Morgan Stanley's Acquisition Eaton Vance
By: Aidas Kaveckis, Rachel Tang, Jasmine Karimzada, Solomon Wong
Overview of the deal
Morgan Stanley and Eaton Vance announced a $7 billion merger deal in a 50% cash and 50% stock transfer transaction on 08 October 2020. The expected completion of the deal is in Q2 of 2021. Fitch ratings estimates that Morgan Stanley will focus on integrating E*Trade and complete the deal with Eaton Vance before engaging in further M&A.
Morgan Stanley is aiming to increase “more durable, lower-risk resources of revenue”, according to Fitch ratings. The previous $13 billion acquisition of E*Trade bolsters its wealth management business; through this deal, Morgan Stanley Investment Management will manage $1.2 trillion in assets, doubling its size to one of the world’s largest asset managers.
Company Details: Morgan Stanley
Morgan Stanley is a multinational investment bank offering financial services to governments, institutions and individuals through their Institutional Securities, Wealth Management and Investment Management divisions. As one of the world’s leading investment banks, Morgan Stanley operates in over 30 countries.
Headquarters: New York, United States
CEO: James Patrick Gorman (Jan 2010 – Present)
Number of employees: 60,000+
Market Cap: $115.499 billion
Enterprise Value (EV): $234.12 billion (27 November 2020)
LTM Revenue (ending September 2020): $45.415 billion
LTM EBITDA: $15.74 billion
LTM EV/Revenue: 5.16
LTM EV/EBITDA: 14.87
P/E Ratio: 10.79
Company Details: Eaton Vance
Eaton Vance is an investment and asset manager, managing funds and offering financial services to individuals and institutions. As one of the oldest investment companies in the United States, it has 5 investment affiliates that offer strategies including passive, active, responsible and rules-based investing.
Headquarters: Boston, Massachusetts, United States
CEO: Thomas Faust Jr.
Number of employees: 1,870+
Market cap: 7.86 billion
Enterprise Value (EV): 9.55 billion
LTM Revenue (ending October 2020): $0.451 billion
LTM EBITDA: 413,606
LTM EV/Revenue: 5.52
LTM EV/EBITDA: 23.10
P/E Ratio: 57.27
The acquisition creates an investment management business that will oversee $1.2 trillion of assets, almost double of Morgan Stanley Investment Management’s (MSIM) current AUM of $715 billion, and generate more than $5 billion in revenue. Both MSIM and Eaton Vance have been growing assets in the run-up to the deal. MSIM experienced organic growth of 21% for the 14 quarters to the end of Q2 2020, while Eaton Vance has seen organic growth of 19%, significantly higher than the industry average of -3% for active shops. The increased scale and growth potential provides a stronger market position for Morgan Stanley to compete effectively against rival banks and passive fund houses.
A key rationale for this deal is the complementary portfolio strengths of both companies, which will allow the combined business to cross-sell a broader range of products and offer more customization in clients’ portfolios. In addition to its strength in fixed income, Eaton Vance has a strong foothold in ESG through its Calvert business, providing an opportunity for Morgan Stanley to tap into the rising trend in ESG investing and direct indexing.
In addition, MSIM will get Eaton Vance affiliate Parametric, which offers SMAs of customized indices, as part of the deal. Parametric’s offerings could complement E*Trade’s stock plan business which Morgan Stanley recently acquired. The acquisition fills product gaps in MSIM’s portfolio which is relatively stronger in equities. As the biggest distributor of Eaton Vance funds already, Morgan Stanley can offer Eaton Vance’s products to its international client base. Eaton Vance is the top US distributor of individual separate accounts, which Morgan Stanley can leverage on to sell its existing products to retail investors.
Morgan Stanley expects the deal to reduce the combined expense base by 4%, delivering annual savings of $150 million. It will have a break-even effect on earnings per share immediately and can be marginally accretive in the longer term.
Along with its acquisition of discount brokerage E*Trade, the decision to acquire Eaton Vance is in line with Morgan Stanley’s wider strategy to diversify away from investment banking which is prone to volatile revenues. Instead, it plans to grow fee-based asset management services with higher, more reliable margins. Morgan Stanley’s wealth and investment management businesses already account for 40-50% of the bank’s revenue. Adding Eaton Vance is expected to boost the business’s annual revenue by one-third, representing a significant shift in Morgan Stanley’s overall focus. Morgan Stanley CEO James Gorman hopes that this shift will persuade investors to view Morgan Stanley less like an investment bank and more as an investment manager, potentially boosting its stock price - pure play asset managers like Blackrock are trading at double the P/E multiples of Morgan Stanley and Goldman Sachs.
Though steady, predictable fees are attractive, asset managers that charge a premium for actively managed funds face competition from passive funds, which has seen a rise in popularity due to its low cost. For mid-sized asset managers like MSIM and Eaton Vance, achieving scale through consolidation will help them to compete on price and increase operating margins.
Risks and uncertainties
Risk of overpayment for the acquirer
Morgan Stanley will pay Eaton Vance shareholders $28.25 per share in cash, and 0.5833 of its shares for each Eaton Vance share held, which is 38% in excess to Eaton Vance’s closing share price on October 7th, 2020. The key question here is: Does the value created for the acquirer’s shareholders justify the premium paid to the target? If Morgan Stanley wants to capture any value from this deal, they will have to increase the cash flows of the combined companies by at least 38%. This lofty target will remain a critical challenge for the acquirer to achieve and adds risks to its current business.
Increased volatility and compliance costs
Regulators are demanding more legal compliance from asset managers. With the MiFID II introduced in the EU in 2018, asset managers are required to increase their transparency in reporting, pricing and execution of trades. The implications for AM businesses were immediate – operating costs went up and profit from management fees were compressed. As the COVID-19 pandemic brings more volatility to the market, asset managers are seeing an influx of capital into their funds, as well as a rise in costs associated with regulatory compliance. After the acquisition, the combined business’s AUM amounts to a total of $1.2 trillion, and managing such an enormous portfolio will be more difficult than ever given current market conditions.
Obstacles to realising synergies
Integrating Eaton Vance into Morgan Stanley may prove to be challenging, given the differences in portfolio structures of the two companies. For instance, the largest portion of Morgan Stanley’s Investment Management’s assets is held under Global Liquidity, accounting for 37.8% of the AUM, whilst the majority of Eaton Vance’s assets are held under Parametric Custom Portfolios. The difference in investment strategy between both companies can be hard to overcome, and will require significant attention from the management team. Moreover, with more economic uncertainties during the pandemic, tensions are likely to be elevated between the acquirer and target. It remains interesting to see how Morgan Stanley can overcome these barriers and deliver value to its shareholders after the acquisition.
Deal implications for the asset management industry
Morgan Stanley’s Investment Management division’s, as a result of both internal growth and acquisition of Eaton Vance, AUM will now be over $1.2 trillion. As a result, Morgan Stanley will leap from being a top-50 asset manager in the world to top 20, becoming a true global player in the asset management industry.
Following the 2008 global financial crisis, investment banks were selling off asset management businesses. In 2009 for example, Morgan Stanley itself sold off Van Kampen Investments to Invesco – a move which was called a mistake by the Morgan Stanley CEO James Gorman in 2018. The market currently is seeing a complete reversal of this trend - asset management is moving towards consolidation, as current players are seeking expansion of their investment businesses.
Jamie Dimon, the CEO of JPMorgan Chase, said in October that his bank was “very interested” in buying an asset manager, while David Solomon, CEO of Goldman Sachs, hinted that he would “take a very hard look” if a suitable acquisition opportunity appeared. Recent notable transactions include Franklin Templeton’s $6.5bn acquisition of Legg Mason, Brookfield Asset Management’s purchase of a majority stake in Oaktree Capital and Charles Schwab’s acquisition of USAA.
Dan Simkowitz, head of Morgan Stanley’s Investment Management division, said that the acquisition of Eaton Vance had “nothing to do with” consolidation in the investment management industry but was rather an opportunity to purchase an attractive asset, as well as fill gaps in Morgan Stanley’s business. However, the CEO of Morgan Stanley, James Gorman, had said 2 years ago that he wants to double the asset management business of the company in the upcoming 5-7 years.
One reason why the sector is moving towards consolidation is large competition. According to Willis Towers Watson, the top 500 asset managers amounted to US$ 104.4 trillion AUM at the end of 2019. “Asset management is the second-most fragmented industry globally after capital goods. The top 10 firms have a combined market share of just 35 per cent,” said Michael Cyprys, an analyst with Morgan Stanley. Such low market share by the biggest players in the industry leaves a lot of room for M&A activity in the future.
According to a report by Morgan Stanley, strong financial markets during 2020 helped fuel the growth of assets, however, it has masked problems such as lower revenue growth, fee pressures, and outflows, which became apparent during the stock market downturn in March. Decreasing profit margins are putting more and more pressure on asset managers, therefore, expanding inorganically and increasing scale could help lower costs.
Moreover, according to a report by Piper Sandler, a Minneapolis-based investment bank, only half of the asset management business today will remain by 2030, as 10 companies will emerge victorious and control more than 5 US$ trillion each, due to ever-increasing M&A activity in the industry. The deal between Morgan Stanley and Eaton Vance could very well set off a chain of “merger mania” in the asset management industry, an industry which is inevitably moving towards consolidation due to competition.