February 21, 2020

Breakingviews: Morgan Stanley beats Goldman to E*Trade punch

by Breakingviews.

Morgan Stanley boss James Gorman has stolen a march on David Solomon at Goldman Sachs. His $13 billion all-share deal to buy online brokerage E*Trade Financial gives Morgan Stanley more stable revenue, higher returns and cheaper funding – in short, just what Solomon’s strategy is designed to achieve.

Gorman’s dive into retail brokerage comes just weeks after Solomon laid out his own grand plan. Part of that entails cutting the cost of funding by $1 billion, which in turn involves replacing expensive debt with customer deposits. Yet building a retail bank takes time. Goldman’s consumer deposits totaled $60 billion at the end of 2019. Morgan Stanley’s E*Trade deal would add almost that much in one go.

Then there’s diversification. Gorman already had a head start after branching into wealth management over a decade ago. Last year, volatile trading income made up around one-third of Morgan Stanley’s total revenue, compared with more than 40% at Goldman. Taking E*Trade’s revenue into account, Morgan Stanley’s reliance on trading would have been around 30%.

Buying a giant online broker isn’t without risk. For Morgan Stanley’s 15,000-plus financial advisers, it might feel like inviting cannibals in for dinner – after all, E*Trade and its rivals recently cut trading commissions to zero. But at least the price is reasonable. The $400 million of expected cost savings alone are worth just over $3 billion today, taxed and capitalized. That neatly covers the $3 billion premium in the announced deal – and the cost reductions will boost Morgan Stanley’s return on equity, too.

So why didn’t Goldman pounce on E*Trade? At $84 billion as of Wednesday, it’s in the same market-value ballpark as Morgan Stanley. One answer is the bank prefers to build its own businesses, and is focusing on other areas like credit cards and transaction banking. But Solomon also has yet to resolve issues surrounding the bank’s role in Malaysia’s 1MDB corruption scandal, potentially making approval from regulators for a big acquisition more of a hurdle.

The window for doing deals may not be open for long. Morgan Stanley expects to own E*Trade by the end of 2020. Soon after, the United States could have a new, less Wall Street-friendly president. There’s probably no better time for Gorman’s move – especially if it puts Solomon on the back foot.


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