Morgan Stanley: State Street's Purchase Of Charles River Makes Strategic Sense

State Street Corp (NYSE: STT) shares have taken a beating since the company announced the $2.6-billion acquisition of Charles River Development.

The Analyst

Morgan Stanley analyst Betsy Graseck upgraded State Street from Equal-weight to Overweight and hiked the price target from $109 to $115. The analyst named the stock a top pick.

The Thesis

State Street investors have punished the stock for the financing dilution while ignoring the target company's earnings and synergies, Graseck said in the Tuesday upgrade note. The price-to-earnings multiple is at a five-year low, she said. (See the analyst's track record here.) 

The Charles River acquisition makes strategic sense, as it arms State Street with "straight through processing" technology integration, which can help streamline trading operations, thereby cutting reconciliation and audit costs, Graseck said. 

The view that asset managers will force State Street to include all of Charles River's front office services in its existing pricing bundle is "too negative" of a scenario, the analyst said. 

Graseck estimates State Street's new offering of a front-to-middle-to-back office trade platform can help lower operational costs of asset managers clients by 75-115 basis points. This would lead to $10 million to $15 million in annual operational expense savings for large asset managers, she said. 

Trust banks have outperformed large-cap banks by a median 6 percentage points per quarter ahead of the last three recessions, with the outperformance lasting four to six quarters, according to Morgan Stanley. 

Catalysts such as improving organic operating leverage and buybacks that Morgan Stanley projects will begin in January 2019 should push State Street's forward P/E back in line with its five-year historical average, Graseck said. 

The Price Action

State Street shares have lost a little over 10 percent year-to-date.

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