Morgan Stanley Makes a Trade

The biggest news of the day came before the market opened, when Morgan Stanley disclosed plans to buy E*Trade Financial for roughly $13 billion in stock. It's a new direction for the Wall Street mainstay, but illustrates broader trends in the banking and brokerage industries.

Morgan Stanley's peers from JPMorgan Chase, to Bank of America, to Goldman Sachs, have been building out or emphasizing their consumer businesses in recent years. They mean diversification from traditional investment banking and trading revenue streams, and can also provide a cheap source of funding for loans. Morgan Stanley already has a sizable wealth management division.

As for E*Trade, online and discount brokers have been feeling the squeeze from evaporating trading commissions. Low interest rates, meanwhile, have weighed on the income they generate from uninvested funds customers deposit in their accounts. And industry consolidation has already begun with Charles Schwab’s deal to buy TD Ameritrade last year.

Morgan Stanley expects to see $400 million of cost savings and $150 million of funding synergies from the deal. But it may also be attracted to E*Trade’s corporate stock-plan servicing division, in which it manages stock that some employees receive as part of their compensation. It bought a similar business in Solium Capital last year.

"Combined, Morgan Stanley and E*Trade will have $580 billion in stock-plan assets under their roof," Daren Fonda wrote today. "Stock-plan customers aren’t necessarily brokerage or advisory customers, but they are terrific prospects. As their wealth grows, they become more valuable to financial services firms."

Essentially, Morgan Stanley can put itself in prime position to turn those customers into wealth management clients down the road.

Business reasons aside, it may not be the most shareholder-friendly deal. As Andrew Bary explained today:

The merger isn’t expected to be accretive to Morgan Stanley’s earnings until 2023 and will dilute tangible book value per share. Morgan Stanley is issuing its cheaply valued stock, which trades around 10 times projected 2020 earnings per share, and paying 15 times estimated 2020 projected earnings for E*Trade.

Some investors would have likely preferred to see Morgan Stanley taking advantage of its relatively underpriced stock price by buying back shares, rather than issuing billions of dollars worth of new ones. At the bank's current rate of repurchases, the E*Trade deal equals about two years of stock buybacks.

That could also explain some of investors' lukewarm reception to the deal. Morgan Stanley stock ended the day down close to 5%, while E*Trade soared almost 22% to just below the deal price.