Trying (and Failing) To Understand Wachovia's A.G Edwards Acquisition

Breakingviews.com likes Wachovia's (WB) acquisition of A.G. Edwards (AGE) because, it says, the deal’s return on investment after two years “looks to be somewhere in the order of 11%m[...] That comfortably exceeds A.G. Edwards cost of capital.” Some thoughts:

1. If the people at BV.com think A.G. Edwards’s cost of capital is well below 11%, they have meaningfully miscalculated A.G. Edwards’s cost of capital. It’s likely at least 12% and, given the current bubbly environment for the stock market, is very likely much higher.

2. Regardless of capital costs, an 11% IRR is nothing to shout from the rooftops. Wachovia would have done better (and saved all those investment banking fees) if it had simply taken the $7 billion and bought back stock. Plus, no execution risk!

3. While we’re on the topic, I don’t see why it’s such a big plus that Wachovia will now have “a larger pool of retail investors to buy its deals.” That hasn’t exactly worked so great for Morgan Stanley.

4. Where did this “rule of thumb” for valuing annual cost saves by multiplying them by 10 come from? That’s news to me. (If it really is a rule of thumb, it sounds like an investment banker’s rule of thumb.) Why not just figure the net present value of the estimated $395 million cost savings by . . . calculating their net present value? Even at a 12% discount rate (which is likely too low, given integration risk), I get to $3.3 billion, not $4 billion.

5. I’d also net that $3.3 billion against any one-time charges that will inevitably occur in the integration process.

6. I’ll believe that $395 million savings number when I see it.

And don’t forget, the Wachovia integration team is still working on getting its arms around Golden West. Why Wachovia is giving up 7% of itself in return for a retail brokerage business at the top of the market I don’t understand...

Tom Brown is head of BankStocks.com.

WB 1-yr chart

AGE 1-yr chart

Comments

[RichL:]

I carry no brief for breaking views, but the AGE deal isn’t as bad as you portray. The negative about WB is that they are serial acquirers. However, look at what they are acquiring. Westcorp was the best auto lender, Golden West the best thrift, and AG Edwards the best retail broker. You may disagree with the prices paid, but one must pay up for high quality in any market.

Does Mr. Brown believe that the staff that is integrating the GDW acquisition is the same personnel to fold in AGE. Yes, it’s the same buyer, but they are different businesses. I don’t see risk emanating from that aspect of the transaction. I lack the omniscience to foretell that this is the top of the market, so I defer to Mr. Brown’s expertise on what the future will bring.

The value here is that WB sells many structured products to retail. When you can sell hundreds of different products with high-implied volatility, the portfolio effect of this diversification creates a lower volatility portfolio, which can be hedged more inexpensively. This is likely quite profitable, and the added distribution can’t hurt. The two businesses together will likely be stronger. Brokerage has better growth prospects than branch banking. If there can be any cross-selling of product beyond the money-market funds, the deal might be better than you think.

2007 Jun 04 08:35 AM

[TM65:]

Why did A G Edwards sell to Wachovia? What was the real reason? Who made money from the sell? I know a shareholder that lost. I do not think I am the exception. The above stated reasons from Tom Brown might be misleading. We are now in the middle of a bailout, Sept., 27, 2008 and Wachovia is trying to sell. When did the sales people for A G Edwards know that they were selling to Wachovia?

2008 Sep 27 02:26 PM