Morgan Stanley & E-Trade
By Taran Narula, Head of FIG at the KCL M&A Society
Acquirer: Morgan Stanley
Date of Announcement: 20/02/2020
Acquirer Advisors: Morgan Stanley
Target Advisors: JP Morgan
On 2 October 2020, Morgan Stanley (“MS”) announced the acquisition of E-Trade in an all-stock deal worth US$13 billion. The deal is valued at $58.74 per share, with shareholders entitled to receive 1.0432 MS shares per share of E-Trade. The deal represents the largest takeover by a US bank since the 2008 financial crisis.
Acquirer - Morgan Stanley
Morgan Stanley is a multinational investment bank and financial services company headquartered in New York City. A member of the Fortune 500, it was founded in 1935 and is beneficially owned by MUFG, Japan’s largest bank. Its main areas of business are institutional securities, wealth management, and asset management.
CEO: James Gorman
HQ: New York City, NY, USA
Share Price at the time of writing: US$52.20
Market Cap at the time of writing: US$94.44 billion
Target - E-Trade
E-Trade is a financial services company headquartered in Arlington, Virginia, which offers services such as trading, investing, margin lending, and corporate stock plans through its core electronic trading platform. E-Trade hosts approximately 5.2 million retail client accounts totaling $360 billion in assets.
CEO: Michael Pizzi
HQ: Arlington, VA, USA
Share Price at the time of writing: US$49.26
Market Cap at the time of writing: US$10.89 billion
Ten years ago, approximately two-thirds of Morgan Stanley’s profits were from buying and selling securities. However, the post-crisis MS has evolved more cautiously and has markedly shifted away from its archetypal investment bank role by delving further into financial advisory; last year, its wealth management arm brought in more profit than its securities trade. In addition, increased competition amongst large US investment banks to expand to a broader range of consumers and access a greater range of funds has generated significant funding pressures for competitors including MS. Thus, given the COVID-19 induced uptick in retail investor activity amidst uncertain market conditions and the proven performance of the bank’s wealth management business, there is a clear incentive for Morgan Stanley to pursue the acquisition of E-Trade.
The discount brokerage industry has been facing increasing margin pressures due to an uptake of zero-commission trading and price competition across electronic trading platforms. After Charles Schwab dropped online commission fees to match zero-fees pioneer Robinhood, competitors including E-Trade were forced to follow suit. E-Trade is not the US’ largest online trading platform, and given Schwab’s recent merger with competitor TD Ameritrade, analysts speculated that the platform provider would need to find a partner in order to alleviate these margin pressures and continue to compete. Thus, there is a clear motivation for E-Trade to seek acquisition by MS.
The direct short term outcome of the acquisition is the absorption of E-Trade’s 5.2 million client accounts and $360 billion retail client assets to MS’ 3 million client accounts and US$2.7 trillion in assets. This is a welcome development for the bank, especially due to its recent struggles to fund loans to wealthy clients. E-Trade’s strong deposit base of US$56 billion per year will generate significant funding benefits for Morgan Stanley. Indeed, since the deal was first announced in February 2020, E-Trade experienced rapid demand brought on by COVID-19 induced market volatility where crowds of retail investors joined to book profits: whereas only 52,000 new accounts were created in Q1 2020, there were 363,000 and 356,000 E-Trade retail accounts created in Q2 and Q3 2020 respectively. MS will be hoping for similar levels of growth, especially heading into winter with the pandemic showing no signs of abatement.
In addition, MS claims that the deal will help generate significant cost synergies. Access to E-Trade’s deposits will reportedly lower the bank’s funding costs by at least US$150 million over the next couple of years. This is on top of US$400 million in other savings that will be realised by the deal. These savings will help offset the US$800 million in integration and restructuring costs arising from the deal.
Source: American Banker
Finally, the acquisition appears to increase the scale and breadth of MS’ core wealth management business. E-Trade’s direct-to-consumer brokerage platform nicely falls in place alongside the bank’s market-leading financial advisory services catering to its wealthy clientele. It is expected that wealth management will make up almost 60% of Morgan Stanley’s pre-tax profits, which can operate to counterbalance the risks of its more volatile business of institutional trading. As a more stable revenue source — certainly less volatile than its core markets business — an increase in wealth management revenue is likely to bring balance to Morgan Stanley’s business model.
One interesting possibility is the integration of the bank’s advisory with E-Trade’s digital capabilities and access to retail investors. An integration of these facets could augment and enhance MS’ offerings to a wider range of consumers, especially since a vast number of consumers are working from home due to the pandemic and will continue to do so in the winter.
Morgan Stanley has long been seen as an investment bank for wealthy Americans and large corporations. The acquisition of E-Trade, however, spins that perception on its head. It remains to be seen how exactly MS will attempt to integrate E-Trade’s platform into its service suite, but it would appear that a long-term consequence of the acquisition is that one may no longer need millions in a bank account to access the services of an established investment bank. If all that is needed is an E-Trade account, the deal could significantly expand the access to investment banking to an entirely different class of retail investors, beyond the wealthy clientele — something of a democratisation of investment banking.
More importantly, MS’ acquisition of E-Trade represents the bank going long on the young and middle-class getting richer. Younger investors, who make up a sizable portion of E-Trade’s retail user base, are generally more eager to digitally interact. By implementing an environment conducive to the preferences of these investors through E-Trade, the deal is expected to result in a pipeline of investors bearing emerging wealth whom Morgan Stanley are betting will level up to the bank’s own wealth management platform as they amass more wealth. Indeed, the bank’s long bet on emerging wealth looks promising: in the past ten years, Americans below the 1% have doubled their fund holdings.
Image source: morganstanley.com
Risks & Uncertainties
As one of the most high-value acquisitions of 2020 (and the highest value bank acquisition since the financial crisis), this deal represents a significant outlay for Morgan Stanley. As with any acquisition of this scale, there are significant risks and uncertainties. Here, however, the stakes are higher: not only has the market been rife with volatility and uncertainty since the spring, but the deal has faced considerable criticism for being over and above E-Trade’s true value. Rival Goldman Sachs, for instance, managed to raise a similar year-on-year deposit amount of US$50 billion (versus E-Trade’s US$56 billion) by developing a similar product albeit organically and in-house.
Morgan Stanley may also face regulatory constraints as a consequence of the Dodd-Frank Act enacted in response to the 2008 financial crisis. The legislation seeks to prevent financial institutions from gaining too much market power through acquisitions and thus becoming “too big to fail”. Although the deal was given the regulatory go-ahead, regulators are still likely to keep a close eye on Morgan Stanley’s integration and use of its newly-acquired electronic broker, particularly in light of an uptick in mergers, acquisitions, and developments in the sector — the Charles Schwab-TD Ameritrade merger and Goldman’s Marcus business, for instance.
In addition, although E-Trade’s margin pressures are likely to be alleviated with the backing of an established investment bank, it remains to be seen whether E-Trade can continue to compete with other major players in a largely price-competitive electronic brokerage industry. E-Trade’s requirement for a minimum $500 deposit is likely to be a hurdle for many young investors. Given MS’ long bet on emerging wealth, it may decide to maintain or increase the minimum deposit to price out facetious investors. This may work towards the bank’s long-term objectives, but in the meantime could reduce E-Trade’s market share.
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