Citi, Morgan Stanley far apart on joint venture value

[1]

Morgan Stanley estimates the retail brokerage business it jointly owns with Citigroup Inc is worth less than half as much as Citigroup believes, Citi said in a regulatory filing on Thursday.

The disagreement came as Morgan Stanley tries to buy another 14 per cent of the joint venture known as Morgan Stanley Smith Barney, beyond the 51 per cent it already owns.

The numbers in the filing imply that Morgan Stanley values the entire venture at around $9 billion and Citigroup says it is worth some $22 billion.

A third party appraiser will help set the final price in a process set to conclude at the end of August, with the sale slated to close September by 7.

The stakes are high for both banks, which are looking to build capital levels and keep liquidity high as regulators ratchet their requirements higher.

Too high a price could force Morgan Stanley to shell out more cash, while too low a price could force Citigroup to take a non-cash charge to lower the value of the business on its books. Some measures of the bank's capital would fall.

One positive for Citigroup -- even if Morgan Stanley's estimate ends up being the price at which the deal happens, Citi's capital levels will rise under the newest standard being implemented over the course of this decade, known as Basel III.

A Morgan Stanley spokeswoman declined to comment on the appraisal.

Under the contract between the two companies, an arbitrator will value the company, but the banks' valuations can still influence the final price of the deal.

If the independent valuation is in the middle third of the range between the two banks' estimates, the appraiser's valuation will hold.

If the value is in the lowest third of the range, the price will be half-way between that value and the lowest appraisal; if the value is in the highest third, the price will be half-way between that value and the highest appraisal.

The joint venture was created in 2009, coming out of the financial crisis as Citigroup, which was badly crippled by losses on mortgage-related securities, set out to shrink its balance sheet, partly by selling its Smith Barney brokerage.

Morgan Stanley, for its part, was looking to diversify its revenue stream after getting burned by bad trades and investments in its investment bank.

Since then, the value of brokerage assets has waxed and waned with customer sentiment about Wall Street and the outlook for investment returns.

SEC FILING

Citigroup said in its filing with the Securities and Exchange Commission that its appraisal 'slightly exceeded' its own carrying value of approximately $11 billion for its 49 per cent stake.

That would put the value for the whole business at around $22 billion. The filing said Morgan Stanley's valuation was 40 per cent of Citi's, which amounts to about $9 billion.

The Morgan Stanley Smith Barney business has not been performing as well as initially projected by Morgan Stanley due to weak client trading activity and the cost of combining the brokerages.

Morgan Stanley now aims for its wealth management operations, which are mainly comprised of its stake in Morgan Stanley Smith Barney, to earn pre-tax profits that are in the mid-teens as a percentage of revenue by the middle of next year -- below the 20 per cent goal originally set by Chief Executive James Gorman.

For Morgan Stanley, buying more of the venture is part of a strategy to emphasize the stability of wealth management revenue streams over the volatility of investment banking.

Morgan Stanley has options to buy the rest of the venture through 2014.

Citi called its valuation of the venture 'reasonable and supportable,' adding it expects to close the sale of the 14 percent stake to Morgan Stanley by September 7.

A big mark-down of Citigroup's valuation of its minority stake in the venture would be another embarrassment this year for the nation's third-largest bank by assets.

In March, the Federal Reserve rejected the company's assessment of how much capital it could return to shareholders and still withstand a period of severe stress.

And in April, a majority of Citigroup shareholders refused to endorse the executive compensation plan adopted by company directors which resulted in CEO Vikram Pandit being paid $15 million in 2011.