Ken Lewis's Call Option on Countrywide

The most recent deal not going according to the merger-arb playbook is Bank of America's (BAC) acquisition of Countrywide (CFC). The takeover takeunder is valued at $6.47 per share, but Countrywide is trading at only $5.11. How come? Well, have a look at the MAC clause (a/k/a section III 3.8(a) of the merger agreement), detailing the representations and warranties made by Countrywide:

Since September 30, 2007, no event or events have occurred that have had or would reasonably be expected to have, either individually or in the aggregate, a Material Adverse Effect on Company.

That's the entire dreadful fourth quarter. My feeling is that this clause is a "get out of jail free" card for BofA: if Ken Lewis changes his mind, he shouldn't find it too hard to find a material adverse effect at some point in the past few months.

And that's not the only clause he has to rely on, either. There's section III 3.5(c), too:

Company has previously made available to Parent an accurate and complete copy of each... communication mailed by Company to its stockholders since January 1, 2005 and prior to the date of this Agreement. No such Company SEC Report or communication, at the time filed, furnished or communicated (and, in the case of registration statements and proxy statements, on the dates of effectiveness and the dates of the relevant meetings, respectively), contained any untrue statement of a material fact or omitted to state any material fact required to be stated therein or necessary in order to make the statements made therein, in light of the circumstances in which they were made, not misleading...

And III 3.6(a):

The financial statements of Company and its Subsidiaries included (or incorporated by reference) in the Company SEC Reports (including the related notes, where applicable)... fairly present in all material respects the consolidated results of operations, cash flows, changes in stockholders' equity and consolidated financial position of Company and its Subsidiaries for the respective fiscal periods or as of the respective dates therein set forth.. and have been prepared in accordance with GAAP consistently applied... The books and records of Company and its Subsidiaries have been, and are being, maintained in all material respects in accordance with GAAP and any other applicable legal and accounting requirements and reflect only actual transactions.

And there's more where those came from. Maybe Lewis is smarter than the market gave him credit for: he basically bought a call option on the company at a very low strike, rather than purchasing Countrywide outright.

Comments

[Pj568:]

Given the 3rd quarter closing date, it seems like the real MAC clause is whether CFC can avoid any type of liquidity or capital crisis during the next 9 months or so.

2008 Jan 21 01:03 AM

[Richard Shi...:]

Good points Felix. The question is whether you think BAC is a hold at this point, I do. The market may discount BAC as if the CFC deal is already done, but truth is that if things get too dicey BAC can probably count on help from the Fed, Treasury and various home loan institutions. Is this the deal that is "too big to fail." 1 year ago this would have already been labeled "anti-competitive" by the same folks who took a huge sigh of relief when the deal was announced. The times, they are a changin'

2008 Jan 21 08:22 AM

[cohenbarryj:]

The filing is 98 pages long but what we don't see and is a major point of contention at the regulatory agencies are the "schedules." These list (privately) all the various issues to the buyer. In this case what we don't know is what has CFC told BAC in these schedules that we don't know but assume would blow the deal. If it is in the schedule then MAC is tough. The one thing that gives me pause is that CFC must have signed-off audited books for the deal to close. Got to think the audit is going to be tough. Anyway the market sure doesn't believe the deal is happening at least not at the original purchase price. I think it goes through by the way since BAC has had a look at the apple twice know and there is nothing we can think about that BAC and their lawyers havn't thought about and more. Besides BAC share are no worse then their peers by any noticible amount post the deal.

2008 Jan 21 04:54 PM

[Chancer:]

I also think BAC has a good idea what's in the books. They had a good look when they put in first $2B. Mozila gets his "golden parachute" and bailed out of potential BK; so he has every incentive to be 100% candid, assuming he knows all (sometimes I wonder if he does).

2008 Jan 21 05:40 PM