Will JP Morgan Sweeten the Offer?

I really don’t see how Bear Stearns (BSC) shareholders will approve the $2 deal. Apparently, I’m not alone. The stock is currently at $6 and it went as high as $8 Tuesday.

Part of that buying is being driven by BSC creditors (hedge funds, mainly) who don’t mind taking a small equity loss in exchange for a big debt gain—they just want the deal done. No one knows how much equity Bear truly has, but there’s around $300 billion of Bear Stearns bonds out there. If the whole mess goes to a bankruptcy court, then the stock holders go to the back of the line.

Of course, the debtor’s strategy could backfire if the price goes too high and JP Morgan (JPM) gets cold feet. Still, I doubt that would happen. As always, one shouldn’t fight the Fed.

I would say that the most likely outcome is that JP Morgan will sweeten the offer. To add some context, it’s really not that much for JPM. The company’s market value has already increased by $20 billion this week. The offer for Bear will cost JPM $236 million. What’s the big deal if it doubles or even triples the offer? Plus, it could win JPM some goodwill.

Dimon is a very smart guy, and it might be a shrewd move to get out in front of what could become very unpleasant. If I were him, I’d meet with Joe Lewis, Legg Mason (LM) and other major BSC holders. He’s already won big. He can afford to be magnanimous.

On top of that, let’s not forget that JPM owns a gigantic call contract of whenever-$2s, and there’s also the building deal. Plus, it’s not unreasonable for the U.S. credit market to recover over the next few weeks. That could be a huge boon for BSC’s debt. To quote Michael Scott, it’s win-win-win. In fact, taxpayers could win as well.

I think we ought to move beyond the question of whether the Fed should be involved in—what I’ll call—a quasi-bailout. Instead, let’s look at the deal that was made, and it makes JPM look Putin-esque. The WSJ reminds us that it’s not uncommon for the government to make money off bailouts:

During the 1995 peso crisis, the Clinton administration offered Mexico $20 billion in loans, with the country's oil revenues as security. The International Monetary Fund offered another $18 billion. Critics condemned the loans as a bailout. In the end, Mexico didn't require the entire amount, and the country's finances recovered. The U.S. ended up making a profit on the interest payments.

The government also turned a profit from the Air Transportation Stabilization Board, an entity set up after the Sept. 11 attacks to support the airline industry. The board ultimately provided a total of $1.56 billion in loan guarantees to six carriers. The government earned just under $350 million from fees and stock sales, according to the Treasury Department.

Last year, the Fed made a profit of $34 billion. It’s very possible that the central bank could make money on whatever they’ll get from Bear’s book. I still don’t understand who gets what. This seems to be a classic case of we don’t know what we don’t know. Perhaps the best move for the Fed is to hold the bonds to maturity.

Comments

[Msg212:]

I think its ridiculous that some people actually think bondholders are buying BSC stock on the cheap in order to pass the deal through. First of all, BSC bondholders are investment grade investors, who often are restricted from buying stock in Companies. The amount of hedge funds that own BSC bonds are miniscule compared to other insitutional funds. Also, if you were a bondholder, why would you want to double your exposure in BSC? So you own $1 billion of bonds and now you want to own $1 billion of common equity too? Sounds ridiculous to me...I don't think PMs at various hedge funds would want to double their exposure. Third, why should JPM sweeten their offer? What is $6 or $8 a share going to do for investors? Maybe Joe Lewis makes loses $100 million less, but for the average investor, their investment in BSC is done. Only a significant higher offer, like $20 a share, would be meaningful to everyone and I doubt Jamie Dimon is stupid enough to offer that.

2008 Mar 19 09:06 AM

[todd07:]

Concerning msg212...that line of reasoning should land you a nice job at the Bear Stearns risk management desk. For all intents & purposes BSC equity is worth nothing in comparison to the amount hinging on bondholders recovering their loans. The difference is several orders of magnitude.

2008 Mar 19 04:24 PM

[Augustus:]

for Msg212,
1% of BSC bonds = $3 Billion.
10% of $3 billion in bonds = $300 Million => JPM price to buy.

Costs less than 0.1% of Bond value to "guarantee" that the deal closes IF it took all the shares to do that.

2008 Mar 20 11:30 AM

[nyka:]

Enter your comment I wholeheartedly agree. I can see JMP raising the offering price to $2.10.

2008 Mar 20 05:03 PM