Morgan Stanley Monday agreed to sell a 21 percent stake to Japan's Mitsubishi UFJ Financial Group for $9 billion to shore up its finances, but investors balked at the deal's terms and sent the investment bank's shares reeling.
One week after revealing a preliminary agreement, the companies announced that Japan's largest bank will acquire 9.9 percent of Morgan's common stock at $25.25 a share, or $3 billion. That's 19 percent below its $31.25 book value at the end of August.
The Japanese bank also will buy $6 billion of convertible preferred stock, which pay a hefty 10 percent dividend and have a conversion price of $31.25 a share. Morgan Stanley said the weighted average of the transaction values its shares at $29, or a 28 percent premium to its current price.
MUFG's investment "is a strong endorsement of Morgan Stanley's world-class global franchise and future potential," Morgan Stanley Chief Executive John Mack said in a statement. "This strategic alliance offers a powerful opportunity to accelerate Morgan Stanley's transition to a bank holding company."
Yet the deal also shows how the worsening credit crunch is making even the largest financial players more cautious. MUFG's announcement represents a slight change in plan since last Monday, when Morgan said it would sell an equity stake of as much as 20 percent for about $8.5 billion.
Toshihide Mizuno, senior managing director of MUFG, told reporters Monday in Tokyo that while it was taking half its stake in preferred shares, it eventually would own a fifth of Morgan Stanley.
"A week ago when we announced this deal, we had been thinking that the stake would all be in common stock," Mizuno said. "But considering the current state of the economy and the market we wanted to minimize and hedge our risk."
The total deal, on a weighted average basis, prices Morgan at 7 percent below its book value and would reduce shareholders' per-share earnings by about a fifth.
Morgan stock was down 7 percent, after slumping as much as 19 percent in early trading in New York.
In one year, half the preferred stock can convert into common if Morgan's stock trades for more than 150 percent of the conversion price, or roughly $47, for a certain period.
The fifth-largest U.S. bank said the investment provides capital to pursue investment opportunities, bolster capital and increase its liquidity. A Morgan Stanley spokeswoman declined to elaborate on the bank's plans under a strategic alliance.
Including the Mitsubishi capital, Morgan would have a Tier One capital ratio of about 15 percent, among the highest in the banking industry. Morgan on Monday said it "significantly" reduced its balance sheet since the end of August.
Yet the deal failed to stop the erosion of its shares after two brutal weeks, when investors and clients lost confidence in the ability of even the largest Wall Street banks to survive the credit crunch.
Its shares fell by half amid the demise of Lehman Brothers Holdings, prompting Morgan to pursue bank mergers and on Sept. 21 abandon its broker-dealer model to become a bank holding company under Federal Reserve oversight.
The price of its debt-default insurance had soared to distressed levels. On Monday those prices fell to a still lofty upfront payment of 12 percent of the sum insured, or $1.2 million to protect $10 million of debt.
Last week Goldman Sachs Group, which like Morgan converted to a bank structure, quickly struck deals to raise $15 billion of equity capital from Warren Buffett's Berkshire Hathaway Inc and the public.
Goldman also will pay a hefty 10 percent dividend on $5 billion of preferred stock.
MUFG noted that once the full 21 percent stake is attained, the U.S. investment bank will become an equity-method affiliate of the Japanese bank, which means it will be a factor in MUFG's earnings.