Morgan Stanley: Stock Is Too Cheap to Sell

In my latest Bloomberg column, I reflect, as a former managing director, on Morgan Stanley's strategy and competitive position.

(UPDATE: A PR person from Morgan Stanley called Bloomberg and questioned whether they had a policy that would prohibit me from commenting on a former employer. The answer, of course is no, and the relationship was disclosed. I also turned down a package from Morgan Stanley last year that included a considerable amount of money, health care benefits, and some other things, rather than sign a confidentiality agreement that would have prohibited me from ever writing anything about the firm -- anything -- without their permission and that would have allowed them to sue me if I said or wrote anything they considered criticism of the firm, by their definition, which definition was not spelled out in the agreement.

There are valid reasons why corporations want these agreements, and why people at times sign them. I really don't have any quarrel with Morgan Stanley wanting its ex-employees to sign NDAs. I respect people who refuse to sign them but don't condemn those who do. As  a journalist who might want to comment on Morgan Stanley in a meaningful way at some future date, I could not sign it myself.)

Am anticipating several perfectly reasonable questions/comments about this column:

> How can you own the stock of an investment bank? It's a black box.

> Even if it wasn't, how can you value an investment bank? It's too market dependent.

> Even if these things were not true, how can you invest in an investment bank? It's a terrible business, however defined (bad business model, or evil business).

And the answers are...Yes, the model is a black box. Who knows what the book value really is, and it shifts with the market all the time, so using book value as a basis for valuation is questionable. Buffett, notably, has limited his risk by owning a preferred (although, not surprisingly, he wants the upside in the form of the warrants). In short, he's betting Goldman Sachs will be a survivor, and can at least pay its tithe to him and redeem the principle someday. The rest is gravy. Why own the common?

One reason is that I don't get to make OTC deals like him. Another is that I inherited the Morgan Stanley.

It's definitely a questionable investment. Free cash flow has been an elusive concept at the banks. Even when they do well, the employees get paid and the shareholders get the leavings. Morgan Stanley has made a lot of dumb moves, such as selling what was arguably its best business (MSCI). So yes, I am going to dump the Morgan Stanley eventually; this just doesn't seem like a particularly auspicious time. It and Goldman have the playing field essentially to themselves, and I would like to see what they can do with it. In terms of downside, despite financial services reform, I still believe these two banks are too big to fail -- they would be sold instead. (Morgan Stanley employees have had a case of who-will-buy-us-itis for years.) Because of the deal it struck during the financial crisis, Morgan Stanley now has a big brother, Mitsubishi, so that answers the who-will-buy-us. The brand is worth something, and the retail network gives it a valuation floor of some amount -- which Bear and Lehman did not have.

Regarding Goldman, the stock is cheap for a host of reasons, many deserved. Pragmatically, the hysteria over the fraud charges was overdone, and this got reflected in the stock price. This quarter showed every sign of being a "kitchen sink," mea-culpa-to-the-proletariat situation. Goldman is the cockroach of investment banking; almost impossible to kill. Its employees aren't going down the elevator at night to jump to any other firm, and they never will. Goldman has an incredible culture, for better or worse.

The economy is in terrible shape, which worries me about the market. Along with that, our economy is rigged right now in a certain way. The financial services businesses get to scrape off an outsized portion of every dollar of GDP for no real good reason except that they are too powerful for anyone to stop it. You and I don't get to do that, unless we invest in the companies that are are doing it. Short of being a hedge fund manager and charging 2-and-20, Goldman might be the best way. It has enormous competitive advantages. You don't have to like them to invest in them. No matter what the market does, they're going to find some way to profit from it. I think that's been pretty well proven by now. With that said, I don't view the Goldman as a long-term holding either. If the valuation recovers there is no reason to hang around; there are better and safer ways to invest (asset managers anyone?).