Wednesday, June 18, 2008

Bookkeeping: Not Impressed with Morgan Stanley (MS) Results so Closing it Out

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After picking through some of the news reports from Morgan Stanley (MS) earnings (keep in mind these are black boxes so its hard to really analyze the data as you would a normal widget maker), I have to say I came away unimpressed, especially in light of what Goldman Sachs (GS) did. Now I did not expect them to repeat Goldman's performance but they did not even appear to come close. A bet against energy as the cherry on top?
  • Morgan Stanley (NYSE:MS - News) on Wednesday said quarterly earnings dropped by more than 50 percent on trading losses and a slowdown in investment banking, even after the investment bank realized $1.43 billion of pretax gains from asset sales.
  • Morgan Stanley's shares dropped as much as 7.8 percent as analysts questioned the sustainability of the bank's earnings, which came mainly from selling businesses.
  • The second-largest U.S. investment bank reported income from continuing operations of $1.03 billion, or 95 cents a share, for its fiscal second quarter, ended May 31, down from $2.36 billion, or $2.45 a share, a year earlier.
  • Net revenue fell 38 percent to $6.5 billion from the same quarter last year, dragged lower in part by a contrarian bet on energy that didn't pan out and actions by a London trader that violated company policy.
  • Some analysts said the investment bank's core earnings were just a few pennies per share, falling far short of average analyst expectations of 92 cents. (and that's the main problem) Most of the company's earnings came from two one-time items: a $698 million pretax gain from the sale of its Spanish wealth management business and a $732 million pretax gain from the sale of part of its stake in MSCI Inc=. (not good)
  • Gains from asset sales helped offset $245 million of severance related to job cuts, $436 million of losses from proprietary mortgage trades and $519 million of net losses on leveraged loans.
  • Revenue dropped in almost every business. Investment banking fees fell by half. Fixed income trading net revenue sank by 85 percent, reflecting the mortgage losses as well as reductions in other markets.
  • "Not only was Morgan Stanley's result far below that of Goldman, even Lehman did better in the client franchise," wrote David Trone and Ivy De Dianous. (ouch)
There are two ways to go with this position - first, it's part of a barbell strategy which means it should not have much correlation with the more "global growth" type of companies we own, so we want to have some exposure to that part of the market.... also it's been hit pretty hard of late, and when the "early cycle" stocks do rebound it could put on a serious move as it's fallen quite a bit; or second - just stick to the best of breed even though the best of breed has not fallen nearly as much and hence could offer less upside on a "worst of breed" rally.

Although I think Morgan Stanley might in fact bounce more than Goldman does on a rally since it's been hit far harder, I've just decided to stick to Goldman, and we're going to sell Morgan Stanley. The variance in the two reports is simply too much; relying so much on things like asset sales is simply not a long term business plan. I thought they'd benefit more from the damage at Bear Stearns but it appears almost all of that business fled to Goldman instead....

Again, when the hedge funds do pile back into financials the "worst of breed" or "stocks that have fallen the most" will in fact most likely rebound the most, but even with this barbell approach I still want to stick with the stronger companies. I'll just add to Goldman on future dips so I can keep my exposure to this part of the market relatively constant.

I am closing a 1.4% stake in Morgan Stanley, with about a $2500 loss. No big deal. After opening under $38 this morning the stock has trended up all day ("not as bad as expected! buying"), so we'll exit here near $40. Probably with some patience we could get a mid $40s price point to sell, but I'd rather just have the cash and look elsewhere. I bought MS in mid April, and at the time the chart was actually the best among the foursome of major investment banks - now it's just another of the pack. We'll revisit this name in maybe 6 months, after another 2 quarters under their belt and see if they are rebuilding the business without turning to asset sales as the main driver of growth.

Long Goldman Sachs in fund; no personal position


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