Morgan Stanley Bets E-Trade Will Dodge the Dean Witter Jokes

Morgan Stanley's merger a quarter century ago with a brokerage that had branches in Sears was met with sneers. Wall Streeters joked it was a deal combining white shoes with white socks.

But with the painful Dean Witter Discover deal now ancient history, the firm is taking another stab at luring mom-and-pop investors: a $13 billion acquisition of E-Trade Financial Corp., the discount brokerage that shot to prominence in the day-trading heyday of the 1990s.

Like his predecessors, Chief Executive Officer James Gorman is using mergers to reshape the bank for a daunting new era. Morgan Stanley's tie-up with Dean Witter Discover in 1997 was followed by the purchase of Smith Barney in 2009, a deal that cemented its pivot to managing people's money as a source of growth.

"I worked for a guy who used to say there is no birth without blood and pain," former CEO Phil Purcell, who left Morgan Stanley in 2005, said in an interview. "Dean Witter was painful. Smith Barney was very painful. It was also the right strategic move."

And the roughly 30% premium Morgan Stanley is dishing out for E-Trade?

"They are paying a premium for a company that is a fraction of market value," the 76-year-old former CEO said. In 1999, "there were people who were gods on Wall Street at the time saying we should acquire Charles Schwab. That would have been a catastrophe," he said, referring to Schwab's valuation relative to Morgan Stanley.

"Everything James Gorman has done has been right," Purcell said.

Big financial companies are in a race to lure small investors with digital services that many view as the industry's future. Goldman Sachs Group Inc. is making its first forays into the world of retail finance, and even itself considered a deal with E-Trade before giving it a pass, according to a person with knowledge of the matter.

Skeptical Investors

Morgan Stanley's E-Trade takeover is the industry's biggest since being saddled with regulations that crippled some of its signature businesses in the wake of the financial crisis.

Gorman spent his first decade atop Morgan Stanley reshaping the white-shoe firm into a wealth-management colossus that's tried to diminish its exposure to the vagaries of the trading and investment-banking operations that dominate Wall Street.

Now he's taking a leap into a digital-banking future that could draw in millions of customers and give Morgan Stanley a springboard to go international with new banking products.

Investors and some analysts are still skeptical.

"The plain old timing of this deal is not ideal," Mike Mayo, an analyst at Wells Fargo & Co., said in a Bloomberg Television interview. "After seeing so many of these marriages go afoul, we have more of a skeptical hat on."

Shares of Morgan Stanley slumped as much as 4.4% after the deal was announced, though Gorman said he expects that decline to be short-lived.

"We just bought a $13 billion business," he said in an interview. "The fact that shares are down a few percent is not surprising. I don't expect that to be a permanent state."

Digital Demand

The all-stock takeover adds E-Trade's $360 billion of client assets to Morgan Stanley's $2.7 trillion, the companies said Thursday in a statement. Morgan Stanley also gets E-Trade's direct-to-consumer and digital capabilities to complement its full-service, advisory-focused brokerage.

"Our clients increasingly want digital access and digital banking, and their clients want wealth-management advice," Gorman said. "A number of stars aligned."

In reshaping the firm since the financial crisis, Gorman has been emphasizing Morgan Stanley's wealth-management powerhouse. Purchasing E-Trade helps him add clients who are less wealthy than its traditional customers.

The New York-based company has lost some business to the retail brokerages in recent years as those firms invested heavily in their web platforms.

Upheaval in the retail-brokerage industry also helps explain the timing. In early October, Charles Schwab Corp. eliminated commissions for U.S. stock trading, spurring other brokerages to follow suit and sweeping away an important revenue stream.

The following month, Schwab agreed to buy rival TD Ameritrade Holding Corp. for about $26 billion and create a mega-firm with $5 trillion in assets, forcing smaller brokerages like E-Trade to contend with a much more formidable competitor.