Wells Fargo and the Wachovia Bid: Crafty or Crazy?

Back in mid-July, I presented the idea that Wells Fargo (WFC) and US Bancorp (USB) are the two best-positioned banks, and are therefore the only bank stocks worth owning. Both are up about 25% since, against a single-digit rise in the KBW Bank Index (KBE), though that hardly captures the entire picture as a non-diversified set of bank holdings could have easily gotten your portfolio killed.

The particular irony here is that while I praised the prudence and conservatism of Wells and US Bancorp in that post, I also ripped on Wachovia (WB) and its low loss reserves, which I speculated would have shown the company to be effectively bankrupt if it was "trued up" to something reasonable. Fast forwarding, and Wachovia's independence is all but gone and it is caught in a takeover fight between Citigroup (C) and the same Wells Fargo that I liked for staying clear (so far) of this credit mess.

Now that Wells Fargo is wading into the acquisition arena with a $15 billion (give or take, not including assumed debt) all-stock bid for Wachovia, is it a sign it has grown impatient from sitting on its hands as undercapitalized and less-rigorous institutions failed, or was this a shrewd time to strike? The bid values Wachovia at 1.3x 2007 pre-tax, pre-provision earnings; by comparison, Wells Fargo trades at 6.9x the same metric. Throw in the recently clarified rule about tax offsets for losses from an acquisition and the fact that Wells can still raise equity capital, and this could actually work out for the company.

Of course, there is another nuance worth noting – Wells isn't offering cash for Wachovia, it's offering its stock, which has performed fantastically relative to your typical financial. A high priced stock is a great currency for acquisitions, and a smart management team will take advantage of that. Given that Wells Fargo stock is still (incredibly) within spitting distance of its peak price-to-book multiple in the post-2000 bubble era, I imagine that this confluence of factors provided a powerful incentive for Wells' management team to make the offer they did.

The chart below shows the trailing 10-year average price-to-book multiples of Wells, US Bancorp, Citi and Bank of America (BAC) – with US Bancorp's valuation holding up even better than that of Wells, will it be long before it too looks to take advantage of that and make acquisitions of weaker rivals?

Update: It seems likely that Wells Fargo will lose its AAA/Aaa rating from at least one agency - good for Wells' management team for being willing to focus on strategic, value-enhancing deals as opposed to myopically pandering to Moody's and S&P. Additionally, while I've seen the argument that the first bidding war to develop over an otherwise-insolvent bank is a good thing for the financial sector, I think Wachovia's size makes it the exception more than the rule, and am still adhering to the minefield mentality in terms of stock selection - by taking no liquidity risk, for example.

Stock position: None.

Comments

[James Wilson:]

Splitting Wachiova would be best for both companys.

2008 Oct 07 05:54 AM

[Ishortyou:]

Now that the 'bail out' plan came through, Wachovia needs fast to take advantage of it, it needs to sell its toxic loan portafolio from its banking subsidiaries around 122 billion if not more to the government close to even cost prices and take serious advantage of the tax break plan and remediate their banking book of business. They also need to contact their customers that did the run on the bank like chickens without head to bring their deposits back and reassure them that they are ok and there is not reason to panic because of the talking heads of FOX news and rest of media and the incompetence of the FDIC. This strategy will demonstrate to the public that the current 'bail out' plan is working and that Wachovia is the first product of it.

2008 Oct 07 06:02 AM

[AChuckatkins:]

Ishortyou has some excellent ideas. Merely because of its size, WB need to exist as an independent bank. WB has an excellent banking operations and an excellent reputation for customer service but was caught up in the Golden West credit fiasco. The Federal Governent has assisted many other companies and industries. Why not WB? The Fedral Government and the FDIC could do the banking industry a service by assisting in the stability of WB. I believe that is one or should be one of the goals of FDIC. If something doesn't happens soon to stablize some of the big banks we will eventually end up with 4 or 5 giant banks surrounded by a number of small banks that can't compete with the giants. And these small banks will also eventually fade will away by merger and our banking system will consist of only 4 or 5 giant banks like other countries.(period)

I understand the new socalled bailout bill allow assistance in providing additional capital for some of the banks. If the bailout funds are used quickly to take some of the toxic loans off the books of some of the banks it would crate some confidence in the banking system and we could avoid some of these consolidations.

FDIC's action in this matter is tantamount to amputating a person's broken leg instead of providing medical treatment.

2008 Oct 07 07:13 AM

[sumosama:]

I must have missed something...disclosure says no holdings with all of these great ideas! Is this just monday morning quarterbacking? Put your money where your mind is...

2008 Oct 07 12:51 PM

[James Cullen:]

Sumosama,
Seems lately when I show any optimism and do that, it doesn't work out too well...

2008 Oct 07 03:18 PM

[directcommu...:]

splitting wach and having the us govt own part would be even better. news.yahoo.com/s/ap/20...

2008 Oct 09 07:55 PM