Can James Gorman make Morgan Stanley great again?March 30, 2011: 5:00 AM ET
He has been CEO of the storied but bruised investment bank for a year. All he has to do is reduce risk and restore profits at the same time.
By Duff McDonald, contributor
FORTUNE -- On an April Friday last year, Morgan Stanley CEO James Gorman received a call while on vacation with his family in Anguilla: In just four days the Agricultural Bank of China was holding a "bake-off" for investment banks that wanted to handle its initial public offering. Ted Pick, co-head of equities for Morgan Stanley, told Gorman that the CEOs of other banks would be there. It was crucial that he come along. Gorman cut his vacation short and joined Pick on a plane to Beijing three days later.
Not long after his new boss was buckled in for the 16-hour flight, Pick informed Gorman that his part of the presentation would last for all of three minutes. And when they got to China, it turned out that none of the other promised investment bank CEOs were there -- Pick had played Gorman about that small detail.
Rather than throw a tantrum, as many Wall Street chieftains would have, Gorman just laughed. His nonchalance was justified. Morgan Stanley (MS) was chosen as one of the lead investment banks on the largest IPO in history -- a $22 billion offering. The firm earned nearly $30 million in fees for its efforts.
That composure and focus tell you a lot about Gorman. Sure, he comes across as a bit of a stiff. He has ramrod posture. He speaks in perfectly crafted sentences and paragraphs, in the modulated manner of the lawyer and consultant he has been in previous lives. And he has an exquisite but slightly aloof politeness, especially compared with some of his, shall we say, earthier peers. He lacks the bombast of J.P. Morgan Chase's Jamie Dimon and eschews the know-it-all disdain of Goldman Sachs's Lloyd Blankfein. And as a mostly under-the-radar figure who isn't prominent in the Wall Street CEOs' club, he's not the sort to be spotted lunching at the Four Seasons on Park Avenue. Indeed, Gorman has the type of elusive personality that can make it easier to define who he isn't than who he is.
But Gorman is clearly willing to do what it takes. "James isn't a backslapper," says Larry Fink, CEO of BlackRock, who recommended that Morgan Stanley's then-CEO, John Mack, hire Gorman in 2006. "But that's not what John needed at the time. He needed strategic thinking and cohesiveness. That's also what Morgan Stanley needs right now. James brings teams together in a much more comprehensive and analytical way than other CEOs tend to do. In a firm that size, getting the troops' respect is as important as anything. And I think he's earning it."
Still, Gorman's task is formidable. The Morgan Stanley franchise was damaged in the credit crisis and its aftermath -- the firm bled red ink for two painful years -- and it's Gorman's job to revitalize it before it's too late.
His strategy, in basic terms, boils down to this: He's returning the firm to something that resembles the old Morgan Stanley -- focusing on traditional fee-earning lines of business such as investment banking and wealth management. Meanwhile, he's been shedding many parts of the pre-crisis incarnation of the company, which teemed with risk in the form of proprietary trading and other investments. Certainly, plenty of the recent changes are driven by circumstance -- or legal requirements. But that doesn't make the challenge any easier. And though the man has been moving fast in the 14 months since he's had the top job, he's still playing something akin to three-dimensional chess every single day he goes to work.
Not just Mack's man
In January, Gorman, 52, celebrated a year at the helm of Morgan Stanley by announcing results for 2010. The profits -- some $4.5 billion -- were a pleasant surprise to those who have watched the investment bank get pounded so badly that, for a brief moment at the height of the 2008 crisis, its very survival was in question.
No one today would describe Morgan Stanley as being on a winning streak. But sitting in his 40th-floor office at the firm's headquarters north of Times Square in February, Gorman predicted that within a year people will be doing just that.
The man doesn't lack for conviction. Asked about the breadth of challenges he has already faced, Gorman says, "Look, you deal with the choices you are confronted with. We faced a series of really hard choices that had to happen very quickly. To my mind, even though the changes have taken place on a fast beat -- not just in my year as CEO, but over the last few years -- we have accelerated our upside potential by getting them done so quickly. We know what we are. Our business is originating, distributing, and managing capital for individuals and institutions ... I feel good about the decisions we made. Now we've optimized -- we are in the best possible situation strategically. All that remains is to see how it translates into results. But if you're not in a good position strategically, you don't get to that next step."
Gorman replaced a man, John Mack, who was almost universally beloved at Morgan Stanley. Mack was a steadying force during a period in which the elite investment bank -- born with a silver spoon when Depression-era laws forced the breakup of J.P. Morgan -- grappled with its identity. After losing a power play with Phil Purcell in the wake of the firm's 1997 merger with Dean Witter (a cultural mismatch famously derided as "white shoes, white socks"), Mack departed in 2001, only to return in 2005 as the ostensible savior of the firm Morgan Stanley lifers thought Purcell was destroying. A North Carolinian with a silky Southern accent, Mack has remained chairman of the firm with the stated intention of stepping down in another year.
Gorman is cut from a different cloth. Unlike the visceral Mack, he is a process man, not a salesman. And he's a relative outsider -- a person who spent most of his career outside Morgan Stanley -- as well as an Australian, who still has that distinctive accent even after decades in the U.S.
James Patrick Gorman was born on July 14, 1958, in Melbourne, the sixth of 10 children. It's quite a brood. One of his five sisters sits on the Supreme Court of Australia. One brother, an inventor, has developed a device that helps you roll over when you're snoring. Another brother -- a onetime comedian who apparently didn't inherit the same manners James displays -- once quipped at an audience member, "Is that your head or are you wearing it for a bet?"
Gorman's father was an engineer; his mother, an emergency-ward nurse. The family learned calm under pressure, he says, and an engineer's way of looking at the world. That, and an ability to live in total chaos. "Imagine managing 10 kids," says Gerry Gorman, a cousin. "His dad used to wake them up every morning by blasting Tommy Makem and the Clancy Brothers." Gorman was an achiever from early on. He earned two degrees -- a BA and JD from the University of Melbourne -- by the age of 23. (That's no great achievement, he says. His sister earned the same degrees by 21.) He then spent four years at a law firm. But after realizing that lawyers merely did what they were told, rather than make decisions, he decided to enter Columbia's MBA program.
From there, it was on to a decade as a McKinsey consultant in New York. "He was well regarded at McKinsey -- a thoughtful problem solver," says one former colleague, "although even then, people thought he was a little formal." Gorman worked primarily for financial services clients, including American Express (AXP) and Merrill Lynch.
In 1999, David Komansky, then Merrill's CEO, persuaded Gorman to become its chief marketing officer. "He had a nice balance between academic ruthlessness and people skills," recalls Komansky. "McKinsey people are intellectually acute, but they normally come up a little short on the people side. James had the ability to form his ideas and then sell them to the people involved, as opposed to trying to use the power of the assignment to make them do what he wanted."
Gorman soon took control of Merrill's sprawling brokerage unit. He fired a third of the firm's brokers, closed a quarter of the branches, and transferred accounts of less than $100,000 out of brokers' hands and into call centers.
The moves worked. Margins surged from 12.2% in 2001 to 20% in 2005. Indeed, Gorman's time at Merrill was largely marked by success. But like more than one Merrill executive, Gorman soon found himself out of favor after Stan O'Neal took over as CEO. As luck would have it, John Mack had just returned to Morgan Stanley and was looking for someone to oversee his brokerage force. A timely recommendation from BlackRock's Fink paved the way to some interviews, and before long Gorman signed on.
Gorman began at Morgan Stanley in 2006 much as he had at Merrill, firing more than 1,000 underperforming advisers. "That stopped people in their tracks, both internally and externally," says Andy Saperstein, head of U.S. wealth management. "It was meant to show the Street we meant business, that we were focusing on high-end clients and we wanted high-end performers."
Despite making tough moves and being an outsider, Gorman managed to avoid alienating his new colleagues -- at least, the one at the top. "Investment banks like to have organ rejection when you come in from the outside," says Mack. "And he didn't get that. He had this ability to paint a picture of his vision that was so clear it looked like it was taken with a camera. Everyone understood what we were trying to do." (Adds Mack: "Now he's doing it for the entire firm.")
Gorman may have struck some as a bloodless technocrat. He certainly didn't have the public profile of Morgan Stanley stars of that era such as Mary Meeker or Zoe Cruz. Despite that -- or perhaps because of it -- he zoomed to the top: Mack made him co-head of strategic planning with Colm Kelleher in 2007 and then co-president with Walid Chammah after the firm's trading losses in 2007 resulted in Cruz's firing.
As he fended off rivals and neared Morgan Stanley's pinnacle, Gorman somehow found the time to take up boxing. He has a photo of Muhammad Ali meeting Elvis Presley in his office, titled "The King Meets the Greatest." He has another of Ali gracefully ducking a Joe Frazier jab. Asked whether his own boxing includes taking punches, Gorman responds, "I don't actually fight. I'm not stupid."
Reshaping Morgan Stanley
Here's Gorman's challenge: The bank has three main businesses -- institutional securities (which includes equities, fixed income, and investment banking), wealth management (the brokerage and investment advisory businesses), and asset management (which comprises a broad variety of funds for institutional investors). Overhauling one of them in your first 12 months would be a tall order. Gorman decided to transform all three. "Investment banking represents about 20% of the revenues of this company, and that business is fine," says Crédit Agricole Securities analyst Mike Mayo. "The other 80%, though, is undergoing some sort of restructuring and management change. They have a lot of kinks to work out."
Gorman's strategy starts with financial streamlining. Morgan Stanley is not going to be a massive bank with a sprawling balance sheet à la J.P. Morgan Chase (JPM). Or a swing-for-the-fences risk-taker like Goldman Sachs (GS). (Or a debt-laden house like Lehman Brothers.)
So Morgan Stanley, first under Mack and now under Gorman, has become more fiscally prudent. Since the second quarter of 2007, the last before the financial crisis began, the balance sheet has been slimmed by a third (though it edged up in 2010). Leverage has been cut in half. And Morgan Stanley has slashed its reliance on commercial paper -- the short-term credit that can be yanked at a moment's notice. With a higher proportion of long-term debt, Morgan Stanley is much less vulnerable to a run on the bank than it was in 2008.
Gorman has accelerated other strategies launched during Mack's last years as CEO. Near the end of his tenure, Mack sold the Discover credit card unit and parted with the company's market data business, MSCI. Under Gorman, Morgan Stanley then sold its retail asset-management operation, including Van Kampen, for an after-tax gain of $673 million. Proprietary trading has been shut down in anticipation of new regulations forbidding it. The firm is unloading its hedge fund business, Frontpoint. It sold its passive stake in the Chinese investment bank CICC and bought a domestic Chinese license with a new partner. Some of those businesses were highly profitable, but that's not the point. Gorman is focusing the firm on what it does best.
Finally, Gorman ratcheted down compensation from 62% of net revenue in 2009 to 51% in 2010, made more of it deferred, and even instituted rules under which some compensation could be "clawed back" in the future to discourage bets that make money in the short term but harm the firm in the long. When an employee asked him at a January town hall meeting to explain why, if 2010 performance was up, 2010 bonuses were down, Gorman was blunt. "You can't operate a business running at a loss," he said, "and particularly if you're doing it by paying yourselves. It just doesn't fly. We have to play for a longer game than a 12-month game. We've shown discipline. If we perform, we will pay according to performance. We have no problem with everybody in this firm doing extremely well financially."
Gorman is not just cutting. He's building -- actually, rebuilding -- too. He authorized the hiring of hundreds of new traders and salesmen in the company's fixed-income division -- which trades everything from commodities to credit, interest-rate products, and foreign exchange -- in an attempt to buttress an important piece of the firm that was falling to pieces: In the three quarters through September 2010, the firm had averaged $1.8 billion in fixed-income revenue, less than half the average of its top five competitors.
"We feel we're punching below our weight in fixed income," Gorman said at a February investor conference. He is not alone in that assessment. "Morgan Stanley has always been a decent player in high yield, although they've been slipping of late," says a hedge fund manager who trades high-yield bonds with all the major banks. "They lost a ton of talent through the crisis. They are probably around eighth in the counterparties we deal with -- way behind Goldman, J.P. Morgan, and Barclays (BCS) -- and they used to be in our top five." Gorman and his team have set an ambitious goal for the fixed-income business: a two-point market share gain.
Gorman also knows when to leave well enough alone. The firm's fabled investment bankers continue to thrive, vying for supremacy at the top of several industry "league tables," and holding the top spot in mergers and acquisitions. In 2010, Morgan Stanley was a co-lead manager of the largest domestic initial public offering ever, that of General Motors (GM). It also advised on the merger of United and Continental Airlines (UAL).
Wealth management has been a bright -- or at least a brightening -- spot for Gorman. He was originally hired to fix that unit. The question was, How? Should they sell it or double down? Gorman chose the latter. In the depths of the financial crisis, Morgan Stanley negotiated a deal to pay $2.75 billion to Citigroup (C) for 51% of Smith Barney, creating arguably the largest wealth-management business on the planet. And the company intends to exercise an option to buy the rest of it over time. "It's the one good thing that came out of the financial crisis, at least as far as this company is concerned," says Mack.
Margins in the business began heading in the right direction with Gorman's arrival in 2006. After a decline in 2008, they've resumed their ascent: From a meager 6% pretax profit in 2009, they climbed to 9% for all of 2010 and 12% in the fourth quarter. Other metrics are also improving: revenue per rep, assets per rep, and broker turnover. Gorman sees more profitability -- much more -- down the road. If the stock market helps out, at least part of that will be easy: The firm makes much more in fees from wealth-management customers when they move out of safer investments and into equities. "This is all about throughput once you've established the network," he says.
That's the beauty of the wealth-management business: If you're small, fixed costs can be 25% to 30% of your cost base. If you're really big, they can dip to 10% to 15%. It's also a tremendous engine to distribute product brought to market by the investment bank.
Gorman also has made some astute personnel moves. He hired former Merrill star Greg Fleming to stanch losses in the company's third-largest unit, its asset-management division, which had a rough couple of quarters in 2008 -- including a $690 million loss and a significant loss of assets. The division has since seen two quarters of strong profitability. If the group can continue to perform, further increases in assets under management should follow. Gorman rewarded Fleming by giving him oversight of wealth management as well in January.
The company's fourth-quarter numbers were surprisingly robust, which sent the stock moving from under $25 in late November to over $30 in January. But third-quarter 2010 numbers were dismal. One quarter does not a track record make. Gorman says the engines are turning over, and not necessarily the same ones at the same time. He promises that the whole machine is going to catch a spark soon.
The hangover persists
Truth be told, the effects of staring into the abyss are still being felt at Morgan Stanley. A disastrous foray into the subprime market in late 2007 nearly broke the firm -- it lost $9 billion in the process -- and in the fall of 2008, Morgan Stanley was saved only by a $10 billion infusion from the U.S. government. Mack has argued that when it comes to subprime, he was just doing what everybody else was. He believes he and his team saved the firm at the 11th hour. (Only on Wall Street can a person take a $10 billion bailout and still think he deserves credit for saving the firm.)
The company's fixed-income division lost meaningful talent looking for safer employment harbors in the midst of the crisis and also saw the market move away from Morgan Stanley's forte in more esoteric securities and toward Goldman Sachs, Citigroup, and J.P. Morgan Chase, whose larger global presence and bigger balance sheets lured panicky clients away from smaller rivals. Morgan Stanley remains strong in a few select markets, like oil and gas trading, but saw market share erode in rates, foreign exchange, and high-yield credit.
Mack also left Gorman a staggering loss on a crapshoot Atlantic City hotel project known as Revel -- Gorman has since written off $1.16 billion of the $1.2 billion investment rather than spend the additional $1 billion needed for completion -- as well as a number of disparate and balance-sheet-intensive businesses that delivered the kind of earnings volatility that investors run from, screaming. In short, Mack handed over a number of big bets with the firm's capital that didn't -- or have yet to -- pan out.
There is no shortage of talented people atop Morgan Stanley. What they don't have is a track record of risk-management discipline. Says Bank of America analyst Guy Mozkowski: "That's the most important thing they can get right."
Up a few bucks but never the big winner
As a CEO with a tenure of little more than a year, Gorman deserves some patience. But he has already been guilty of one cardinal sin in the mind of investors: excessive optimism. Not long after taking the helm, he described 2009 as a year of transition for the company, and predicted that 2010 would be a year of execution. That schedule is now being pushed back a year. "You saw evidence of results at the end of 2010," says Gorman. "You will see more in 2011. And more in 2012. Probably by the end of 2012, we won't be having this conversation."
For now, Wall Street analysts and investors seem willing to give him the benefit of the doubt. Says Bruce Berkowitz of Fairholme Funds, who has a $1 billion bet on Morgan Stanley (along with similar-size wagers on Goldman, Citigroup, and Bank of America (BAC)): "I'm impressed with him to this point."
Gorman has made clear his to-do list: Continue to rebuild talent in securities, maintain strong investment-banking results, and improve profits in wealth and asset management. He seems to be making progress on all fronts. But he'll need a continued strong stock market to get him there.
What does he hope his legacy will be? Gorman is too smart to take that bait, but he responds with a bit of Australian argot. "Look, I'm not here for a haircut," he says. Translation: He has real business to transact.
Gorman, a man who has pared risk and made Morgan Stanley a more balanced institution, seems unlikely to make the sort of big bet that either propels the firm into a new golden age -- or torpedoes it. He's a more cautious and consistent player than that. Here's how his friend Ken Buckfire, CEO of investment bank Miller Buckfire, describes Gorman's performance in a summer poker game that's been going on the better part of two decades: "He's usually up a few bucks but never the big winner." For Morgan Stanley in 2011, that may be just the kind of approach that's called for.
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