Morgan Stanley and Citigroup Inc. executives raced overnight to end a two-month dispute over the value of their jointly owned brokerage, hashing out a deal that sent shares of both banks higher when markets opened today.
Perella Weinberg Partners LP, an investment bank hired to provide an independent valuation for Morgan Stanley Smith Barney, set off the flurry of talks yesterday by delivering a verdict below $13.5 billion after U.S. markets closed, people with direct knowledge of the matter said. The figure was so low -- in the bottom third of a range between Morgan Stanley’s $9 billion estimate and Citigroup’s $22 billion -- it triggered a contractual clause pushing the price on a 14 percent stake down even further.
After months of debate over the unit’s earnings potential and the brokerage industry’s future, the overnight effort yielded an agreement for Morgan Stanley to buy the rest of the business in pieces through 2015 at a fixed valuation of $13.5 billion. The accord avoided repeated fights in future years over what the unit is worth and helped Citigroup lock in a price higher than Perella’s current assessment.
Citigroup Chief Executive Officer Vikram Pandit, 55, and Morgan Stanley CEO James Gorman, 54, both praised the deal in statements for providing “certainty” as they finish the unit’s sale in coming years. “The more we put the past behind us, the more we can focus on our future,” Pandit said.
Morgan Stanley climbed 3.9 percent to $17.25 today in New York. Citigroup advanced 2.6 percent to $32.66. Spokesmen for the New York-based banks said they couldn’t comment.
The banks had tried and failed to bridge their differences during talks in late August, according to one of the people, who declined to be identified because the negotiations weren’t public. As the month ended, the firms announced that the value would be set on Sept. 10. After Perella delivered the valuation yesterday, Gorman called Citigroup’s leadership about 5:30 p.m., the person said.
Investment bankers for both sides convened at Morgan Stanley’s headquarters around 7 p.m. to work out a resolution, one of the people said. Morgan Stanley’s contingent was led by Gorman and mergers chief Robert Kindler, who squared off with Citigroup securities-division Chairman Edward “Ned” Kelly, the people said. Peter Weinberg and Gary Barancik oversaw Perella Weinberg’s involvement, one person said.
Pandit monitored the talks from Citigroup’s headquarters on Park Avenue, one person said.
While the talks were initially supposed to determine the price Morgan Stanley would pay for a 14 percent stake, the sides soon began discussing a price for Citigroup’s entire 49 percent holding, that person said. Morgan Stanley’s hand was strengthened by Perella Weinberg’s valuation. The basic terms of a deal were hashed out within hours and passed to lawyers to draw up the legal paperwork, another person said.
Morgan Stanley’s Gary Shedlin, a former Citigroup investment banker, supported Kindler in the negotiations, while Kelly was backed up by Citigroup investment bankers including David Head, the person said.
The two banks formed Morgan Stanley Smith Barney in 2009 in a deal negotiated by Kelly following Citigroup’s $45 billion bailout by U.S. taxpayers. Morgan Stanley paid $2.75 billion for a 51 percent stake and the right to buy the rest over time. Morgan Stanley announced in May that it would exercise its option to buy a 14 percent piece, increasing its stake to 65 percent.
The original agreement spelled out a formula for setting the valuation. First, the gap between the banks’ estimates would be divided into thirds. If Perella’s estimate fell in the middle portion, the transaction price was to be set at that level. If it were in the upper or lower third, the final price would be the average of Perella’s estimate and the closest bank estimate, according to a procedure Morgan Stanley outlined in a May filing. The rules were supposed to discourage the sides from trying to artificially skew the valuation.
Because Perella’s appraisal was in the bottom third, the formula would have produced a valuation of less than $11.5 billion, one of the people said.
Citigroup today said it expects to take a $4.7 billion pretax charge in the third quarter because the $13.5 billion valuation is lower than the carrying value on its remaining stake. The expense may have been greater, had the bank failed last night to negotiate a higher valuation for the 14 percent stake.