Morgan Stanley May Pay Citigroup $3 Billion in Merger

By Bradley Keoun and Christine Harper

Jan. 10 (Bloomberg) -- Morgan Stanley may pay Citigroup Inc. as much as $3 billion for control of a venture that would combine their brokerage units and overtake Bank of America Corp. as the largest financial adviser to individuals, a person with knowledge of the discussions said.

Morgan Stanley, led by Chief Executive Officer John Mack, may get 51 percent of the new company and an option to acquire the rest over three to five years, according to the person, declining to be identified because the deal isn’t complete and the talks are confidential. The transaction may be announced as soon as tomorrow, the person said.

Citigroup, which reported $20 billion of losses in the past four quarters, would get cash for its Smith Barney brokerage, while Morgan Stanley would get recurring fee revenue and more potential banking customers. The joint venture would employ about 22,000 advisers, compared with the approximately 20,000 at Bank of America after its purchase of Merrill Lynch & Co. Morgan Stanley Co-President James Gorman, 50, may oversee the company, tentatively named Morgan Stanley Smith Barney, the person said.

“There’s been a lot of pressure for Citi to monetize some of their more valuable assets and Smith Barney is certainly one,” said Michael Nix, a money manager at Greenwood Capital Associates LLC in Greenwood, South Carolina. “There’s also been a lot of pressure for Morgan Stanley to look at how they can better lever their business units.”

Bailout

Spokespeople for Morgan Stanley and Citigroup declined to comment. Both firms are based in New York.

The worst financial crisis since the 1930s has recast rivals in the financial industry as merger partners and transformed the U.S. government into one of the biggest investors in Wall Street firms, including Morgan Stanley and Citigroup.

As Lehman Brothers Holdings Inc. sank into bankruptcy in September, crippled by the frozen credit markets, Merrill, then the biggest U.S. brokerage, agreed to be taken over by Charlotte, North Carolina-based Bank of America. Morgan Stanley converted from a securities firm to a bank holding company and Citigroup, led by Chief Executive Officer Vikram Pandit, took $45 billion of U.S. bailout money.

Under the deal being negotiated now, Morgan Stanley and Citigroup would contribute their brokerage units to the joint venture, two people with knowledge of the talks said. Morgan Stanley would also pay Citigroup $2 billion to $3 billion, or 20 percent of the total value of Smith Barney, to gain majority control, one of the people said. The venture may be led by Morgan Stanley managers and a board with a majority of Morgan Stanley appointees, the person said.

Rubin Resigns

The news came as Citigroup announced that former U.S. Treasury Secretary Robert Rubin, who joined the company in 1999 and has opposed calls to break it up, plans to quit the board.

Directors have also discussed replacing Win Bischoff, Citigroup’s chairman, the Wall Street Journal reported today, citing unidentified people familiar with the talks.

The U.S. government’s taxpayer-funded cash injections into the nation’s biggest banks may cause regulators to pressure some firms to break up or restrict activities that could threaten the financial system’s stability, analysts say.

Morgan Stanley, the second-biggest U.S. securities firm before converting to a bank in September, would draw on its existing cash to pay for the brokerage merger and wouldn’t raise new money for the deal, a person familiar with the matter said.

77 Percent Drop

Morgan Stanley received $10 billion from the U.S. Treasury last year. The firm, which lost 70 percent of its market value in 2008, has been trying to attract retail deposits from brokerage customers to help reduce its reliance on debt markets for funding.

Citigroup, which is expected to post a fifth consecutive quarterly loss when it reports fourth-quarter results later this month, has received $45 billion from the U.S. Treasury and $306 billion of government guarantees for troubled mortgages and toxic assets. The bank suffered a 77 percent decline in its stock price last year.

Citigroup was formed in 1998 by the $37.4 billion merger of Travelers Group Inc., led by Sanford “Sandy” Weill, and Citicorp, led by John Reed. Travelers, which owned brokerage Smith Barney Holdings Inc., had a year earlier paid about $9 billion for Salomon Inc., the parent of Salomon Brothers Inc., to form Salomon Smith Barney Inc.

Some analysts and investors have called for the company to be broken up, saying that Citigroup is too large to manage.

Breaking Up

“Morgan Stanley has been much more efficiently run because it really wasn’t a combination of so many different things,” said Richard Lipstein, a managing director at Boyden Executive Search in New York, which specializes in financial services. “Smith Barney was having difficulty getting their arms around the cost cutting on the broker side.”

Pandit, who has been Citigroup’s CEO for more than a year, told employees on a conference call in November that he didn’t plan to dismantle the company and didn’t want to sell Smith Barney.

He and Chief Financial Officer Gary Crittenden instead said they wanted to sell businesses that weren’t crucial to the bank’s main operations. In July the company agreed to sell its German retail bank, Citibank Privatkunden AG & Co., for $6.6 billion, and last month it sold a processing business in India with about 12,000 employees for $512 million.

In a memo this week, Crittenden said the firm had sold 21 businesses over the past year and that divestitures would “again be critical in 2009.”

Dean Witter

Pandit, 51, in September replaced Sallie Krawcheck, the head of the wealth-management division, which includes Smith Barney. Taking her place was Michael Corbat, a 25-year veteran of the bank. At Morgan Stanley, Ellyn McColgan was named president of the wealth management business in December 2007, reporting to Gorman.

Smith Barney has 14,133 financial advisers in about 600 offices in the U.S., according to Citigroup’s Web site. It had about 9 million U.S. client accounts as of Nov. 3, oversaw $1.32 trillion of client assets, and generated $7.94 billion in revenue during the first nine months of 2008.

Morgan Stanley gained its retail brokerage in the company’s 1997 combination with Dean Witter, Discover & Co. The business had 8,426 financial advisers at the end of November, $546 billion in total client assets, and generated $6.3 billion in revenue during 2008 when the gain from an asset sale was excluded, according to a company report last month.

To contact the reporters on this story: Christine Harper in New York at charper@bloomberg.net; Bradley Keoun in New York at bkeoun@bloomberg.net.