New York: Citigroup’s $22 billion valuation of its brokerage joint venture with Morgan Stanley reflects an extremely optimistic view of the future of Wall Street profits, making a multi-billion-dollar loss on the business more likely for Citi.
Sources familiar with the situation said Citi’s appraisal works out to 50 times current one-year earnings for the joint venture, Morgan Stanley Smith Barney. The long-term average price-to-earnings ratio for retail brokers is only about 18 times.
Morgan Stanley’s $9 billion appraisal is about 20 times current earnings and implies an expectation that profits will stay in a rut, even when the costs of combining the two companies’ brokerages subside.
The companies exchanged appraisals as a step to set the price that Morgan Stanley, which owns 51 percent of Morgan Stanley Smith Barney, will pay to buy another 14 percent from Citigroup.
People at both companies believe an arbitrator will come down somewhere in the middle, which would still force Citigroup to take a non-cash charge to earnings to write down the value of its 49 percent of the business.
Revenue growth rates for wealth managers have fallen so much that there are few deals being made these days, much less at pre-crisis valuations, said Matthew Morris, head of corporate advisory services at the US arm of RGL Forensics, an accounting and valuation firm.
Still, Morris said, “the two sides are shockingly far apart while presumably using the same valuation framework.”
The yawning gap in the values is a sign of how even five years after the financial crisis started, Wall Street remains far from a full recovery.
Smith Barney became part of Citigroup in 1998 when former Chief Executive Sandy Weill turned the bank into a financial conglomerate. Weill said on Wednesday that he now believes banks should be separated from investment banks.
The subsequent joint venture was forged in the financial crisis in January 2009 when Citi looked to raise capital and Morgan Stanley sought a stable source of revenue.
Rather than have Morgan Stanley raise enough money to buy Smith Barney at once, the two parties agreed to share ownership and plan for Morgan Stanley to buy the rest in increments through 2014. Each side contributed wealth management assets, and Morgan Stanley paid Citigroup another $2.75 billion in cash to take operating control.
It was a time when financial markets were on virtual life support from the government, and there were few benchmarks for what the business was worth.
Citigroup used the deal to write up the value of its assets to what is essentially its current appraisal, which boosted some measures of its capital.
Morgan Stanley did not write up its own wealth-management assets at the time of the deal. The two sides have been poles apart in valuing the venture ever since.
Now the companies have hired boutique investment bank Perella Weinberg Partners to make a judgment of the fair value by the end of August. The schedule should allow the sale of the 14 percent slice to be complete by Sept. 7.