Morgan Stanley Bulls Could Get Gored by Citigroup Deal

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Updated from 3:31 p.m. EST

Morgan Stanley (MS Quote) shares spiked nearly 10% early Monday as the company closed in on a deal to take a majority stake in Citigroup's (C Quote) Smith Barney brokerage, but there are some potential pitfalls to the firm's strategy.

The potential deal has been heralded as a chance for a combined Morgan Stanley-Smith Barney to compete with the newly merged Bank of America (BAC Quote)-Merrill Lynch, as Morgan continues to redefine its business model in the wake of last fall's collapse of the investment banking industry. Days after Lehman Brothers filed for bankruptcy, Morgan and rival Goldman Sachs (GS Quote) won approval to convert themselves to bank holding companies.

But emphasizing the retail business in the current environment is dangerous, Sanford Bernstein analyst Brad Hintz says in a report he released Monday. He argues that a retail recovery will lag a recovery in the broader economy, while institutional businesses such as M&A and IPOs will anticipate it.

"Unfortunately, the achievement of merger synergies in joint ventures is never as easy as the pro forma numbers would imply," Hintz writes. "Turnover of brokers is always a challenge in a combination and the integration challenges that Wachovia faced in its Prudential and AG Edwards rollups make Bernstein question the ability of Morgan management to quickly achieve the theoretical margin improvements from this combination, given the continuing weaknesses of the 'Dean Witter' franchise."

Still, the move further distinguishes Morgan Stanley from Goldman, as those arch-rivals try to articulate their strategies. Goldman appears far less eager to make acquisitions or announce a shift in its business model.

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