Morgan Stanley picks Plan B; AIG up as holders seek alternative; Nobel Learning jumps on buyout bid

By Paul Deckelman

New York, Sept. 22 - Morgan Stanley - never comfortable with the prospect of a shotgun wedding to Wachovia Corp., considered the least secure of the major U.S. commercial banks - on Monday struck out in a different direction. Along with rival Goldman Sachs, Morgan Stanley sought - and received - regulatory permission to convert itself from an investment bank into a commercial bank, which would put it under the authority of the Federal Reserve and allow it to take deposits as a way of building capital. Morgan Stanley also announced that it would sell as much as a one-fifth stake in the company to a major Japanese bank. But shareholders were less than enthused, as early bullishness faded.

American International Group Inc. shareholders, on the other hand, were enthused at published reports indicating that quick asset sales by the ailing insurance giant might allow AIG to speedily repay a lifeline extended to it last week by the government, thus keeping the company independent.

Outside the financials, Knowledge Learning Corp. offered to acquire Nobel Learning Communities Inc. - but an analyst said that the $17 per share offer may undervalue the latter company.

Overall, Wall Street gave up most of the gains which it had notched on Friday at the tail of a powerful two-day surge, as investor nervousness about the details of the proposed giant government rescue plan for the financial markets, combined with a sharp rise in crude oil prices battered the financial markets. The bellwether Dow Jones Industrial Average fell 372.75 points, or 3.27% percent, to 11,015.69. Broader indicators followed suit, with the Standard & Poor's 500 index down 47.99 points, or 3.82%, to 1,207.09, and the Nasdaq composite index off 94.92, or 4.17%, to 2,178.98.

Morgan Stanley makeover plans disappoint market

Morgan Stanley and Goldman Sachs, the last two remaining old-line investment bankers, each took the step of informing the Federal Reserve that they wanted to convert to commercial banks, which would make them eligible to take deposits - a reliable and predictable source of funds, rather than be left at the mercies of the commercial paper and other short-term capital markets. It would also entitle them to be eligible for emergency loans from the Fed, should the need arise.

A trader said that the main benefit to such a strategy, from Morgan Stanley's perspective, would be that "this way [chairman and CEO John Mack] gets to stay in charge, and keep their ego and charge on after whining about people shorting his stock."

Mack faced the likelihood of loss of control of the company as Morgan Stanley negotiated last week - under pressure from Wall Street - with Wachovia Corp. in the wake of the financial-sector turmoil which also saw rival Merrill Lynch & Co. sell itself to Bank of America Corp in a $50 billion all-stock deal. On the news that the Fed had approved the move by Morgan Stanley and Goldman, news reports spread that the talks with Wachovia had been shelved, indefinitely. This way, the trader said, "they're still Morgan Stanley and they can thumb their suspenders." As for Wachovia, "no, they don't need them any more."

Noted banking industry analyst Richard Bove of Ladenburg Thalmann & Co. said the changeover from investment bank to commercial bank will not change the way either Morgan Stanley or Goldman conduct their investment banking and trading operations, since the two Wall Street firms "have already been banks for a long time."

Bove cited their moves into mortgage lending and other activities associated with commercial banking. Now, he said, they would seek to win retail and corporate banking customers by selling products such as certificates of deposits.

The analyst said it would be unlikely for either Goldman or Morgan Stanley to speed up the conversion process by trying to take over any existing large-sized banks. He said that there are "a whole bunch of small banks in the United States that might be willing to sell out to them, but not big banks. Why would they want to link up with a company which is struggling to stay alive?"

Bove said the move away from the traditional investment-banking model and to a bank holding company model by the last two big investment banks reflects the sentiments in the market, which are "forcing the deleveraging of the banks."

More regulation, smaller checks

But there's a downside, and it's a big one. While investment banks were and are answerable to the Securities and Exchange Commission, the Fed is considered a much tougher overseer.

"Being a bank holding company is not the same as being a brokerage firm," a trader said. "There are a lot more Fed eyeballs on you and restrictions on what you can do - you can't leverage as much and there's more scrutiny and filings. They're going to have a lot more regulation, be less leveraged and the checks are going to be smaller to people - like in a bank."

He said that it might turn out to be a case of that old saying coming true - be careful of what you wish for because you may get it - and you'll regret it.

Shareholders seem to already be regretting it. Morgan Stanley (NYSE: MS) initially rose some 16.3% - but shrank back from that peak and in fact fall all the way back down and then some, ending the day down 12 cents, or 0.44%, at $27.09. Volume of 56.4 million was not quite twice the norm.

Morgan Stanley separately announced that it had agreed to sell as much as a 20% stake on undisclosed terms to Japan's Mitsubishi UFJ Financial Group. The investment would be based on Morgan Stanley's book value as agreed upon completion of satisfactory due diligence. Upon the closing, a representative of MUFG will join the Morgan Stanley board.

The trader also opined that Morgan Stanley's move would likely not encourage Merrill Lynch shareholders to try to keep their venerable investment independent by voting down the recently announced Bank of American deal when it comes up for a vote.

"With the volatility of this market, how can you complain" about the terms of the Merrill deal with B of A? He said the Charlotte, N.C.-based banking giant agreed to pay " a nice fat premium" - this at a time "when Bank of America had stopped trading with Merrill Lynch a couple of days before hand, so now they were on the verge of going out of business. So it's not enough?

"Bank of America stock will be up by the time the deal closes and everyone will be happy."

Merrill Lynch (NYSE: MER) lost $1.45, or 4.92% on Monday to end at $23.05. Volume of 38 million was a little under the norm.

AIG alive on talk of quick sales

Also in the financial realm, American International Group's shares (NYSE:AIG) jumped as much as 43.3%, before dropping back to finish up 87 cents, or 22.60%, at $4.72. Volume of 398 million shares was four times the usual turnover.

The shares shot up on a report in The Wall Street Journal on Monday which said that large shareholders are looking to organize a quick sale of assets and to raise capital in order to pay off the Federal Reserve takeover loan, thereby keeping AIG independent,

The trader, noting that the stock got as high as $5.50 for a while , said "there was supposedly a big meeting today of a lot of the big shareholders and who knows what, about putting something together to get [AIG] it back.

"What they could do is sell off a couple of the big areas, like ILFC [the company's crown-jewel International Lease Finance Corp. aircraft-leasing operation], pay the Fed off and buy it back. I don't think it's very difficult at all. If they're able to do it, I don't see how many people at the Fed would argue against being able to get one of these red herrings off your hands, and quickly, after getting yelled at for 'socializing the country.'"

Nobel Learning leaps forward

Away from the financials, Nobel Learning Communities' shares zoomed over 25% after the West Chester, Pa.-based education company received a $17 per share buyout bid from privately held Knowledge Learning Corp.

That represents a 33% premium over where Nobel had been trading on Friday.

However, Nobel Learning (Nasdaq: NLCI) was still trading well under the proposed takeover price, finishing up $3.26, or 25.7%, at $16. Volume of 28,000 shares was about four times the norm.

Signal Hill Capital Group LLC analyst Trace A. Urdan suggested that despite the one-third premium over Friday's levels, the offer was on the low side. "On a near-term basis, $17 looks like an upside - but in terms of long-term opportunity it is probably a pretty low price for what Nobel has built and will continue to build."

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