Morgan Stanley and Citigroup Inc. (C) executives held unsuccessful talks since August in a final push to settle a dispute over the value of their jointly owned brokerage, people with direct knowledge of the matter said.
An independent appraiser's report, delivered late on Sept. 10, and a phone call from Morgan Stanley Chief Executive Officer James Gorman to Citigroup CEO Vikram Pandit helped settle the matter within hours.
The overnight effort yielded an agreement for Morgan Stanley to buy the rest of Morgan Stanley Smith Barney in pieces through 2015 at a fixed valuation of $13.5 billion. The accord avoided repeated fights in future years over what the unit is worth and helped Citigroup lock in a price higher than the appraisal. The decision also forced Citigroup to take a $4.7 billion writedown on its investment in the business.
“It's pretty clear who the winner and loser was,” said David Trone, a JMP Securities LLC analyst who has a market underperform rating on both firms. “Morgan Stanley positioned itself very well in this transaction from the start.”
Perella Weinberg Partners LP, the New York-based investment bank hired to provide the appraisal, set off the flurry of talks by delivering a valuation below $13.5 billion, people with direct knowledge of the matter said. The figure was so low -- closer to Morgan Stanley's $9 billion estimate than Citigroup's $22 billion -- that it triggered a contractual clause further depressing the price on a 14 percent piece of the business.
Gorman, 54, and Pandit, 55, said in statements that the deal provides “certainty” for investors, assuring them of the price and timing for the sale of Citigroup's remaining stake. “The more we put the past behind us, the more we can focus on our future,” Pandit said.
The venture was formed in early 2009 when Citigroup sold Morgan Stanley a majority stake in its Smith Barney brokerage. At the time, Citigroup sought to raise capital after its $45 billion U.S. bailout. Morgan Stanley got a 51 percent stake in the venture and the right to buy the rest over time. The deal generated a $9.5 billion pretax gain for Citigroup.
“At the time it was struck, Morgan Stanley held all the cards and got itself in a very savvy position,” Trone said.
Morgan Stanley said in May it would exercise an option to buy the 14 percent piece, increasing its stake to 65 percent. The banks' agreement required them to hire an independent appraiser, and they chose Perella Weinberg in July.
Perella Weinberg bankers Peter Weinberg and Gary Barancik presided over a series of meetings in August with executives from the two banks, hearing out both sides on arguments over matters including the potential value of future tax benefits and the amount of preferred stock in the venture's capital structure, one person said.
Complicating the task was the lack of publicly traded companies comparable to Morgan Stanley Smith Barney, the person said. Publicly traded brokerages such as Stifel Financial Corp. and Raymond James Financial Inc. are significantly smaller.
Perella Weinberg sought to keep most meetings open to both sides to provide them with opportunities to rebut arguments while reducing the likelihood of any complaints that the process was unfair, one person said.
The banks tried to bridge their differences during talks in the weeks before Perella Weinberg's Aug. 30 deadline for submitting its appraisal, according to three of the people, who declined to be identified because the negotiations were private.
Toward the end of the month, Citigroup and Morgan Stanley (MS) asked Perella Weinberg to delay the report to give them more time to reach a settlement, two people said. One of the banks wanted more time to provide additional supporting details to Perella Weinberg, another person said.
The firms announced in an Aug. 28 press release that Perella Weinberg would delay the appraisal until Sept. 10.
While the discussions initially were geared toward determining the price Morgan Stanley would pay for the 14 percent stake, the sides soon began discussing a price for Citigroup's entire 49 percent holding, one person said.
Citigroup executives moved to lock in a fixed price for its entire stake partly because they were concerned that the business was deteriorating under Morgan Stanley's management, two people said.
The banks failed to reconcile their differences as talks continued last week, the people said. With no deal in place by the Sept. 10 deadline, Perella Weinberg e-mailed its appraisal to the firms minutes after the 4 p.m. close of U.S. stock markets in New York. At about 5:30 p.m., Gorman called Pandit to initiate a new round of talks, one person said.
Investment bankers for both sides met at Morgan Stanley headquarters about 7 p.m. to work out a deal, one person said.
Morgan Stanley's contingent was led by Gorman and mergers chief Robert Kindler, supported by Gary Shedlin, a former Citigroup investment banker, the people said. They squared off with Citigroup securities-division Chairman Edward “Ned” Kelly, who was backed up by investment bankers including David Head, the person said.
Pandit monitored the talks from Citigroup headquarters on Park Avenue, one person said.
Perella Weinberg's valuation strengthened Morgan Stanley's hand during the final negotiations, another person said. The basic terms of a deal were hashed out within hours and handed off to lawyers, clearing the way for a press release three minutes after U.S. markets opened yesterday, that person said.
Morgan Stanley has to buy an additional 15 percent stake by June 2013, according to the statement. Morgan Stanley has an option to buy the rest of the brokerage earlier than 2015, subject to regulatory approval. The firm may buy the remaining 35 percent as soon as next year, Howard Chen, a Credit Suisse Group AG analyst, wrote in a note to clients yesterday.