Buying in Bear: An Insurance Policy?

Bear Stearns’ (BSC) customers and counterparties are getting their transactions “reinsured” by J.P. Morgan (JPM). No one is questioning that this is required for Bear to stay in business. But, is Bear paying a fair price to reinsure its transactions? If Bear shareholders turn down the merger, JPM gets about 20% of the company for $2/share and the option to buy Bear’s building at a slight discount. Given that few details of the actual agreement have been disclosed, it is difficult to know if there are any more components to the premium being paid for the JPM insurance policy.

 JPM is obviously taking risk beyond the $30B backstop provided by the Federal Reserve, but it seems that they would win whether the deal consummates or not. JPM is increasing its odds of closing by promising to make all Bear debt holders whole after the deal closes. Rumors are being reported that large Bear bond holders are buying the equity to help insure stockholders approve the deal. JPM also spoke of paying retention bonuses to Bear employees. This could also buy some votes.

 The stockholders only win if the deal fails to gain stockholder approval. Joe Lewis (with a 9.4% stake) called the deal “derisory” (laughably small). Bruce Sherman of Legg Mason complained to Bear Stearns’ officials that JPM acknowledges Bear is worth much more than JPM is willing to pay. (JPM acknowledge as much in the March 16 conference call).

 If the shareholders manage to defeat the deal, than the price of the JPM insurance seems reasonable. The only trouble is Bear may have to find a new place to live. However, no office space might be needed. The best solution for Bear's shareholders might be to sell the prime brokerage and clearing operations, and then liquidate the remaining assets. This is not likely to make Treasury Secretary Paulson and Federal Reserve Chairman Bernanke very happy.

 The Wall Street Journal references: “Though 'Arbs' Say Otherwise, $2 May Be It” and “J.P. Morgan's Good Office Deal?”

Disclosure: Author unfortunately is long BSC.