: Financial Advisory, Self-Directed, and Workplace” - James Gorman, Chairman and CEO of Morgan Stanley
Company Details (Acquirer - Morgan Stanley)
Morgan Stanley is a fully integrated, multinational investment bank and financial services company, headquartered in Manhattan. Founded in 1935 as a result of the Glass-Steagall Act, which required the division of investment banking, it now serves clients in over 42 countries. Having historically served as an advisor to the corporations and the ultra wealthy, Morgan Stanley is now attempting to diversify its customer base into Main Street.
- Founded in: 1935
- CEO: James P. Gorman
- Number of employees: 60,300
- Market Cap: $69.00bn - EV: NM
- LTM Revenue: $41.42bn - LTM EBITDA: NM
- LTM EV/Revenue: NM - LTM EV/EBITDA: NM
Company Details (Target - E-Trade)
E-Trade is a listed U.S.-based company located in Arlington, Virginia, United States, engaged in providing financial services including trading, investing, banking and lending for retail and institutional customers. E-Trade has over 5.2m client accounts with over USD 360bn of retail client assets.
- Founded in 1982
- CEO: Michael A. Pizzi
- Number of employees: 4,300
- Market Cap: $10.21bn - EV: NM
- LTM Revenue: $2.88bn - LTM EBITDA: NM
- LTM EV/Revenue: NM - LTM EV/EBITDA: NM
Projections and Assumptions
The key short term benefit of the deal is that the combined platforms will have $3.1Tn client assets, 8.2MM retail client relationships and accounts, and 4.6MM stock plan participants, which will enable the combined business to have best-in-class product and service offerings to support the full spectrum of wealth. The transaction is expected to increase Morgan Stanley’s return on tangible common equity by more than 100bps with fully phased-in synergies, improve the wealth management division’s pre-tax profit margin to over 30%, and drive significant revenue opportunities due to enhanced technology and service capabilities. Upon integration, the new combined wealth and investment management businesses will contribute 57% of the firm’s pre-tax profits, excluding potential synergies, compared to only 26% in 2010. This marks a successful milestone in Morgan Stanley’s journey to rebalance their business such that a greater percentage of revenues are derived from ‘balance sheet light’ sources of revenues.
For shareholders, significant cost and financial synergies promise to result in value creation. Shareholders from both companies will benefit from estimated total cost savings of $400 million, as a result of combining the bank entities, optimizing the shared corporate services and maximizing the efficiency. Moreover, shareholders will benefit from financial synergies of $150 million.
A direct operational consequence will be that Mike Pizzi, CEO of E-trade will be joining Morgan Stanley, continuing to run the E-trade business within the Morgan Stanley franchise and lead the ongoing integration effort.
Long Term Upsides
Morgan Stanley’s acquisition of E-Trade exemplifies the industry’s current path of consolidation, which was sparked after Charles Schwab initiated the ‘race to zero’ among discount brokers. This consolidation is expected to persist as the convergence of technology in the wealth management business leads to swifter and more efficient innovation.
In the long term, the deal will position Morgan Stanley as an industry leader across all segments of wealth management, shifting its focus away from ultra-high net worth individuals and expanding into a more diversified client base. Providing a brokerage platform accessible directly to main street consumers will allow Morgan Stanley to tap into the world of direct-to-consumer financial services. This will provide a durable and steady revenue stream, partly hedging the volatility of revenues from institutional trading.
The deal marks an important step in Morgan Stanley’s shift from the sell side to the retail side, and opens up many possibilities for the firm to strengthen its offering to this newly acquired consumer segment. The deal also presents opportunities for further expansion, as clients acquired through E-Trade have the potential to become full-fee paying brokerage clients as their wealth grows over time.
Risks and Uncertainties
Regulation presents itself as the main risk Morgan Stanley faces in this transaction. As a result of the Dodd-Frank Act passed by the Obama administration, regulators have become wary of bulge bracket banks attempting to gain market power through acquisitions. The act aims to prevent financial institutions from becoming “too big to fail” and ex Fed governor Daniel Tarullo explained that regulators will assess whether “the merged company is more likely to run into trouble and whether such a stumble would cause broader problems”.
Furthermore, E-Trade may face competition from other brokers, especially Robinhood. E-Trade still requires a minimum deposit of $500, which may be too high in the eyes of inexperienced or young traders who want to start off with smaller trades. In addition, E-Trade has not yet adopted a $0 commission for all products policy, as Robinhood has.
The next large hurdle is whether regulators will agree to the merger, and then subsequently attention will shift to whether E-Trade can defend its electronic trading market share.