Bear Stearns Firesale: Notes and Predictions

Wow. What a difference a day makes. Bear Stearns (BSC) is now, apparently, being fire-sold for $2 a share to avoid being fire-sold for the values of its assets minus its liabilities.

I was reading the WSJ piece on the topic, and it seems like there was a lot of pressure applied by the Fed to ensure Bear got sold, with no regard for shareholders (the article states this, in essence). So counterparty risk is now secure. Great! But wouldn’t it have been better to run a real process and determine the value of the company? Wouldn’t it have been more valuable to not send the message that the “health of the financial markets” is more important than a firm’s sale occurring at their true equity value? (And aren’t both of those, taken together, a contradiction? Mis-valued assets was how this mess got started.)  So, let’s make some bold predictions! I don’t think they will all be right, but they are obviously all reasonable to me. I’ll show my hand and give the probability I ascribe to the prediction coming true, as well.

Prediction: Lots of shareholder lawsuits. K.K.R. was looking a bidding, so was J.C. Flowers, and the Fed says the deal needs to be done today, so they get crammed out. Who do you sue? Everybody of course! Hence JPM estimates $6b in costs for this transaction, first item listed–litigation. Probability: 100% (Bonus prediction: Someone notable from Bear joins in a lawsuit or files one themself! Probability: 50%)

Prediction: The price gets raised. A process wasn’t run, shareholders will demand more, and the Fed is taking $30 billion in risk. For $1 billion in accretion to earnings, and not even being in the first loss position on the toxic assets Bear is holding, why pay such a low price? This will become a problem for JPM. Keep in mind, this can be raised (the pruchase price) by having to pay out certain shareholders more than the bid price. For example, employees they wish to retain might have shares made whole at a higher level than the sale (you have 40k shares of BSC, you get $40 in JPM stock for each share if you stay, for example). Probability: 70%

Prediction: JPM will never see some of those assets add to their franchise. If the prime brokerage business really saw the kinds of outflows reported by the media (from Bear, that is) JPM could already be finding itself over-paying for that asset. And the mortgage and securitization business at Bear? Management for that business are at the top of that market in terms of knowledge and relationships–watch that business experience brain drain quickly. Probability: 70%

Prediction: Integration will be a nightmare. Culture clash will occur at many points in the process and within many businesses. JPM and Bear’s cultures aren’t compatible. Bear is a very raw environment and is very cut-throat. You’ll see this get ugly, fast. Big names on both sides will leave and power struggles will be common. Perhaps this is normal merger behavior, but it will be worse because the Bear employee have already been financially destroyed. You’ll see resentment for JPM from ex-Bear employees and silos form within the firm. It will be difficult to interact with certain parts of the firm depending on where you worked when JPM bought Bear. Ouch. Probability: 60%

I’m sure much more information will leak out as this deal develops. If this drags on or lots of game-changing information comes to light, I might revisit these later.

Comments

[The Market ...:]

I'l tell you who to sue. Sue the Fed. This was extortion on the grandest scale I have ever witnessed in my 30 years of tracking the markets. The Fed freaked and the employees of BSC got royally screwed. I don't know what more evidence you need that the current Fed Reserve doesn't have a clue as to what's going on.If Hank Paulson ends up at JPM after his stint at Treasury ends(Probability 80%) it will be a clear sign that he's not out to help the US economy or its citizens.
The very fact that BSC is trading well above the offer price of BSC tells me something else about this deal.It was just a way of buying time for BSC and the financial markets to avoid a meltdown(probability 100%).BSC has a month to get its house in order then all the stockholders can vote down the deal,BSC continues on its own as if nothing has ever happened and the stock quickly recovers to the $30 level.All the assets previously marked down start to get repriced upward over a 2 year period and BSC is healthy again(probability 75%).Do you honestly think the employees of BSC want to take a bath like what they're looking at when they can find a way out?
You guys out there act like every mortgage is going to default-they're not and the ones(homes) that do will get quickly snapped up by investors,new mortgages will be written to sound credits.We don't have to make this S&L 80's^2.

2008 Mar 18 11:14 AM