Morgan Stanley's Midlife Crisis
Philip J. Purcell was in his element. On Jan. 25, the lanky 6-ft. 4-in. chairman and CEO described his dream to a crowd of 70 Morgan Stanley (MWD ) executives at The Boulders resort nestled in the sandy Sonoran desert foothills of Arizona. The firm, he said, should become the gold standard for financial services, just as Walt Disney Co. (DIS ) is for entertainment and IBM (IBM ) once was in computers. "To me, a great company is defined by the fact that it is not compared to its peers," says Purcell.
Purcell had reason to be upbeat. Just three days earlier, the firm's charismatic president and chief operating officer, John J. Mack, who had been president of Morgan Stanley before it was bought by Dean Witter & Discover Financial Services Inc. in 1997, told Purcell he was quitting. With Mack's resignation, one of the most bruising power struggles for the title of chief executive on Wall Street had ended abruptly. And to the surprise of many, Purcell had won. The rout was so complete that the board even refused to let Chairman Emeritus Richard B. Fisher speak to them about Mack's departure. Consolidating his victory, Purcell immediately put himself in charge of what had been Mack's domain: the investment bank.
Yet since then, McKinsey & Co. alum Purcell hasn't had much to celebrate. So far this year, Morgan Stanley's stock price has underperformed those of its peers by as much as 25% (chart). Now, analysts expect its second-quarter earnings to slide 37%, vs. 28% for its rivals, according to Thomson Financial/First Call Corp. And on Apr. 24, Purcell ordered the biggest staff cuts--1,500 of 65,600 employees--in Morgan Stanley's 68-year history. With initial public offerings and mergers and acquisitions stuck at less than half last year's levels, Purcell may be forced to make further cuts. Already, other banks are chasing after the firm's top guns by offering at least 25% more than they earn at Morgan Stanley. Since January, Deutsche Bank alone has hired four people above director level, including David Jacobs, head of the global consumer investment-banking group, in May.
LOADED FOR BEAR. Yet none of this is stopping Purcell from striking out in bold new directions. To regain Morgan Stanley's edge, the 57-year-old CEO believes it must do more than just beat "the boys downtown," its traditional investment-banking rival Goldman, Sachs & Co. (GS ) He wants to take on huge financial juggernauts such as Citigroup (C ) and newly minted J.P. Morgan Chase & Co. (JPM ) That means Purcell may have to buy a commercial bank. Like other investment banks, Morgan Stanley is under increasing pressure to lend money to top corporate clients in order to snag lucrative investment-banking deals. "You either allocate enough capital to bank it yourself, or you buy a bank," says Purcell. To truly compete in the same league as Citigroup, Purcell feels he must also build up retail and asset-management franchises that outflank rivals everywhere from New York to Hong Kong to Munich. And in a brutally competitive credit-card market, he must either shed his Discover Card operations or build them up by digesting a rival--possibly as large as American Express Co., with a $55 billion market capitalization.
Morgan Stanley is in the throes of a midlife crisis. Not since Purcell snapped up Morgan Stanley for $10.5 billion in 1997 has the firm attempted to change so profoundly how it conducts business on so many fronts at the same time. With Mack out the door, Purcell is finally free to implement the kind of business model he had in mind. If Mack had remained, says Richard K. Strauss, securities industry analyst at Goldman Sachs, the firm "would have focused more on corporate and investment banking." More than just bolstering credit cards, retail, and asset management, Purcell is reining in the macho dealmaking culture that has defined Morgan Stanley. He is changing compensation across the bank, preaching client satisfaction, bridging chasms between departments, and giving a younger generation of managers attuned to strategic thinking a bigger role in the business.
Still, the spirit of Mack the Knife, as he's known, continues to haunt the firm. Inside Morgan Stanley, there are rumors that Mack is being considered to succeed Citigroup's Sanford I. "Sandy" Weill or Merrill Lynch's David H. Komansky. Both firms decline to comment. There is even, perhaps wishful, speculation that he may come back to run Morgan Stanley again. If Mack lands at a rival, Purcell could end up more threatened than he was before Mack left. After all, Mack was responsible for building up the firm's prestigious investment-banking franchise that garnered 64% of its $8.5 billion in pretax earnings last year. And Purcell has yet to win the hearts and minds of the investment bankers. He angered many when he apologized in early February to clients upset that Morgan Stanley invited ex-President Bill Clinton to speak at a high-yield bond conference rather than back the decision. The department head concerned later left the firm. "No one on the institutional side would think to leave if Purcell left," says a Morgan Stanley banker who asks not to be named. "In fact, they'd probably have a party."
But Purcell has a history of proving naysayers wrong. After leaving McKinsey in 1978 for ailing Chicago retailer Sears, Roebuck & Co., he defied conventional wisdom by successfully launching the Discover Card in 1986 when there supposedly was no room in the market for another major credit card. Then, he made also-ran securities firm Dean Witter, spun off from Sears in 1993 with a market capitalization of about $4.7 billion, strong enough to buy Morgan Stanley four years later.
WHIZ KIDS. Now, Purcell is clearly counting on staging an encore. "The way [our] businesses are going to develop is going to be different from what most people predict," he says, relaxed and smiling in his office towering over New York's Times Square. "It will play to our strengths." For example, Purcell sees Morgan Stanley's fast-growing business of providing hedge-fund managers with pretty much all the services they need--clearing and execution of trades, accounting, and risk management--as a wave of the future. Morgan Stanley is now Wall Street's largest prime broker for hedge funds, serving at least 201 of them with aggregate assets of $32.6 billion, according to a recent Hedgeworld research study of 998 hedge funds. (The next largest is Bear, Stearns & Co., with $22 billion in assets.) He wants Morgan Stanley to provide similar bundles of services to other customers such as pension and mutual funds, which he expects to become more like hedge funds in the future. "No one agrees with that. But that's how firms gain an edge," he says.
Under Purcell's command, Morgan Stanley has started to shake up its ranks. Until now, employees were paid handsome bonuses for landing deals or boosting the revenues of their own departments. But in September, the firm will start to phase in rules that tie compensation to how big a share Morgan Stanley gets of the total fees each client pays to Wall Street rather than the absolute dollar amounts of transactions. Purcell is building a 32-story skyscraper on Seventh Avenue to consolidate Morgan Stanley employees spread around New York City. And he has enlisted a team of newly promoted whiz kids to create a system for serving clients methodically--and better. Many are hard-driven strategic thinkers, not unlike Purcell. They throw around broad concepts like "Big Hairy Audacious Goals" such as generating billions of dollars in new revenues. "Easily the most important thing I've done is pick people," says Purcell.
"HERCULEAN TASK." He wants his bankers to become so familiar with their clients that they can recommend financial solutions across equity and debt divisions as adroitly as Amazon.com Inc. suggests books and other products to repeat customers. As a first step, Morgan Stanley is now identifying its best clients across the firm. "If I go to see the CEO of Allstate now, and I want to know how much business we do with them, it's a Herculean task," says Purcell.
As one of two new co-heads of the investment bank, Vikram S. Pandit, is Purcell's lead architect. On a table in his office, Pandit keeps a replica of the Rosetta stone, the key that enabled archaeologists finally to decipher Egyptian hieroglyphs. To him, it symbolizes cracking the code to better serve clients by breaking down barriers between different departments. As a start, Pandit and Stephan Newhouse, his fellow co-head, have created a team of 15 fortysomething managing directors who have worked at Morgan Stanley an average of 17 years. Most of them head traditional product divisions, such as fixed-income or equities, while four are in completely new roles focusing on strategy, marketing, risk, and overseeing all research and analytical work. Other managing directors are now responsible for monitoring clients both on client relationship committees in separate divisions and across the entire investment bank.
The most drastic reorganization within the investment bank so far has been carried out by Zoe Cruz, known as Cruise Missile, who became head of the fixed-income division in September. Since January, she has cut the number of people who directly report to her to 8 from 22. By doing so, she shattered a chain of command that had been in place for more than a decade. To keep up with the growing needs of rapidly consolidating clients, for instance, she put one person in charge of the fixed-income division's high-yield, investment-grade debt, and securitization departments. "Clients started knowing more about Morgan Stanley across our products than we knew about them," says Cruz. By reversing that equation, Cruz expects to drastically boost the bank's share of global debt issuance.
Already, the new team has pulled off a controversial deal that made Wall Street sit up and take notice. In March, they orchestrated the $3.6 billion spin-off of Agere Systems, Lucent Technologies Inc.'s (LU ) optical electronic unit, the fourth-largest initial public offering in U.S. history. Pandit's team not only had to pick the precise moment when the deal could be priced as telecom issues melted down but also risked a complicated debt-for-equity swap to raise the most cash possible for Lucent. Morgan Stanley essentially extended a bridge loan to Lucent by purchasing at one point as much as $2.3 billion of its debt to be exchanged for Agere equity at the IPO. the tactic saved Lucent $200 million in taxes.
But when rumors started swirling that Lucent was about to go bankrupt, Morgan Stanley's stock plummeted. In fact, Morgan Stanley was at less risk than many initially thought. Most of the debt was commercial paper with a one-day maturity that was backed by $6.5 billion in existing credit lines from other banks. Ultimately, the deal paid off handsomely. Goldman Sachs estimates that, all told, Morgan Stanley received $75 million for the transaction. Morgan Stanley executives declined to comment on their fee. But they satisfied their client: "Like most people, I'm skeptical of bankers," says John T. Dickson, president and CEO of Agere. "In this instance, they earned the money." The boldness of the deal also impressed some skeptical competitors. "A lot of firms probably could not have pulled that deal off," says a senior banker at a rival firm.
TWO ARMIES. Morgan Stanley's retail network is getting as radical a shake-up as the investment bank. Sixteen of the 19 executives who run the retail brokerage are new to their jobs since September. One of the new hires, marketing whiz Stephen Liguori, who worked for Citibank, Kraft Foods, and PepsiCo, is building the division's first consumer-marketing department from scratch. The new team is also now introducing a common operating system for the firms' two distinct armies of brokers--one from Dean Witter and one from Morgan Stanley--four years into the merger. Although the communications network necessary for Dean Witter brokers to access Morgan Stanley research and IPO data was put in place immediately after the merger, the two back offices were never combined. "We were in such a good market in 1997 that everyone said, `Let's not screw it up,"' recalls John Schaefer, who became the head of Morgan Stanley's retail division in September. "We woke up four years later, and we still hadn't taken care of the piping. It's hard to serve clients with a patchwork of operating systems."
Morgan Stanley's asset management division is also breaking down barriers. In May, it finished combining four different mutual fund groups and renamed the division Morgan Stanley Investment Managers, which has $400 billion in assets under management. The change has given the group's portfolio managers much better access to the CEOs of major companies. "We get first call now," says Mitchell M. Merin, head of asset management.
MOUTHFUL. The credit-card division is the wild card in Purcell's strategy. Persistent market rumors have it that Morgan Stanley may sell its Discover unit or merge with American Express. Although Discover is just No. 5 in the business in the U.S., with $47.6 billion in debt outstanding, Purcell does not feel that a major transaction in the near term is necessary. "It's a fine business," Purcell says. With a market capitalization of $66 billion, it would be difficult for Morgan Stanley to swallow American Express, worth $55 billion. "I'm not sure who would buy whom," says Guy Moszkowski, securities-industry analyst at Salomon Smith Barney. And many bankers doubt recently appointed American Express CEO Kenneth Chenault would want to work for Purcell. Meanwhile, if the U.S. District Court in Manhattan strikes down Visa and MasterCard rules that prevent thousands of banks from also offering Discover cards, Morgan Stanley's franchise would become much more valuable. Indeed, if you listen to executives in the division, they're as interested in buying other credit-card companies as they are in selling. "We will be bidders on international card portfolios as they become available," says David Nelms, head of the credit-card division. "In terms of being a seller, I think we provide great value for Morgan Stanley. There's a lot of value. I don't believe Discover is worth more to someone else than it is to us."
In its foreign operations, Morgan Stanley's investment bank is top-notch. Where the foreign division falls down is in its retail, asset management, and credit-card franchises. So far, its only European credit-card operation is in Britain. And it is little more than a niche player in European asset management, with $40 billion in local funds under management. Morgan Stanley has a profitable institutional business in Holland, and it acquired a midsize Spanish retail broker called AB Asesores for about $350 million in 1999 as well as a small British broker called Quilter Holdings Ltd. for $235 million in 2000. In addition, it is expanding a small, private-banking operation in Germany. But compared with the big Continental banks or even U.S. firms such as Merrill Lynch & Co. or Fidelity Investments, Morgan Stanley's asset management in Europe has a lot of ground to make up. "It's a question of walking before you run," says John J. Studzinski, deputy chairman of Morgan Stanley International.
SHRINKING IPO. In Asia, Morgan Stanley is wrestling with how it can maintain the relations that Mack had built up over many years. Newhouse, not Purcell, has taken Mack's seat on the board of the firm's joint venture in China, called CICC. Before Mack left, Morgan Stanley looked set to pull ahead of the pack by leading China Telecom's IPO, which was expected to be China's largest ever--a deal that Mack had cut. The Chinese government is now considering splitting the company into several different offerings. Nevertheless, "it will certainly be a multibillion-dollar transaction," says Mario Francescotti, head of Morgan Stanley's operations in Hong Kong. However, the IPO will be smaller than expected and could be delayed by up to six months.
Purcell has made an amazing journey from Sears Roebuck to Morgan Stanley. And it remains to be seen whether he can uphold the grandeur of one of the most famous names in investment banking. But that's clearly his intention. Less than two weeks after Mack left, Purcell dropped Dean Witter from the firm's name.
By Emily Thornton in New York, with Stanley Reed in London