For JPM, we view the key risk to be its own balance sheet liquidity, although most of the real risk on BSC’s balance sheet has been back stopped by the Fed, thereby exposing JPM to little real risk over the long term.
– Meredith Whitney, Financials Analyst, Oppenheimer (quoted in “Is $2 a Share a Fair Price for Bear Stearns?” , The Wall Street Journal’s Deal Journal, Monday March 17, 1:45pm EST)(bold and italics added)
When I found out last night that Bear Stearns was being acquired for $2 I was shocked. $20 wouldn’t have surprised me. But $2 – that’s shocking.
It raises the question: What is Bear Stearns worth?
I think this question has to be taken up in two parts.
First, as everybody knows, Bear Stearns has a lot of toxic assets on its books. They also have a lot of liabilities – $383.6 billion to be exact. The fear is that if the assets turn out to be worth far less than the liabilities, any acquirer will be on the hook to make up the difference. This could, potentially, amount to tens of billions of dollars.
That leads us to the second consideration in valuing Bear Stearns: the value of their businesses and real estate. Bear Stearns has a significant prime brokerage operation ($566 million in pretax income in 2007), wealth management operation, investment bank, mortgage business and trading operations. In addition, they apparently have a very nice headquarters on Madison Avenue that is worth in excess of $1 billion.
Sanford Bernstein analyst Brad Hintz estimated in a note today that Bear’s businesses and real estate are worth $7.7 billion, about $60 a share (“JP Morgan Feasts On Bear Meat”, Barron’s, Weekday Trader, Monday March 17).
The question then becomes: are Bear’s businesses worth more than the potential risk on its balance sheet? In other words, is Bear Stearns worth anything? (See also “It Is Tough to Value Bear, But It Had Better Sell Fast” (subscription required), The Wall Street Journal, C1, Saturday March 15).
Because of the enormous risk in Bear’s positions and its tremendous liabilities, that’s how you can get a number like $2.
But there’s another twist. The Fed is providing “special financing” to JP Morgan on this deal. Essentially, the Fed will backstop up to $30 billion in losses on Bear’s portfolio.
What this means is that JP Morgan is really hedged in its exposure to Bear’s toxic book and it appears to be picking up Bear’s choice assets on the cheap.
That’s why JP Morgan’s (JPM) stock is having such a good day: up 10% on big volume.
Given that the Fed is going to backstop $30 billion I think that all the value in this transaction is going to JP Morgan and Bear shareholders are getting robbed. If JP Morgan had to assume all of Bear’s liabilities, okay. But they don’t. Their essentially free riding on the Fed and scooping up desirable assets on the cheap.
If the Fed is going to bail out Bear Stearns, why shouldn’t the bailout benefit Bear shareholders equally with JP Morgan shareholders? JP Morgan can pretend like they are doing some kind of good deed here but that’s baloney. They are scooping up choice assets and are sloughing off the real risk on the Fed.
If you value Bear’s businesses and real estate at just $2.5 billion that gives you $20 a share. Given the Fed is assuming most of the risk with Bear’s book, that seems like a fairer price to me. Even $30.
The only thing I might be missing is if JP Morgan is in fact assuming a good deal of risk in Bear’s book which could potentially exceed the Fed’s backstop. But I doubt it.
Disclosure: Top Gun has no position in shares of Bear Stearns (BSC) or JP Morgan (JPM).