November 30, 2023

Investment Banking

Let Your Investment Banking Do The Walking

How Morgan Stanley’s Diversified Revenue Model Helped It Overcome Slow IPO Activity

Investment banks enjoyed a record year in 2021. According to Renaissance Capital, initial public offering (IPO) activity was at the highest level ever, with 397 companies going public. This year has been a different story, however.

Equity markets have seen higher volatility due to rising inflation and prospects of rising interest rates. That, coupled with geopolitical uncertainty stemming from the Russia-Ukraine war, has made many companies pump the brakes on going public in the quarter. As a result, investment banks saw lackluster results in the quarter.

One investment bank that saw a slowdown was Morgan Stanley (MS -3.37%). However, the firm put up better numbers than expected, beating analysts’ earnings estimates by 20%. What helped Morgan Stanley was its diverse business mix — something it’s been working toward for years.

A person makes a presentation in a conference room.

Image source: Getty Images.

A drastic slowdown in investment banking

In the first quarter, Morgan Stanley’s net revenue dropped 6% from a year earlier, while its net income fell 11%. What drove the earnings decline for the firm was a drastic slowdown in investment banking activity. Investment banking revenue was down 37% from last year, but drilling down further reveals equity underwriting declined nearly 83%.

Equity underwriting is a service provided by Morgan Stanley and other investment bankers that among other things helps private companies go public through IPOs. According to Renaissance Capital, IPO activity was at its lowest level in six years. The first quarter saw just 18 IPOs, down from 101 in the first quarter last year and 84 in the fourth quarter.  

A chart shows the IPO activity over the past ten years.

Data source: Renaissance Capital. *Data through April 20, 2022. Chart by author.

Morgan Stanley has been preparing for a scenario like this

A positive takeaway for Morgan Stanley investors is that it didn’t do as poorly as it could have. It previously relied heavily on investment banking (in its institutional securities segment) to drive revenue. In recent years, the firm has worked to diversify its income streams. In 2009, 66% of its revenue came from institutional securities, while in 2021, that figure was 50%.

Charts show Morgan Stanley's revenue mix from 2009 and 2021.

Data source: Morgan Stanley. Chart by author.

With its acquisitions of E*TRADE and Eaton Vance, Morgan Stanley has worked toward diversifying its sources of income. While it still sees fluctuations in earnings based on investment banking activity, the swings aren’t as big as they used to be since it now has a higher share of revenue coming from wealth management and investment management.

How its other businesses performed

During the quarter, wealth management revenue increased slightly from last year, up 0.4%. The firm increased client assets by 19% to $1.8 trillion in the quarter. Its investment management segment also saw modest growth, up 1.6% year over year. Assets under management (AUM) in this segment were up 1.9% to nearly $1.5 trillion.

In its institutional securities segment, the firm saw strong advisory revenue, which increased 97% to $944 million and helped offset weak IPO activity. Taken altogether, Morgan Stanley’s declines in revenue and net income were modest, especially when compared with Goldman Sachs, a firm that is more heavily reliant on investment banking. In Goldman Sachs’ first-quarter earnings, revenue declined 27%, while net income was down 43%.  

Morgan Stanley faces headwinds from inflation, rising interest rates, and other geopolitical factors. However, it has done a stellar job of diversifying revenue streams so it could ride out lean times in the investment banking cycle. That, coupled with its meager 10.4 price-to-earnings ratio, makes it look like a solid stock for long-term investors.