Morgan Stanley: Exposure To Asset Management & Investment Banking

In our previous analysis on Morgan Stanley (NYSE:MS), we examined asset management business growth which we expected to remain robust with its AUM reaching $1.5 tln following the acquisition of Eaton Vance and projected its asset management revenue growth at 4.5% in 2022. Moreover, we expected its investment banking growth to normalize after a strong year of growth to 5% in 2022 and trading revenues to decline by 11.8% in 2022 based on our projection of the decline of the volatility index. Lastly, we determined that its capital position is superb with a capital ratio of 21.8% and projected its net change in capital requirements of -$278 mln in 2022 as our capex assumption.

In this analysis, we identified the breakdown of the capital markets industry and analyzed the companies within the subindustries in terms of their financial metrics to determine their financial performance relative to each other. We then examine the revenue breakdown for Morgan Stanley based on its exposure to the investment banking and asset management subindustries. Based on our analysis, we then examined its revenue breakdown to determine its future financial performance.

We then looked into Morgan Stanley’s revenue breakdown by region to determine its overseas expansion based on joint ventures and acquisitions as well as its international pipeline of IPOs which we covered in our previous analysis. We used this to determine their capex requirements for the foreseeable future.

We calculated the market share of Morgan Stanley and its competitors based on its investment banking and asset management revenues and examine how it has changed over the past five years. Based on this, we looked into any geographical and fundamental factors that had benefited any of those companies and how Morgan Stanley fares compared to its competitors.

Diverse Revenues From Asset Management And Investment Banking

From the chart above, the capital markets industry within the financial sector is broken down into the buy-side and sell-side. The buy-side consists of the asset management sub-industry as they are involved in the management of pooled funds for their clients. On the other hand, the sell-side is represented by the investment banking & brokerage and financial exchange & data providers as they provide fee-based services related to client investment activities.

To determine the differences between these subindustries in terms of their relative financials, we compiled data from 80 companies and categorized them according to their subindustries. Then, we calculated the average gross and net margins (5-years), employees and revenue per employee. We plotted the data in the bubble chart below where the average number of employees and 5-year net margins are on both axes with the size of each bubble represented by the average revenue per employee.

*Historical 5-year

Source: Company Data, Khaveen Investments

Based on the table, the financial exchange & data subindustry has the best profitability as it has the highest average 5-year net margins (27.65%). This is because the subindustry has the leanest operating structures with the lowest average number of employees (6,291) compared to the other subindustries. For example, Nasdaq (NDAQ) and ICE (ICE) (largest stock exchanges by market capitalization of listed companies) only have 4,830 and 8,858 employees receptively which is lower than the average for asset management and investment banking. Financial exchanges & data providers are involved in the sale of market data. For example, according to Investopedia, these companies live data feeds which are charged as a premium service to cover its costs whereas delayed quotes are provided for free. They are similar to highly profitable software companies in terms of distribution where they are able to sell the same product to many customers.

The asset management market has the second-highest margins. Compared to the investment banking market, it has a leaner structure as a buy-side type of company with a lower average number of employees than investment banking (sell side). Furthermore, as explained in the chart comparing the buy-side and sell-side, asset management (buy-side) generally has a leaner structure focusing on core functions and outsourcing than sell-side firms like investment banking (sell-side) having in-house capabilities. According to a survey by Northern Trust of 300 asset managers, the main areas that they planned to outsource were data management, back-room operations and middle office functions.

Additionally, asset management has the highest revenue per employee average ($1.86 mln) which highlights its greater efficiency compared to other subindustries. Also, in relation to the difference between compensation where the buy-side generally depends on the analysts’ recommendation and the success of the fund, asset management generally requires and emphasizes greater hard skills such as quantitative and analytic skills while investment banking requires more soft skills according to Investopedia.

In terms of the growth outlook, the financial exchange and data providers have the highest CAGR (8.25%) with the rise of data analytics which is expected to grow at a CAGR of 11.5% through 2028. Asset management follows with the second-highest CAGR (6.2%) driven by the growth of AUMs at a forecast of 21% to 2025 according to Bloomberg.

Based on the company’s reported revenue streams in its annual report, we categorized its revenue into subindustries. The investment banking segment is the largest at over half of its revenues, but asset management also represented a large portion of revenues. We believe this indicates its diverse revenues in the capital markets industry but without exposure to the financial exchange and data subindustry. To compare and determine Morgan Stanley’s positioning in the industry, we calculated the weighted average industry net margins and revenue per employee based on the company’s revenue breakdown by subindustries (asset management: 58.7%, investment banking & brokerages: 38.6%). Additionally, we then calculated the implied revenue for Morgan Stanley based on the weighted average industry average revenue per employee to compare against its actual revenue.

Source: Khaveen Investments

Based on the table, we see that the company’s actual net margins are higher than the weighted average of the industry’s margins which indicates its profitability strength. However, its revenue per employee ($0.797 mln) is lower than the weighted industry average ($1.68 mln). This is as the company’s employee count is more than 3 times higher than the weighted average industry average which highlights its larger workforce than the industry average. Based on the average revenue per employee, its actual revenue is lower by nearly half the implied revenue due to its lower average revenue per employee. Overall, we believe this highlights the company’s profitability strength but the inability to command a premium from its workforce with its lower than average revenue per employee.

We updated our revenue forecast with the full year 2021 results from our previous analysis. To project the company’s revenue beyond 2022, we based its investment banking & brokerage and asset management segments on the market forecast CAGR through 2026 tapered down by 0.5% as a conservative estimate.

Source: Morgan Stanley, Khaveen Investments

Global Expansion Supported By Leading Market Shares

Source: Morgan Stanley, Khaveen Investments

Based on its annual report, the company derived the majority of its revenues from the Americas region in 2021 followed by EMEA and Asia. Though, Asia had been its fastest-growing region among the 3 in the past 10 years while EMEA had been its lowest growth. We believe its exposure to Asia, while its smallest, could continue to drive its growth outlook. The Asian region is also forecasted to have the highest GDP growth forecast through 2024 followed by EMA and then the Americas.

According to data from Dealogic, Morgan Stanley saw its market share dip in 2021 in the US for M&A advisory and was overtaken by JP Morgan (JPM) at the second spot. Though, it performed better in its international markets where it had the second-highest market share only behind Goldman Sachs (GS) in Europe and JP Morgan in Asia. In 2021, the company’s market share in both regions increased especially in the Asian region. In Europe, the top 7 of the 10 companies were based in the US. Morgan Stanley, Goldman Sachs and Citi (C) were the only companies to gain share.

In Asia 7 of the top 10 were from the US and the top gainers were JP Morgan, Morgan Stanley, Citi, Credit Suisse and Evercore while the China-based companies which are CICC and CITIC Securities (OTCPK:CIIHF) lost market share in 2021. We believe this highlights the increasing competition as China opens up its financial sector to foreign firms with more than 100 foreign companies approved by the Chinese government. While Morgan Stanley performed well in Asia and Europe, we believe Citi was the top performer as it gained share across all 3 regions as it outlined its strategy to close its banking operations in 13 countries and focus on institutional banking and wealth management, especially in Asia and the US.

Overall, we believe Morgan Stanley’s strong competitive positioning could continue driving its international growth outlook. Furthermore, the company announced that it increased its ownership stake in its China brokerage joint venture formed with China Fortune Securities to 94%. Moreover, it also announced its expansion in Europe with its fintech startup investment program in the UK. We believe this highlighted its focus on international expansion. Furthermore, the company has a high market share (13.9% in Europe and15.1% in Asia) in international markets. In our previous analysis, we covered its strong pipeline of IPOs including Better.com, Tuya (TUYA), DigitalOcean (DOGN), Vine Energy, Vantage Towers (OTCPK:VTWRF) and Oscar Health (OSCR).

Based on the company’s past acquisition track record and the total acquisition costs, we calculated its average cost per acquisition for each year to project its capex through 2026.

Source: Morgan Stanley, Khaveen Investments

The company has had an average of 4 acquisitions in the past 5 years at a cost per acquisition of $679.7 mln. Based on this, we projected its acquisition cost through 2026 at $2.4 bln as our capex assumption for the company.

Market Share Across Different Industries

To compare the company’s competitiveness within the capital markets industry, we analyzed its market share and its competitors in the investment banking and asset management subindustries from 2017 to 2021.

Source: Company Data, Khaveen Investments

From 2017 to 2021, Morgan Stanley lost some shares but remained in the 4th position behind market leaders Goldman Sachs, JP Morgan and Bank of America. Among the top 4 companies, Goldman Sachs performed the best with the highest growth rate in the past 5 years and solidified its market leadership followed by JP Morgan which trailed Goldman Sachs. Though, Morgan Stanley outperformed Bank of America with a higher growth rate and narrowed the gap with it. Outside the top 4 which are all US-based companies, Barclays was the best non-US-based investment bank and was the second-best performer overall only behind Goldman Sachs. It gained market share during the period in contrast to other European competitors whose shares contracted. Previously, Barclay’s CEO highlighted the potential net benefit for the UK’s financial sector following Brexit to compete with international financial hubs.

Overall, half of the US-based companies outperformed the market average which was Goldman Sachs, JP Morgan and Citigroup while the other half which underperformed were Morgan Stanley, Bank of New York and Bank of America. However, the European based banks fared worse as Deutsche Bank, UBS and Credit Suisse had below-average growth. Thus, while we do not see an advantage for US-based banks as half of the companies performed better, we believe that the European-based companies are at a disadvantage.

Source: Company Data, Khaveen Investments

Based on the table, Morgan Stanley remained at the 4th position in asset management only behind Brookfield, KKR and Blackstone. KKR has the highest growth rate followed by Blackstone while Morgan Stanley underperformed the market average. Among the bulge bracket banks, only Goldman Sachs outperformed the market average and gained a share. Compared to investment banks, asset management is dominated by US-based companies. In terms of markets, the top 3 companies which were the best performers were private equity companies.

Overall, in both investment banking and asset management, Morgan Stanley managed to maintain its market position despite growing slower than the market average growth. We see the strength of the company as it is uniquely the only company positioned at the top 4 in both investment banking and asset management.

Risk: Diversification At The Expense Of Profitability

Source: Company Data, Khaveen Investments

Additionally, we staked Morgan Stanley against its key investment banking competitors in terms of its financial ratios including profitability ratios (net margins, ROE and ROA), leverage ratio (asset/equity) and efficiency ratios (non-interest expense/net revenue) to compare their financials. In terms of profitability, Morgan Stanley’s net margins are lower than its US-based competitors except for Bank of New York Mellon. This is as its employee expenses as a % of revenue are higher than competitors at 41% in 2021 compared to BAC (35.3%), Citi (31.2%), JP Morgan (27.2%) and Goldman Sachs (30%). Moreover, based on Dupont analysis, its ROE is the third-highest only behind JP Morgan and Goldman Sachs but is tied with JP Morgan with the second-highest ROA. On the other hand, its asset/equity ratio is not only lower than those companies but also lower than Bank of America and Citi Group which highlights the company’s lower leverage thus a lower ROE. Lastly, its efficiency ratio is also higher than JP Morgan and Goldman Sachs which indicates its weaker efficiency as it incurs more expenses relative to revenue. Though, the company and other US-based companies’ ratios are considerably better than their European counterparts with better profitability, leverage, and efficiency ratios.

Valuation

We updated our revenue projection from the previous analysis with its full-year 2021 revenue and projected beyond 2023 on the market forecast CAGR tapered down by 0.5% per year.

Source: Morgan Stanley, Khaveen Investments

To value the company, we used a DCF analysis as we expect it to have positive free cash flow. We based its terminal value on the industry average EV/Book Value of 3.29x.

Based on a discount rate of 7% (company’s WACC), our model shows its shares are undervalued by 45%.

Verdict

To conclude, we analyzed the company’s diverse revenue streams as it is present in both investment banking and asset management markets and projected its growth outlook beyond 2022 at 5.1% following an expected slowdown in growth as discussed in our previous analysis. Moreover, we believe its international expansion outlook is supported by its market share positioning in Europe and Asia as the second leading company with a market share of 13.9% and 15.1% respectively and only trailing behind Goldman Sachs in Europe and JP Morgan in Asia in 2021. Lastly, we expect the company to benefit as the only company in the top 4 by market share in investment banking (12.1%) and asset management (6.6%). From our previous analysis, our price target has increased with a lower discount rate of 7% in this valuation compared to 9% previously. Overall, we rate the company as a Strong Buy with a target price of $131.76.