Morgan Stanley is a dubious saviour for UBS

UBS AG

Mon 12:54

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
By Liam  Proud
LONDON, Nov 3 (Reuters Breakingviews) - The possibility of Morgan Stanley MS.N buying UBS UBSG.S is the rumour that refuses to die. One crucial question for CEO Ted Pick is what an acquisition would yield for shareholders in the $288 billion Wall Street bank if the Swiss lender decides a change of ownership is the best way out of its domestic capital dilemma. The return on investment looks far from stellar, potentially making it tricky to justify such a risky move.
The Zurich-based group, chaired by Morgan Stanley alumnus Colm Kelleher, is considering how to respond if Swiss lawmakers go ahead with capital reforms which the bank's management dislikes. Options include shifting the headquarters, perhaps by acquiring a smaller US bank, or even selling to a rival. In the latter case, Morgan Stanley seems the most logical acquirer. It has a US head office, a large American wealth-management business and may like to expand its Asian and European presence.
There is also a sharp valuation discrepancy between the two banks, potentially adding to the appeal from Pick's perspective. Morgan Stanley trades at 3.4 times 2026 tangible book value, against UBS's multiple of 1.7. In one sense, then, the US firm could get its hands on a similar business to its own at half the price.
The combination would be the biggest bank deal ever, even if Morgan Stanley decided to leave out UBS's domestic Swiss unit, which Jefferies analysts have valued at $39 billion. Deduct that figure from UBS's current market value and the global wealth, investment banking and asset-management units are worth $111 billion. If Pick offered, say, a 25% premium to that figure, Morgan Stanley's outlay would be a chunky $138 billion. UBS shareholders would own one-third of the combined group and Morgan Stanley investors the rest.
In return, Pick would get businesses producing profit after tax of about $13.1 billion in 2030, using Visible Alpha consensus estimates for UBS, minus the Swiss division. A further carrot would be cost savings, or "synergies" in M&A lingo, which could be huge.
Start with US wealth. When Morgan Stanley teamed up with Citigroup's C.N Smith Barney in 2009, it sought to axe 15% of the units' combined expenses, excluding financial-adviser compensation. Applying the same metric to Morgan Stanley's wealth unit and the UBS Americas brokerage business would save $1.7 billion a year. Bashing together the two banks' asset management arms would be another cost-cutting opportunity. The savings could be 12% of combined expenses, or $850 million. That's based on applying the median cost-synergy ratio for fund management mergers, from a recent benchmarking exercise by Goldman Sachs GS.N for Janus Henderson.
The biggest bloodbath, though, would be in investment banking. If Pick were aggressive, he might aim to axe all of the UBS unit's overheads, like administration and technology, while firing enough surplus investment bankers to halve its compensation bill. Such a purge would strip out costs worth about $7.5 billion, according to Breakingviews calculations.
Add it all up, and the savings from the deal would exceed $10 billion. If restructuring expenses totalled 1.1 times the cost savings, the same ratio as when UBS rescued Credit Suisse in 2023, the return on Morgan Stanley's invested capital would be over 14% - well above a typical 10% cost of equity for Western banks.
However, such a complex integration would also lead to lost business. Some European or Asian billionaires who bank with UBS might be less willing to entrust their nest eggs to an American wealth manager. Likewise, investment banking layoffs would reduce revenue, while trading counterparties that currently deal with both banks would limit their exposure to the combined group. Assume these "dis-synergies" equate to 10% of expected 2030 revenue for UBS's investment bank and its non-US wealth business. In that case, Morgan Stanley's return on investment would fall to just below 13%.
Such a payback looks unappealing for the American group, which analysts expect to earn a 24% return on tangible equity next year. Nor does it leave a huge amount of headroom for unforeseen setbacks like a market correction or deteriorating economy. And while Pick would get the added benefit of releasing capital that UBS would otherwise have to hold under Swiss law, that boost could be offset by a higher surcharge regulators demand from the largest global systemic banks.
Of course, there are many other ways to assess M&A, some of which may paint a kinder picture of the deal. Yet middling returns nonetheless offer UBS investors reasons to doubt that Pick will be their saviour.
This doesn't leave UBS entirely trapped in its landlocked Alpine home nation, though. Buying a smaller American bank - perhaps a wealth manager like Raymond James Financial RJF.N or a regional lender such as Citizens Financial CFG.N - would leave UBS in control of the combined group, and create a potential path to switch domiciles over time. This would also give the Swiss group extra scale in the world's largest economy, helping to boost its profit margins there. The M&A maths suggests UBS is more likely to be an acquirer than an acquiree.
     
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CONTEXT NEWS
UBS is working on possible scenarios ​including shifting its headquarters, or a merger with another bank, if Switzerland introduces new banking rules it deems excessively strict, Reuters reported on October 16 citing three people familiar with the matter.
A group ​inside the bank is considering the various options, which include drawing up a list of smaller banks in the ​United States that UBS could potentially buy, and the prospect of the bank being taken over itself, according to the report.
People familiar with the bank's thinking told Reuters that US investment bank Morgan Stanley would be the best theoretical match for UBS, the report stated. The Swiss bank has repeatedly stated that it is not planning to move and sees great value in its Swiss base.

(Editing by Peter Thal Larsen; Production by Streisand Neto)
((For previous columns by the author, Reuters customers can click on PROUD/liam.proud@thomsonreuters.com))