Did JP Morgan Overpay For Bear Stearns?

 |  Includes: BSC, JPM
by: Roger Ehrenberg

So it's done. Bear Stearns (NYSE:BSC) is being sold to JP Morgan Chase(NYSE:JPM) for the (not so) astonishing price of - gulp - $2 per BSC share. Get the prime brokerage operation, the clearing business, the high net worth franchise, the nice building, and trash the rest. My only question is: did JPM overpay?

Here is what I said a mere two days ago:

Bear Stearns, as we know it, is gone and never to return. Why did Ace have to give up the reins? Ace was all about managing risk. It is hard to imagine this happening with him at the helm. But bottom line: we are seeing another LTCM-style bail-out, only with the Fed's more active involvement. I believe moral hazard will be skirted because equity will largely be wiped out. This is a crisis of liquidity as well as a crisis of uncertainty. Just how much are those illiquid assets worth? Incalculable at this time...JP Morgan Chase (as a potential acquirer)? A very strong possibility due to the business synergies and knowledge of their book. A headache for sure, but at the right price they'll simply take a few aspirin and call me in the morning. They'll print the trade.

Well, it pretty much played out as I expected. JPM as the buyer and equity holders wiped out. From $170 to $2 - simply stunning. The fact is, however, that notwithstanding the seemingly bargain-basement price of $236 million that JPM bought the stock - and with it all of the associated assets and liabilities - of Bear Stearns. Just how large that difference between book value and the $2 is, as I wrote Friday night, currently incalculable.

Sure, they get some plum assets as mentioned above. But that asset value could be wiped out in a nanosecond if some of those Tier III derivatives go to hell, the mortgage book continues to erode as do all the other leveraged credits on their balance sheet. JPM is making a Citadel/E*TRADE type bet, with the hope that the margin of safety is at least as large. The jury will be out for quite some time, but I wouldn't say that the deal is a slam dunk.

I don't take (much) issue with Jamie Dimon for doing this deal. He is taking a calculated risk, a risk that JPM certainly can absorb in exchange for the prospects of a rich payoff. But before we go patting Mr. Dimon on the back let a little time go by. Because this deal might look a lot less like a bargain a few months from now.

Addendum (Monday 3/17 AM):

A few additional comments. JPM is buying the stock, not the assets, of BSC. Therefore, JPM is effectively stepping into BSC shareholders' shoes, open to all the the portfolio write-downs that will inevitably commence. So discussions around the value of one-off assets ("Gee, isn't their building worth $1 billion - so doesn't this mean that JPM is getting paid to take BSC for $236 million?") is neither here nor there except in the context of getting to the bottom of what hard book value is, which is to say net of portfolio write-downs and diminution in the value of BSC's most valuable businesses due to uncertainty.

Just because something thinks prime brokerage was worth $2 billion yesterday doesn't mean that it is today. The same applies to the clearing, high net worth and other client-driven operations. Clients have been voting with their feet and fleeing, so I put little credence in any breakup analyses I've seen to date. Until the dust settles on the current phase of our financial meltdown, who knows. The only thing immune from such client-driven value destruction is the headquarters building (though clearly not immune from other types of value destruction).

I believe the Fed's $30 billion backstop addresses most if not all of the portfolio issues related to BSC's holdings of mortgage securities with some left over. However, the combination of hard-to-value Tier III holdings and leveraged loans together with the value diminution in their high-value businesses raises the question "is it enough?" Bottom line: likely yes. But is also wasn't so likely last week that BSC shareholders and employees would be wiped out and left to wonder "what happened?" So I am invoking the sentiment of that brilliant philosopher Yogi Berra: It ain't over 'til its over. And believe me, my friends, it ain't nowhere near over.