Despite its storied pedigree, months of upheaval at Morgan Stanley ( MS) have left the investment bank facing the future with its birthright tarnished and in need of some instant cachet. A week after half of Wall Street blew the doors off of earnings estimates, Morgan's issues get another airing when it reports its first quarter on Wednesday. One example of a business where the company has a chance to burnish its image is in structured products, a variety of financial derivatives that are generated by investment bankers and which play a big role in fixed-income and commodities trading. Investors looking for clues about the state of innovation at the firm will be combing Wednesday's release for intelligence on this segment. "Morgan Stanley is playing catch-up," said Richard Bove, an equity analyst at Punk, Ziegel & Co. "It has to hire a lot of people and is simply doing what it has to do in order to get up to where the rest of the market is." Other Wall Street firms have set the pace for what looks like a record earnings year for the securities industry. Goldman Sachs ( GS), which wowed analysts last week with extraordinary earnings, pointed to fixed-income, currencies and commodities trading as the main reason for its success. Trading accounted for more than 66% of the company's total revenue in the first quarter, and FICC was responsible for over half of that. For Bear Stearns ( BSC) and Lehman Brothers ( LEH), two brokerages that also posted stellar fist quarters, the contribution was also great. At Bear Stearns, trading accounted for 63% of total revenue, and more than 64% of that was fixed-income revenue. Lehman Brothers trading made up almost 70% of total revenue, and almost 70% of that was fixed-income. Morgan Stanley has historically had a much more balanced revenue mix than its competitors. In the fourth quarter last year, trading accounted for less than 25% of the company's net revenue, excluding interest income. But while the revenue diversity might mitigate some volatility, it leaves the investment bank vulnerable to some tough comparisons in the current market.
"Nothing comes close to the trading business, because nothing posts the profits that it produces," says Bove. "Building the trading operation is essential, because that is where the markets are going." Morgan Stanley's trading desk should do reasonably well this quarter because, like Goldman, it has an established commodities franchise. The firm has also been trying to beef up the bond and strategic finance groups, two areas of interest for co-president and fixed-income specialist Zoe Cruz. Recently, the firm hired two executives from GE Capital to head strategic finance and syndication in its debt group, and it began an asset-backed lending business, one new to the bank. The firm also hired a key leveraged finance investment banker from Citigroup, Ashok Nayyar, and two other high-powered bankers, Whitner Marshall and Kevin Sisson of Citigroup. While not traders, their expertise is viewed by analysts as a plus for that area of Morgan's business. "Investment banking fuels trading," said Bove. "If you have the inventory, you have more control over what it does in the market." The banking-to-trading strategy, particularly in institutional derivatives, has been mined to perfection by Goldman Sachs, whose first-quarter earnings report had all of Wall Street talking last week. With its hires, Morgan Stanley hopes to chip away at that hegemony. "It's an interesting situation where there is still one dominant franchise, Goldman, but you have different people running the show for different products," says Jeffrey Harte, equity analyst at Sandler O'Neill. "We are getting a better feel for how the institutional segment
at Morgan Stanley can get back to being one of the best, and how it can make up for some of the lost ground over the past couple of years." Investors evidently believe Morgan Stanley can get back on track. The shares have risen from $47.66 in May to a recent quote of $60.26, a 26% increase in 10 months. That compares with a 61% increase at Goldman Sachs -- which hit a 52-week high Monday -- over the same period and a 49% climb in Merrill Lynch ( MER) shares. The performance of the three of Morgan Stanley's competitors that reported earnings last week prompted some analysts to raise guidance for the firm. Keefe Bruyette & Woods said in a report that the first-quarter estimate for Morgan Stanley was "much too conservative," raising the earnings-per-share estimate almost 24%, to $1.30 from $1.05. According to Thomson First Call, the consensus estimates for Morgan's first quarter is for earnings of $1.20 a share on revenue of $7.58 billion. "It should be a pretty darn good quarter for Morgan Stanley," said Harte. "But there has been a lot of management turmoil, and it's added a layer of confusion."