ValueAct stake in Morgan Stanley shows challenges in big bank activism

August 16, 2016 2:16 PM EDT

The corporate logo of financial firm Morgan Stanley is pictured on a building in San Diego, California September 24, 2013. REUTERS/Mike Blake/File Photo

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By Olivia Oran

(Reuters) - ValueAct Capital Management's newly acquired stake in Morgan Stanley underscores how tempting big bank stocks are for activist investors, but also how difficult it can be for them to move the needle in terms of performance.

The hedge fund firm disclosed on Monday that it had bought $1.1 billion worth of Morgan Stanley shares during the second quarter, giving it a nearly 2 percent stake in the Wall Street bank.

But unlike some other well-known ValueAct investments, the firm said it as of now has no plans to seize a seat on Morgan Stanley's board or demand dramatic shifts in strategy. Analysts say that's because when it comes to big bank stocks, activists have little choice but to place a bet, express support and wait.

"We ... don't see too much of what an activist can do given the dependence on the markets and control the regulators have over things like capital return," Evercore ISI analyst Glenn Schorr said on Tuesday. "Maybe ValueAct's presence will just keep the pressure on - we'll take it."

Activists have been circling big banks for years, but few have been brave enough to take a position. Dan Loeb's Third Point Management LLC, which has dabbled in Morgan Stanley shares, may provide a playbook for what ValueAct will do.

Third Point jumped into Morgan Stanley's stock briefly in 2013, complained about excessive director pay, then exited at a profit soon after. It then invested in Morgan Stanley late last year and again sold the stock after booking quick gains.

In an email, ValueAct Chief Executive Jeff Ubben told Reuters he is "fully supportive" of Morgan Stanley Chief Executive Officer James Gorman and wants to "focus other investors" on the healthy businesses he has been developing. He did not provide a timeframe or price target for the investment.

Activists say agitating for meaningful change at a major Wall Street bank would be a hopeless endeavor because banks are stuck so tightly under the U.S. Federal Reserve's thumb. The Fed decides how they can use capital, the businesses they can pursue and must approve acquisitions or divestitures. Shareholder profits take a back seat to the safety and soundness of the banking system.

"The regulatory burden is much harder as you go up the size scale," said Jason O'Donnell, chief investment officer at Bluestone Financial Institutions Fund, which builds stakes in small and mid-sized banks.


Even so, big bank stocks can be alluring for value hunters.

Five of the biggest Wall Street banks – JPMorgan Chase & Co, Goldman Sachs Group Inc, Citigroup Inc or Bank of America Corp – trade at 0.76 times book value, on average, according to Thomson Reuters data. ValueAct purchased Morgan Stanley shares at 0.7 times book value, which it described as an "extraordinary discount."

"Bank stocks are incredibly out of favor," said Patrick Kaser, a portfolio manager at Brandywine Global who invests in the financial sector. "They're safer and have more capital but they're priced like they're going to collapse."

Activists launched 97 campaigns last year aimed at the U.S. financial sector, about triple the amount in 2009, according to Thomson Reuters data. Year-to-date, activists have taken aim at 10 U.S. lenders, usually targeting smaller banks with an eye toward M&A.

At bigger Wall Street firms, activists may call for cost cuts and streamlining troubled businesses. Bank management teams are already trying to do this on their own but not fast enough to satisfy many investors.

For instance, after Third Point first acquired a stake in Morgan Stanley, Gorman called Loeb to ask what he would do if he were in charge, according to a talk Gorman gave at NYU Stern School of Business last year. Gorman did not identify Loeb by name, but a person familiar with the matter confirmed he was referring to Loeb.

Loeb told Gorman that Morgan Stanley ought to get out of bond trading entirely, but Gorman explained why that was a bad idea.

"You can fire people, you can rent out their computers, you can convert our trading floor into a basketball court, but what do you do with the assets on your balance sheet?" Gorman recalled telling Loeb. "The only way you can fire the assets is to give it to someone else at a discount. So, with hundreds of billions of assets at a discount, you wipe out $50 billion of capital over night."

A Third Point representative did not immediately respond to a request for comment about the discussion.

ValueAct's Ubben may be more patient.

Explaining the Morgan Stanley investment in a letter to clients, Ubben said the stock was simply too cheap to pass up. He expects the market to eventually realize the value hidden behind distractions like the bank's small but troubled bond trading business and the Fed's heavy oversight.

"It feels like missing the forest for the trees," he wrote.

(Reporting by Olivia Oran in New York, additional reporting by Michael Flaherty; editing by Lauren LaCapra, Cynthia Osterman and Bernard Orr)

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