Breakingviews.com likes Wachovia's (NASDAQ:WB) acquisition of A.G. Edwards (AGE) because, it says, the deal’s return on investment after two years “looks to be somewhere in the order of 11%m[...] That comfortably exceeds A.G. Edwards cost of capital.” Some thoughts:
1. If the people at BV.com think A.G. Edwards’s cost of capital is well below 11%, they have meaningfully miscalculated A.G. Edwards’s cost of capital. It’s likely at least 12% and, given the current bubbly environment for the stock market, is very likely much higher.
2. Regardless of capital costs, an 11% IRR is nothing to shout from the rooftops. Wachovia would have done better (and saved all those investment banking fees) if it had simply taken the $7 billion and bought back stock. Plus, no execution risk!
3. While we’re on the topic, I don’t see why it’s such a big plus that Wachovia will now have “a larger pool of retail investors to buy its deals.” That hasn’t exactly worked so great for Morgan Stanley.
4. Where did this “rule of thumb” for valuing annual cost saves by multiplying them by 10 come from? That’s news to me. (If it really is a rule of thumb, it sounds like an investment banker’s rule of thumb.) Why not just figure the net present value of the estimated $395 million cost savings by . . . calculating their net present value? Even at a 12% discount rate (which is likely too low, given integration risk), I get to $3.3 billion, not $4 billion.
5. I’d also net that $3.3 billion against any one-time charges that will inevitably occur in the integration process.
6. I’ll believe that $395 million savings number when I see it.
And don’t forget, the Wachovia integration team is still working on getting its arms around Golden West. Why Wachovia is giving up 7% of itself in return for a retail brokerage business at the top of the market I don’t understand...
Tom Brown is head of BankStocks.com.
WB 1-yr chart
AGE 1-yr chart