Lunchtime Links: A hypothetical argument for buying Morgan Stanley and closing its entire trading business

Brad Hintz at Bernstein Research has released a note which could strike fear into Morgan Stanley's underperforming fixed income traders. As we noted yesterday, they're not doing very well: even after a whole load of hiring, Morgan's FICC revenues were down 36% year on year in the first quarter (vs. -14% across leading banks as a whole).

Now Hintz has done some sums and come up with a worrying conclusion: Morgan Stanley is currently trading below tangible book value, meaning that if another company bought Morgan Stanley, closed down its trading business and liquidated the inventory positions, it would end up with something worth more than the business it paid for.

Here's the long version

Theoretically, an acquirer of MS at a price below

tangible book value could buy the company, liquidate the inventory positions at their marks; pay off the commercial paper, MTNs and repo; cover the short equity positions on the balance sheet and novate the long and short derivatives; write down the goodwill, shut down the trading units and underwriting activities and still control a massive global M&A boutique, an underperforming asset management operation, an enormous "work in progress" retail brokerage segment and a large pool cash on the balance sheet.

Essentially by buying MS at a low price and liquidating the trading balance sheet, an investor pays off all the debt and gets a high ROE retail brokerage, asset management and M&A advisory business at a low price.

Hintz also notes that Morgan Stanley's fixed income business has consistently failed to meet its cost of capital ever since the credit crisis and that the institutional sales and trading business as a whole consumes around 80% of MS's balance sheet. The implication is that revenues had better manifest themselves soon.

However, Hintz doesn't advocate that Morgan Stanley pursues his hypothetical sale scenario. Overall, he is bullish about the stock and thinks there's plenty of potential for upside long term. Even in the most pessimistic scenario, MS stock looks woefully undervalued, Hintz concludes. This could yet prove good news for the people who received lots of it in last year's bonus round.

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