Today In Break-Ups Of Controversial, Politically Connected Firms With Some Past Legal Troubles

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It's easy to read the News Corp. story in conjunction with Phil Purcell's piece in the Journal this morning arguing that big banks should split off their capital markets and investment banking businesses from their commercial/retail banking and asset management businesses. The parallels are eerie: large conglomerates run by rich yet loathed CEOs could enhance shareholder value by splitting their risky businesses - which face uncertain growth prospects, are constantly caught doing shady things, have uncomfortably close and dysfunctional relationships with government, and yet are beloved by senior management for personal reasons - from the more stable cash cow businesses. Splitting them up would de-risk one chunk of the business without really raising risk on the other one, and the market would value the two chunks separately more than it values them together.

It looks like News Corp. is actually doing this - splitting the dodgy low-growth newspaper business from the more profitable entertainment-and-Fox-News* juggernaut - whereas Purcell has yet to persuade the big banks:

The five obvious too-big-to-fail institutions — Bank of America, Citigroup, J.P. Morgan Chase, Morgan Stanley and Goldman Sachs — have a median stock-market value of considerably less than the values of those component businesses they own that have predictable earnings streams, strong franchises and established client bases.

Examples of these component businesses would include asset management, credit cards, U.S. retail banking, private wealth management, and global retail banking franchises. Spinning these profitable businesses off into independent public enterprises would create enormous value for current shareholders. ... Breaking up these banks and isolating their investment banking and capital-markets businesses solve the shareholder-valuation problem. And by not allowing investment banks to fund the assets on their balance sheets with insured deposits, the risk to taxpayers is largely reduced.

Is this true? Oh I don't know, though obviously lots of people think so. Goldman's research report today upgrading JPMorgan because it's been punished too much for its stupidity, and downgrading Morgan Stanley because it's been punished insufficiently for Moody's stupidity, provides maybe a teeeeeeny bit of ammunition for that theory:

Still, if this is a good idea why isn't anyone doing it? One theory half-suggested by Purcell's op-ed is that the banks are captured by their employees: keeping the businesses together is good for employees, and bad for shareholders, and unlike in many businesses** the employees run the show for their own amusement rather than that of shareholders:

Financial institutions with high stock prices tend to be client-oriented and profitability-driven. Investment banks are neither. At their core are groups of talented individuals who are highly entrepreneurial, risk-embracing, and compensation-driven — and for this reason they should not be publicly owned and, if public, have earned a low valuation.

But of course there's not that much reason to think that employees do in fact like the status quo. These days its hard to avoid stories about bankers and traders leaving universal banks for boutiques and hedge funds and asset managers and other organizations that don't constantly have regulators looking over their shoulders. If you are entrepreneurial, risk-embracing, and compensation-driven, the last thing you want is to share your paycheck with a bunch of bank tellers in the Midwest. In fact it's sort of weird that this breakup doesn't happen of its own accord: once all the traders and investment bankers leave, you won't need to spin off your trading and investment banking businesses.

I don't have any particularly good theories for why it hasn't, though of course "it turns out to be bad for shareholders" has to be your leading contender.*** One pretty sketchy theory might be that, if the true-believer risk-driven trader types end up at hedge funds, and the true-believer client advisory types end up at M&A boutiques and independent retail financial advisory firms, the people left at investment banks are true-believer investment banker types: people whose ability to create value involves working the franchise, making connections between parts of the firm and cross-selling products. And who are client-centric in a way that allows for a certain amount of taking advantage of those clients: who perhaps prefer getting clients the products they want over giving them the advice they need to hear. And who trade better with cheap funding + strict(ish) regulation than they would with expensive funding + a free hand. If those are the assets you have in place, then the way to get the most value out of them is to give them lots of products to cross-sell, and cheap funding to do it with. For the shareholders, of course.

News Corp. Mulls Splitting in Two [WSJ]
Shareholders Can Cure Too Big to Fail [WSJ / Phil Purcell]
Valuing a News Corp. Breakup [DealBook]

* Yeah.

** Highly recommended post. Sample:

Whether shareholders are "the" residual claimants of a firm's earnings is ultimately a political question, and in times and places where labor [or management - ed.] is strong, they are not. ... Seen from this angle, the fact that businesses were investing "too much" during much of the postwar decades no longer is a sign they were being irrational or made a mistake; it just suggests that they were considering the returns to claimants other than shareholders. Though one wouldn't want to read too much into it, it's interesting in this light that for the past dozen years aggregate [Tobin's] q has been sitting at one, exactly where loyal agents for shareholders would try to keep it.

*** "It wouldn't be allowed by regulators" is another, less intuitive but still plausible one - see, e.g., the unlikelihood of unscrambling MS's and GS's bank holding company omelets. Also let's impugn Phil Purcell's motives a bit! His op-ed says he is "president of Continental Investors, a private-equity firm investing in high-growth financial-service companies"; it's unclear from Continental's bare-bones web page what that means though you get just a hint of a sense that he's investing his PA, but, yeah, he invests in private financial-industry companies. Presumably those companies would prefer to compete against other small specialized companies rather than cross-selling behemoths?

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