This might be a little naive, but why does Morgan Stanley need to exist?

June 4, 2012


Well as my father used to say about basketball games, if you are going to get down 20 points, make sure it’s in the first quarter.  With regard to the month of June at least, the market finds itself in a similar position.  Oddly enough however, while we continue to see plenty of risk to the market at a high level, from a bottoms up perspective in tech Friday’s sell off seemed less punishing.  This is not to say there hasn’t been damage.  Through the end of May Terrapin has given up about a point of the up 7% recommendation performance in the first quarter.  A marked turnaround in semi performance as names like FSL and STM have come down precipitously has been more than offset by poor performance in systems as ALU has come back toward lows.  Consumer/Internet performance has remained unchanged as a drubbing in the GOOG/AMZN pair where we remain steadfast was offset by successful social networking shorts most notably ZNGA.  Optical performance improved solidly on the heavy FN short, while comm services deteriorated a bit as the continued implosion of Telefonica offset an improving DTV short.

It’s been almost exactly a year since I first began commenting on the excesses and associated management and banker hubris of this most recent batch of Internet/Social Networking IPOs (P as is Pride;   6/6/11- catalyzed by the upstart’s choice of a single letter ticker and also ironically noting MS as the lead).   That reassuringly successful experience in the Internet space (see table 1 below) has reaffirmed to us the notion that arrogant, delusional managers make bad decisions in good times and worse decisions under pressure and their stocks tend to go down especially given valuations that leave zero room for error.  Though it is also nice to impute something karmic into these outcomes as well.  We contrast this with the paranoid humility we have seen from the likes of LNKD, and wonder if the same exists out there in financial land opposite the uber pompous Mr. Gorman.

The intersection here is the delusional leading the delusional, in that MS led nearly every one of these deals that have, with the exception of LNKD , been a disaster. Four out of five have declined substantially, an average of 40%, yielding a .200 batting average for Morgan Stanley for deals in which they exercise complete control.  Those are boiler room numbers, and in essence we have been short MS by proxy all along in shorting these deals with the exception of LNKD which, based on the data, one would have to conclude that Morgan Stanley got lucky and that Morgan Fairchild would have done almost as good a job.

What we saw out of Mr. Gorman on CNBC last Thursday was nothing short of astonishing and in my view actionable and potentially terminal.  To state the obvious, I view the FB IPO as the Titanic of all equity offerings, easily the biggest screw up in the history of the underwriting business.  Safe to say that if this had occurred at Robertson back in the day the trading floor would have resembled a post battle scene from Braveheart and/or the revenge speech from Animal House (Head of Capital Markets, DEAD,Marmalarde. DEAD  Niedermeyer; DEAD).  Instead we get a man who is plainly arrogant, delusional or both blaming absolutely everything and everyone but himself and his firm for  FB’s poor performance and referring to his clients as naïve for expecting the most high profile IPO in history not to implode immediately upon pricing.  Gorman kept referring to the hype around the deal and while I don’t expect much from Maria B how one couldn’t ask the obvious question is beyond me “Hey Jimbo, do ya think that dramatically raising the price and the range may have had anything to do with this hype you are referring to?.  What is also beyond me is how any MS institutional or retail clients could witness these back to back displays of professional incompetence and dismissive arrogance and not sever or reduce relationships in meaningful numbers.  Given that access to the IPO calendar is a negative vs a positive, it’s hard to see what the point is given several other big bank peers capable of providing the same or better in terms of research, corporate access and balance sheets.

Table 1: Social Networking Comps- GRPN ZNGA P Investors Apparently Also “Naïve”

FB

LNKD

Z

P

GRPN

ZNGA

YELP

IPO Price

$38.00

$45.00

$20.00

$16.00

$20.00

$10.00

$15.00

TR Rec Price

na

$63.00

$30.00

$16.00

$20.64

$14.00

na

Last Update Pr 5/2

$40.00

$106.00

$37.00

$8.73

$10.58

$8.98

$23.00

Current Price

$27.80

$91.15

$36.36

$9.96

$9.69

$6.01

$15.60

pct chg IPO

-26.8%

102.6%

81.8%

-37.8%

-51.6%

-39.9%

4.0%

pct chg TR

na

44.7%

21.2%

-37.8%

-53.1%

-57.1%

na

 

Shares

2833.0

102.6

32.0

-0.4

668.4

880.0

69.0

Mkt Cap

$78,757

$9,352

$1,164

-$4

$6,477

$5,289

$1,076

Net Cash

$10,364

$400

$98

$95

$900

$1,800

$120

Ent Value

$68,393

$8,952

$1,066

-$99

$5,577

$3,489

$956

 

CY12 Revs

5500

900

111

416

2338

1450

124

-growth

48.2%

72.4%

68.2%

51.8%

44.3%

29.9%

112.0%

CY12  EBITDA

3025

175

20

-20

368

400

0

margin

55.0%

19.4%

18.0%

-4.8%

15.7%

27.6%

0.0%

CY12 EPS

$0.65

$0.90

$0.20

-$0.17

$0.20

$0.27

-$0.30

EV/Revs

12.4

9.9

9.6

-0.2

2.4

2.4

7.7

EV/EBITDA

22.6

51.2

53.3

NA

15.2

8.7

NA

P/E

42.8

101.3

181.8

NA

48.5

22.3

NA

CY13 EPS

$0.95

$1.10

$0.50

$0.03

$0.75

$0.37

$0.00

P/E

29.3

82.9

72.7

NM

12.9

16.2

NA

 

Lead Mgr

MS

MS

Citi

MS

MS

MS

GS

 

 

Now I recognize that the financials have come down a lot, are trading well below book value, etc.  However as discussed below if the SHTF again, the world doesn’t need Morgan Stanley the same way it needs JP Morgan.  And after this FB episode and interview, there might even be a cheer or two if MS went down for good.  Mr Gorman has stated plainly that the interests of the firm’s employees and investment banking clients come well ahead of its institutional and retail investor “clients”.  It is worth wondering indeed why the world needs another entity to speculate on derivatives (and the counterparty risk here is likely the only reason the firm might be kept alive), burn their clients and blame them when they do.  We have discussed the MS short in recent weeks in the FB aftermath and have added it to TROW here in our speculative “other” category and look to pair it with a small JPM long to hedge sector rebound risk.

There is a corollary to the “get down early” thesis; there are no 10 point plays, you come back two at a time.  Thankfully, this is where the similarity with the stock market ends.  There are 10 point plays (with a deep bow to Taleb, this seems like a time to note the normal distribution of basketball scores compared to the power distribution of market returns).  Just ask holders of HUTC on Friday.  As I have been noting here and there of late, it seems like one can’t swing a dead cat with hitting a potential 3-5 bagger in tech these days as this sell off progresses.  As usual the issues are timing and catalysts, but the risk reward equation in all cases is compelling in some part because the “risk” aspect is a binary survival call at these levels.

Table 2: The Dirty Almost Half Dozen

Company

Ticker

Price

52 wk high

Upside Potental

Alcatel Lucent

ALU

$1.49

$6.05

At $6 trading at 0.6 EV/Revs

Clearwire

CLWR

$1.16

$4.35

Spectrum worth more than ever

Nokia

NOK

$2.65

$7.38

Burning platform memo 2/8/11 @ $11

Oclaro

OCLR

$2.37

$8.94

Merger could produce $1.00 in EPS

Opnext

OPXT

$0.99

$2.52

Over $4 in last optical rally; 1x revs =$5

.

There are others in micro cap land that offer a similar profile including EMKR IKAN and SQNS.  It’s fair to wonder whether these more marginal names could survive the sort of major global economic downturn that the market seems to be pricing in.  I think the answer is yes to probably in almost all cases.   Everyone on the list has asset value, even impaired asset value, well in excess of liabilities as demonstrated below with NOK and ad nauseum with ALU and CLWR.  Opnext is in a solid cash position as a standalone and the combined entity is in good shape, and OCLR does have non telecom assets that it could monetize in the extreme.  On the other hand, despite its precipitous decline, it’s hard  to see how an FSL survives a serious downturn given its capital structure.  Same with HPQ, with CIEN at risk as well.  It’s also hard to see how names can trade at triple digit PE (eg the AMZN and CRMs of the world) or double digit revenue multiples (eg EZCH Z) with an assumption of total immunity from the global economic concerns at hand .

Nokia is near the top of this list with substantial upside potential in the successful development of the WinPhone platform relative to a handset unit now valued at zero.  We saw a data point on Friday that speaks to the downside risk factor for NOK in Verizon’s $600M plus acquisition of automotive locations based services and telematics  firm Hughes Telematics.  The deal came at nearly a 200% premium (advised amusingly by none other than UBS)  and at 6x a rapidly growing but still money losing revenue run rate with deals with Mercedes and Volkswagen likely the key assets.  As we have noted, NOK has a sizeable, profitable and growing concern in Navteq which is also a player in the GPS and location based services space.  In fact, representatives from Navteq and Hughes Telematics appeared on the same panel at a summit on connected and networked automobiles in 2009.  Nokia paid $8B for Navteq in 2007, which grew revenue nearly 20% in Q1 to $350M with operating margins of 12.9% and might not be worth $8B now but likely is worth at least $2-3 compared to the $4B cap of the entire company.

Finally I also wanted to check in on Randall Stephenson’s comments at the Bernstein conference last week to see whether anything had changed or been amplified.  As it turns out there was a NY Times story on the potential rural broadband initiative we discussed in our report Tuesday.  Outside of that more commentary around spectrum and HTML5, only with more emphasis on near term developments regarding the latter.  On the subject of AT&T it was notable to me as I belatedly work my way through the biography of the far more odious than the hype Steve Jobs to read the following on page 136 “IBM was essentially Microsoft at its worst; they were not a force for innovation, they were a force for evil.  They were like AT&T or Microsoft or Google is”.  Now I could write five blogs on the hypocrisy and foolishness of this statement, but let’s just say that self-awareness with regard to either individual or corporate behavior was clearly not this man’s strong point.

My main interest here for now is the AT&T part.  I have been working on this thesis for over a year, namely they telco’s being perceived as evil as they seek to fund their huge infrastructure investments by taking a few points of the app and software providers 40 points of operating margin versus the perception of AAPL as a koala bear as they tear the throats out of competitors with IP suits, developers with fat tolls, and ruthlessly squeeze suppliers and partners.  It is clearly even more ironic given the role AT&T played in bringing in the IPhone to market. Given that role I wonder if Stephenson takes being called evil in 2011 personally after helping to put $200B in Jobs’ pocket.     Next time I get a chance I will ask Stephenson that question, if anyone beats me to it please let me know what he says and it what type of forum it was asked.  In any case, it certainly underscores the desire to create alternative smartphone ecosystems in addition to GOOG (who I think really wear the white hats here to the extent that matters) and perhaps punish APPL with NOK as a prime beneficiary.