MUFG finalises $9 billion investment in Morgan Stanley

In its search for strategic growth, Japan's largest financial group accepts financial terms that are less attractive than those on Buffett's recent investment in Goldman Sachs.
JapanÆs banking giant Mitsubishi UFJ Financial Group (MUFG) announced on September 29 via a press release that it has finalised its earlier flagged investment in Morgan Stanley. Under the terms of the deal, MUFG will invest a total of $9 billion for a 21% stake in the US investment bank on a fully diluted basis.

The two-pronged deal will see MUFG acquire 9.9% of common stock in the bank, priced at $25.25 per share for $3 billion. It will also buy $6 billion in perpetual non-cumulative convertible preference shares. These shares will pay a 10% dividend and have a conversion price of $31.25 per share. According to the press release, half of the preferred stock will automatically convert into common stock after one year if Morgan StanleyÆs share price trades above 150% of the conversion price for a certain period, while the other half will convert on the same basis after two years.

Immediately apparent is MUFGÆs equity exposure to the US investment bank due to its direct stock acquisition, and the later conversion of its preference shares. And that is despite having curtailed its due diligence. Curtailing due diligence might seem odd, considering concerns about Morgan StanleyÆs balance sheet, but Credit Suisse analyst Shinichi Ina estimates in a report that ôthis is probably because of concerns about potential damage to MSÆs corporate value if MUFG spent too much time on due diligenceö.

In contrast, Warren BuffettÆs investment firm Berkshire Hathaway took on less equity exposure in its recently investment in Goldman Sachs. That investment was done through perpetual preference shares with a 10% dividend, enabling it to reap $500 million per year for a $5 billion investment. Goldman can buy the shares back any time at a 10% premium. In effect, the preference shares act as a form of loan.

BuffettÆs equity exposure is limited to warrants that give Berkshire Hathaway the right to acquire $5 billion worth of common shares at $115 apiece, at any time in the next five years. On the date of purchase (September 23), these warrants were already in the money, with the stock having closed at $125.05 on that day. And the share price surged another 6.4% to $133 on the news of the deal. As of September 30, the shares were quoted at $128.

Meanwhile, MUFG is sitting on an immediate loss of $2.25 per share, with Morgan StanleyÆs share price having closed at $23 on September 30 (although this is up from a $20.99 close on the day of the announcement). Assuming that MUFG bought approximately 118.8 million shares (the consideration of $3 billion divided by the per share price of $25.25) and multiplied by the per share loss of $2.25, MUFG has registered an immediate value decline of more than $267 million on its investment.

However, a source close to the deal argues that itÆs wrong to compare the financial aspects of the MUFG deal with BuffettÆs investment in Goldman. ôMUFG is not making a financial investment like Warren Buffett is, so the investment needs to be looked at differently; MUFG is setting up a strategic alliance through this deal. It is keen to build alliances overseas with a leading franchise like Morgan Stanley in investment banking, corporate banking and asset management.ö MUFG will send one representative to sit on Morgan StanleyÆs board.

Deutsche Securities analyst Shinichi Tamura believes that even on a financial level the investment could make sense, at least theoretically: ôInvesting in Morgan Stanley shifts capital off MUFGÆs balance sheet and enables it to access a higher ROE (return on equity) business than the commercial banking business in Japan. Both measures should raise MUFGÆs ROE, which is currently under shareholder pressure,ö he tells FinanceAsia.

The move fits into MUFGÆs long-standing attempts to become more shareholder friendly and to raise its ROE, says Tamura, noting that the Japanese bank has also been raising its ownership stakes to 100% in affiliates, thereby boosting its earnings. Indeed, most recently it took full control of the Union Bank of California for that very reason.

Tamura says MUFG is faced with the problems of a very competitive, low-growth, domestic commercial banking industry and that it makes sense to expand internationally. Perhaps this equity stake is the first step towards that, but investors in the bank will doubtless be anxious to see concrete evidence of the strategic partnership, perhaps in the form of joint ventures.

MUFGÆs New York-listed shares have traded erratically on the news, declining from $9.09 at the close of trading Friday (September 26) to $8.33 on Monday, before recovering to $8.74 by the close on Tuesday. However, the volatility has been in line with the broader market direction.
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