Morgan Stanley to Sell Stake in MSCI

By Emma Trincal, Senior Financial Correspondent | Wednesday, August 01, 2007

NEW YORK (HedgeWorld.com)�MSCI Inc., Morgan Stanley & Co.'s index subsidiary, filed a statement with the Securities and Exchange Commission Tuesday [July 31] for an initial public offering expected to take place by year-end. The company plans to float $200 million.

MSCI produces indexes and risk and return portfolio analytics, including its flagship international equity indexes marketed under the MSCI brand, REIT and hedge fund indexes as well as the Barra portfolio risk analytics.

Morgan Stanley right now only aims for the sale of a minority stake. The filing did not disclose what this amount would represent as a percentage of the business. In the future, though, and while no decision has yet been made, Morgan Stanley may ultimately consider divesting its remaining ownership interest in MSCI, according to a bank statement.

"The initial public offering and potential separation of MSCI are consistent with Morgan Stanley's strategy to focus our people, capital and resources on our core businesses, including institutional securities, asset management and global wealth management," said John Mack, Morgan Stanley's chairman and chief executive, in the statement. "We believe this transaction will unlock value for Morgan Stanley's shareholders as well as release capital to redeploy into our core activities."

Morgan Stanley currently owns 96.6% of the outstanding shares of MSCI; Capital Group International Inc. owns the remainder of the shares.

While the timing for IPOs is not the best�with fears among market participants of widening credit spreads�MSCI represents a specific business segment for Morgan Stanley, which focuses on providing quantitative tools to large asset managers, including pension plans, endowments, central banks, exchange-traded funds and hedge funds.

"Morgan Stanley is streamlining its operations and indices are not their core business," said Ferenc Sanderson, senior hedge fund analyst at Lipper Inc., which is part of Reuters. "This is likely to benefit their stock price in the marketplace, long term."

According to the Use of Proceeds section of the prospectus, MSCI is also interested in using the IPO proceeds for the payment of a debt incurred for paying a dividend distribution last month.

On July 19 MSCI paid a $973 million dividend to its shareholders. The dividend consisted of $325 million in cash and $648 million of demand notes, according to the filing. "Prior to the completion of this offering, we intend to obtain a new credit facility, the net proceeds of which we will use to pay in full the $625.9 million demand note held by Morgan Stanley. We intend to use all of the net proceeds from this offering to pay a portion of our new credit facility," according to the filing.

"It's a leveraged buyout process, but they're doing it on themselves," said Francis Gaskins, IPO analyst at Los Angeles-based IPODesktop.com, an IPO research firm. "Private equity firms do this all day long but it's somewhat unusual for a company to go through those steps."

Mr. Gaskins described the steps as follows: "First, they paid themselves dividends. In this case, Morgan Stanley is the main shareholder with a 96% ownership. Secondly, they borrowed to pay back their dividend distribution. Finally, they use the IPO proceeds to pay part of the debt incurred as a result of the dividend," he said.

However, the process is far from being an LBO as Morgan Stanley is not selling its subsidiary. "MSCI is simply leveraging its balance sheet," said Mr. Gaskins.

Mr. Gaskins estimated that the IPO could pay back about 30% of the total debt amount incurred for the dividend distribution. As of the end of May, the company held $397 million in cash. A $325 million cash dividend distribution therefore represents 82% of the cash available on the balance sheet. "They took the cash out of the company and wanted the dividend to be paid before the IPO," said Mr. Gaskins. With corporations usually paying a 10% underwriting fee and with the IPO expected to raise $200 million, the net IPO proceeds should be approximately $180 million, said Mr. Gaskins. As a result, the IPO will pay about 30% of the debt, he explained.

For now, MSCI's business is in good shape. Revenues increased $26.3 million, or 18%, to $175.8 million for the six months ended in May, compared to the same period in 2006, according to the filing.

But the IPO valuation will largely depend on quarterly results to be released this month, as the deal is not expected to happen before Labor Day.

"You can't sell on the downside of the curve. It's a healthy business they're in. They can sell, depending on the valuation of the IPO," said Mr. Gaskins.

As the prospectus stipulated, changes in equity markets constitute a risk factor. And while results compared to last year have been good, operation figures have been more disappointing for the most recent quarter.

According to the filing, revenues from February to May were flat, growing by only 1.9% to $88.75 million from $87 million. During the same period, profits decreased by 8.2% to $19.85 million from $21.64 million.

"If the August quarter is flat relative to May, it's going to be a very difficult IPO. They are not going to get the valuation that they want. People don't like flat trend lines," said Mr. Gaskins.

Morgan Stanley will be the sole underwriter for the IPO.

A Morgan Stanley spokeswoman declined to comment. An MSCI spokesman declined to comment as well.