GS vs. MS: Who’s Winning Wall Street’s Battle of the Bulge Bracket?

GS vs. MS: Who’s Winning Wall Street’s Battle of the Bulge Bracket?

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They aren’t quite the Montagues and the Capulets, but if the fierce rivalry between Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS) varies from that family feud chronicled by William Shakespeare, it’s only in the absence of literal dead bodies — and, for that matter, a love affair that might serve to unite surviving members of the two rival factions.

In contrast to the denizens of medieval Verona, it’s pretty clear what Goldman and Morgan have been squabbling about for decades. Both firms have always sought the uncontested right to call themselves the premier “Wall Street” bank. In the 1980s, they were battling the likes of Dean Witter, or, flush from their success turning junk bonds into a mainstream investment product, Drexel Burnham Lambert.

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In the 1990s, they warred with technology-focused investment banks on the West Coast — Hambrecht & Quist, Robertson Stephens — as well as the array of well-capitalized European and U.S. banks greedily eyeing the money to be made from investment banking and trading, from Credit Suisse to Citigroup, in the process of being born. But their primary rival was always each other.

They fought over who would underwrite hot IPOs (and if one had been chosen to do a deal, the other would sometimes refuse to participate.) They squabbled over hiring top recruits from business schools, and the buzz went around in philanthropic circles that one sure way to boost the size of your donation from one firm was to plant a rumor that the other planned to make a sizeable gift. They even tried to one-up each other over the date on which they released their earnings.

But the most recent batch of financial results from both banks, released last week, have prompted some to wonder aloud once more whether it’s time to declare the match over.

The catalyst for such a provocative action? Morgan Stanley’s impressive earnings release, which included a 46 percent jump in earnings, to $1.3 billion, or 60 cents a share, handily beating analysts’ forecasts that it would report profits of 55 cents a share. Morgan Stanley it also beat revenue forecasts. If you include the impact of one-time charges, the profit was actually closer to $1.9 billion.

In contrast, while Goldman Sachs also did well, it was a very relative kind of well. Goldman still depends on trading revenues more than any other bank on Wall Street, and that weighed on its second-quarter results: Its fixed-income, currency and commodities division saw net revenue drop 10 percent. The bright spot, however, was brighter than expected, as investment banking activity. IPO underwriting and advising on M&A transactions like AT&T’s proposed $48.5 billion merger with DirecTV was enough to push Goldman’s earnings to $4.10 a share, 5 percent above year-ago levels and a big surprise to analysts who had been forecasting a large decline in profitability.

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Both earnings releases may have been positive surprises, but only one of them, Morgan Stanley’s, is the result of a trend that analysts believe might be sustainable over the longer haul. That’s because it’s the result of a longer-term strategic shift on the part of CEO James Gorman, who realized in the aftermath of the financial crisis that the bank’s business model needed to change. He doubled down on the wealth management and retail asset management businesses, and eased up on some of the firm’s involvement in trading. That area, he seems to have concluded, simply didn’t represent a prudent use of Morgan Stanley’s capital, once adjusted for the risk, especially when contrasted with asset management.

Years later, that bet is now paying off, even as Goldman Sachs struggles to cope in the low volatility, low interest rate environment that is wreaking havoc on the bottom lines of all those who make money from trading.

Is it too early to brandish Gorman’s hand in the air and declare victory, and send Goldman Sachs CEO Lloyd Blankfein back to his corner in defeat? Possibly — but this time, I think, Morgan Stanley has come closer than it has before.

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There have certainly been occasions when the bank was on top of the heap, such as the mid-1990s. That’s when Morgan Stanley beat Goldman in the gold rush of the early Internet boom in Silicon Valley, thanks to its hiring of star technology banker Frank Quattrone.

Quattrone became the first banker to open up a Silicon Valley office, within yards of all the top venture capital offices on Sand Hill Road, and parlayed his connections with those VCs into a steady stream of incredible deals, starting with Netscape. Memorably, Quattrone was the banker responsible for urging Netscape to double its IPO price the night before the deal priced, to $28: the shares soared 150 percent on their debut, and the dot-com boom was officially off and running, with Morgan Stanley poised to profit the most. Goldman Sachs, by comparison, was a latecomer to the game.

But Goldman Sachs caught up to Morgan Stanley and overtook it; by the end of the decade, it was Goldman that was the investment bank everyone wanted to join — the infamous “vampire squid” of Wall Street. And while both firms survived the 2008 financial crisis — the sole investment banks of their breed to do so, even though they had been forced to transform themselves into “real” banks — it was Goldman that roared back to life most rapidly.

By the next summer, it had reported the largest profits in its entire history, and for 2009 as a whole, Goldman reported net income of $13.39 billion. Morgan Stanley, in contrast, reported a profit of $1.15 billion — but that became a loss after taking into account write-offs and taking into consideration only the firm’s continuing operations.

What’s different this time? The two firms today are possibly more different in their business model than at any other time in their history — and the gap is likely to only become wider with time. Throughout all the decades in which the two have been fierce rivals, they have essentially been fighting for bits of the same pie. It was very much a zero-sum game.

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That simply is no longer the case, and it may explain why we have begun to see some very unprecedented phenomena on underwriting documents, such as Morgan Stanley sharing the spotlight with Goldman Sachs on the Twitter IPO. Morgan Stanley’s primary focus is on wealth management. That’s where it needs to maintain and build market share and where a loss would be intolerable. For Goldman Sachs, the focus is investment banking. The rift is widening.

Perhaps there won’t be a victor in this long-running Wall Street feud at all. Perhaps the two old rivals will simply shake hands and sail off into the distance — in different directions.

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