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Morgan Stanley wants all of Citi venture: sources

By Lauren Tara LaCapra

(Reuters) - Morgan Stanley is interested in buying all of Citigroup Inc's stake in their wealth management joint venture this year in what could be a roughly $10 billion deal, said people familiar with Morgan Stanley management's thinking.

Under the terms of the Morgan Stanley Smith Barney joint venture, Morgan Stanley will get an option starting May 31 to buy 14 percent more of the business from Citigroup, adding to the 51 percent stake it already has. It has options to buy the remaining portion in two more chunks through May 2014.

But both sides are beginning to suggest they would be interested in doing a deal for Citigroup's entire 49 percent stake now instead of waiting for two more years, and have started behind-the-scenes posturing to negotiate.

Morgan Stanley and Citigroup spokespersons declined to comment on the potential for an accelerated deal.

Citigroup is carrying its stake in Morgan Stanley Smith Barney at a $21 billion valuation, while Morgan Stanley is carrying its stake at just shy of a $20 billion valuation. That means the 49 percent stake was worth $10.3 billion or $9.7 billion, respectively, as of December 31.

While that might not be a large gap, investment bankers and analysts said Morgan Stanley is likely to come in with an initial lowball offer in the range of $15 billion, while Citigroup is likely to counter with a value of around $23 billion.

From Morgan Stanley's point of view, Citigroup's need to raise capital, as well as weak earnings and soft valuations for financial firms, should make it an eager seller.

The U.S. Federal Reserve this month denied Citigroup's request to raise dividends after the bank failed its stress test. Citigroup is submitting a revised plan, which would either require a more modest dividend request or more capital. Selling its entire stake in Morgan Stanley Smith Barney would give it more flexibility to pay higher dividends.

However, the joint venture is facing several profit headwinds right now that are expected to fade in the coming years, including high integration costs, low interest rates and volatile market conditions that have kept clients from putting money to work. So Citigroup could expect to get a better price down the road as the tide turns.

Citigroup also has negotiating leverage stemming from the urgency Morgan Stanley is likely to feel to buy the remaining stake.

Morgan Stanley would likely have to raise money to finance the deal, possibly through debt issuance, analysts said. That could become a lot more costly if Moody's Corp followed through with a February 27 warning that it might cut the bank's credit rating by three notches. That looming threat could make management even more eager to buy the business sooner rather than later, analysts said.

Both sides have an incentive to work out the price. If they cannot, they will have to take the issue to an arbitrator, an outcome that neither party wants because the decision would be binding and unpredictable.

"It's great for both sides in that Citi frees up capital and Morgan Stanley has complete control and complete benefits of the retail business," said Chip MacDonald, a lawyer at Jones Day who works on merger and acquisition deals for financial firms. "I think at the end of the day, it's in both their interest to negotiate and get this thing resolved rather than argue about it for an extended period, or forfeit an early deal."

(Reporting by Lauren Tara LaCapra; Editing by Paritosh Bansal and Gerald E. McCormick)

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