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Despite Facebook Debacle, Morgan Stanley Might Be a Buy

MS going through growing pains to reach some stability


Recommendation: Buy at support at $12.50 or buy on breakout over $15.

Option Alternative: Buy to open the MS Jan (2013) 15 calls for $1.75 per share or less on a breakout over $15.

In the aftermath of the disastrous Facebook (NASDAQ:FB) IPO, investors of Morgan Stanley (NYSE:MS) haven’t been happy, either.

Plagued by the perception of overexposure to risky European debt, a two-notch credit downgrade by Moody’s and the black eye of the Facebook IPO — as well as several other highly anticipated MS-led offerings that fell flat, such as Groupon (NASDAQ:GRPN) and Zynga (NASDAQ:ZNGA) — shareholders are hoping that Morgan Stanley can reignite its sputtering engine and return to the well-oiled operations of the firm’s past.

Granted, Morgan Stanley has managed to pull out just enough rays of light to keep investors hopeful. But the net effect has undeniably been negative, with the stock price falling from near $30 at the beginning of 2011 to $15 and under now. That’s just a couple of dollars above a three-year low, and not far from the lowest points touched during the panic of the 2008 crisis. After all, we remain in a headline-driven market — and most of Morgan Stanley’s appearances in the headlines during the past several months have been for the wrong reasons.

A New Gorman Legacy?

James Gorman replaced John Mack as Morgan Stanley’s chief executive in 2010. Mack had been something of a legend at the company — and while he did see to it that MS regained its spot among the Street’s elite banking firms, he did so in part by juicing the risk taken. The 2007-08 crisis brought the firm to its knees, necessitating federal bailout money and a huge injection of capital from Japanese bank Mitsubishi UFJ Financial Group (NYSE:MTU).

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Nevertheless, many investors still were wary when Mack stepped down. While Gorman hasn’t had easy shoes to fill, he has pared down the risk profile of the firm and is attempting to make its earnings less reliant on the operations of risk-happy trading desks dealing in esoteric financial products. But with MS shares down 50% from when Gorman first took over, many investors are nostalgic for Mack.

The process of transitioning to a more sedate, predictable company comes with its share of growing pains. But how long shareholders will give Gorman to see this process through is, needless to say, a vital issue in where the stock goes from here.

The Cost of Rebuilding Morgan Stanley

In its most recent earnings for Q2, one of the highlights of the company’s businesses was its wealth management arm. Despite overall revenue declining 24% from the year-ago period — as well as an announcement to reduce headcount across the firm by 7% by the end of year — income rose by 23% within the wealth management division. This was a surprising figure to some, given the ongoing task of completing the joint venture with Smith Barney, which MS took over from Citigroup (NYSE:C) in 2009.

Unfortunately, though, even this relative bright spot has proved to be more expensive and costly than anticipated. While MS has been in the final stages of converting over Smith Barney to a single, firm-wide platform throughout 2012, the process has resulted in increased technology expenses and temporarily lower production from advisers.

The full impact of this conversion process on earnings from the wealth management arm during the next quarter or two remains to be seen. Until then, the question for prospective investors is whether the current price represents limited downside, given the potential for a turnaround — or if MS’ struggles will endure longer than their patience can hold out.

A Floor at $12.50, Resistance at $1

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MS has shown substantial resiliency below the $13 level, with each sell-off being promptly rejected and the stock then bouncing back higher. But between the Facebook IPO, significant layoffs still looming and a reduction in trading revenue, the stock also has had a difficult time sustaining any rally over $15. Hence this four-month trading channel draws two very clear lines in the sand.

With MS just below the upper end of its channel, this probably isn’t the ideal time to bet on a breakout just yet. However, if MS drops back down to the lower end of the range near $12.50, this could also be a good time to accumulate shares, even if the outlook for the stock is dour.

An outright option position might be superior to a long position on the stock if it’s sized reasonably. In this case, we would recommend buying calls on another breakout to the upside above $15 per share rather than a bounce at $12.50. We like the Jan (2013) 15-strike calls for $1.75 per share or less.

Article printed from InvestorPlace Media,

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