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With big merger advisers such as Marty Lipton and Bob Greenhill facing off on the matter of Morgan Stanley’s future, perhaps it’s no surprise that a cacophony of voices has started calling for the firm to do a deal, whether it’s a divestiture of some units or a sale of the entire company. But is a deal the right solution for Morgan Stanley’s troubles? Probably not, said bankers and analysts familiar with the company, for three reasons: If Morgan Stanley were to divest its Dean Witter retail brokerage or Discover credit card businesses, it would lose the benefit of having diversified businesses that keep its revenue stable through economic downturns. In addition, the firm would likely be too small to be able to compete against its rivals, who are all getting bigger instead of shrinking. “It’s not very compelling to split up the company,” wrote Citigroup Global Markets Inc. Ruchi Madan in a March 29 research note, arguing that if the company improves its performance, no sales would be necessary. And if Morgan Stanley were to sell itself whole, it would be bogged down by integration issues — and history shows that when investment banks are sold, especially to commercial banks, it usually ends up in tears. That doesn’t mean an outright sale won’t happen. Bankers said that several suitors are examining Morgan Stanley anew, including Bank of America Corp. and HSBC Holdings plc, both of which have investment banking divisions run by former Morgan Stanley executives — Carter McClelland and John Studzinski, respectively. Either bank could easily swallow Morgan Stanley whole. Morgan Stanley only has a market cap of $63.7 billion, compared with $177.8 billion for HSBC and $179.3 billion for BofA. Analyst Richard X. Bove, with Punk Ziegel & Co., said the current battles between Morgan Stanley management and eight former executives make a deal imperative as soon as within eight to 12 weeks. “They need a white knight to take them out of the misery they’ve created for themselves and their shareholders,” Bove said, nominating BofA as that white knight. But while the benefits to a BofA or HSBC would be clear — they would finally be on the map in investment banking — the benefits to Morgan Stanley would be murkier. Morgan Stanley would presumably get the advantage of those companies’ balance sheets, but it already has — and uses — its balance sheet to back up deals in which it is involved. One former Morgan Stanley banker points out that BofA and HSBC have been trotted out as buyers before. The only difference now is a small one: “What Phil [Purcell, CEO of Morgan Stanley,] has wanted in the past has been a merger of equals,” said a former high-ranking Morgan Stanley banker. “It’s only different now because Phil does not have the leverage to insist on being the CEO” because controversy has beleaguered Purcell. The Morgan Stanley Eight — shareholders and former executives who incited the current war and have mounted a public relations battle against Purcell — do not want a takeover. “We believe Morgan Stanley can do well on its own,” a source close to the group said. Standard & Poor’s analyst Tom Foley said a deal — especially a spinoff of the Discover or Dean Witter businesses — would position Morgan Stanley for a ratings downgrade from S&P. “We would view a spinoff of any of the businesses as a negative,” Foley said. “We would consider downgrading Morgan Stanley if they were to spin off one of their divisions.” Foley pointed out that a spinoff or sale of those units would reduce Morgan Stanley’s diversification. “A spinoff would make them smaller and would make their earnings more volatile, and volatile earnings are not good for credit ratings,” Foley said. Indeed, in 2002, when Morgan Stanley’s investment banking revenue dipped 31 percent from the previous year and the individual investor group — Dean Witter — was still recording a loss, the Discover card division recorded a 9 percent rise in earnings. On the competitive front, all of Morgan Stanley’s rivals are heading in the direction of greater size, not less. In 2003, Lehman Brothers Inc. bought asset manager Neuberger Berman Inc. to diversify; in 2004, Merrill Lynch & Co. decided to keep its own asset management division after considering spinning it off. And the universal banks, such as BofA and J.P. Morgan Chase & Co., both did huge mergers-of-equals. But even those banks have had to deal with integration, as will Morgan Stanley. “A deal will come with its own set of issues,” a former Morgan Stanleyite said. “It’s not like, ‘Let’s do a deal, and all the problems are solved.’ It’s more like, ‘Let’s do a deal, and we’ll have different issues.’” History works against any investment banking deal, especially those involving commercial banks. Although Citigroup Inc. had relative success with its takeover of Salomon Smith Barney Holdings Inc., most investment banking acquisitions are what one financial institutions group banker calls “bloodbaths” of departing talent. No other bank has attempted a merger with another investment bank since Credit Suisse First Boston’s disastrous $13 billion deal with Donaldson, Lufkin & Jenrette Inc. in 2000. Indeed, Fox-Pitt, Kelton analyst David Trone said the only thing that would concern him would be the departures of rainmakers, although even that would not be compelling enough reason not to act. “Firms like Morgan Stanley have been designed to absorb large-scale departures,” Trone said in a March 30 research note. There’s also the question of why Morgan Stanley would want a sale if its stock price is so infamously low. It now trades at roughly $57, below its $60.32 52-week high. Citigroup’s Madan suggested Morgan Stanley’s stock price is worth about 30 percent more than its recent level — around $70 — and that the bank can boost it to that price by improving performance. And even advocates of a sale would have to agree that a 30 percent premium would be hard to gain in a sale. Copyright �2005 TDD, LLC. All rights reserved.

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