"Too Big to Fail" & Charlie Rose

A recent issue of Fortune Magazine included a nice piece about Charlie Rose - "Why business loves Charlie Rose." I'm thankful for the article because it reminded me how much I enjoy his program so I've now set my DVR to record these episodes. Heck, if Warren Buffet watches it, I probably should.

Mr. Rose interviewed Andrew Ross Sorkin this week, author of "Too Big to Fail" - a book about the events and people surrounding the financial market crash, and I found myself completely engrossed with the conversation between Rose & Sorkin on the program. Lots of intricate details about Hank Paulson, Richard Fuld, Tim Geithner, and others. I just ordered a copy of the book from Amazon...

The discussion quickly reminded me of "Barbarians at the Gate" by Bryan Burrough and John Hely on the leveraged buyout of RJR Nabisco in a previous decade. I finally got around to reading this book over the summer.

While it's hard to believe how Wall Street deals sometimes go down, it's really not when you read about the people behind the deals. In the interview with Rose, Sorkin described his book as a recounting of people and their personalities as much as it is a book about the events themselves.

More on the Bear Stearns Valuation

At market close on Thursday, Bear Stearns was trading at nearly $6/share, yielding a market capitalization of just over $800 million, nearly a tripling of the publicly-announced offer of $2/share ($236 million) from last weekend.

The general consensus indicates that the real estate owned by Bear Stearns in New York City is worth about $1 - 1.3 billion. On March 16, Paul Kedrosky wrote that that this real estate asset would account for a large portion of the sale price.

If this is the case, some things still don't add up to -

1. At the original sale price of $2/share ($236 million), it seems that JP Morgan was buying a $1 billion real estate asset for about 25% of market value. There are proponents of the $236 million price tag that argue that JP Morgan is "buying the stock, not the assets." In the simplest terms however, when you own a stock, you own a share of the company. When you own a share of a company, you own a share of all of its assets. This is the basis of intrinsic valuation.

This is my fundamental position againt the low valuation. I agree that Bear Stearns is not worth the $20+ billion when BSC share traded at $170, but their largest underlying real estate asset is worth more than $236 million.

2. What about the human capital at Bear Stearns? The company paid $3.4 billion in compensation in 2007 (according to their 10K). Assuming that anyone worth their salt has left the company by now, you can probably estimate that the remaining human capital still with the firm by the time this shakes out is worth some value of what they were paid in 2007. Let's call it 10%, which provides a current human capital value of about $340 million.

By these estimates, assuming all other assets in the company are worthless:

Real Estate + Remaining Human Capital = Total Current Value of Bear Stearns

So:

$1 bln + $0.340 bln = $1.340 billion, which calculates to $11.35/share. Given the risk profile of BSC right now, JP Morgan could justify a discount, a "risk incentive" to take the shares at a price slightly below this level.

So with a share price at the $6/share area and a secondary market valuation of about $800 million, we're getting warmer. But it's not surprising to see current shareholders balk at the $2/share originally proposed.

Bear Stearns, Portfolios, and Waldo

Where's Waldo?

Courtesy of the Bear Stearns 10-K for the year ending November 30, 2007:

Some basic math indicates that 33.4% of Bear Stearns' portfolio was held in Mortgages, mortgage- and asset-backed securities. Add the Derivatives line item and you come to 47.5% of their portfolio is relatively risky assets. So how does this compare to a few of the other bulge bracket investment banks?

Hard to say in some ways with the numerous write-downs recently - $8 billion by Merrill Lynch, $9.4 by Morgan Stanley, $17.4 billion by Citigroup. But, some digging reveals how Bear Stearns is certainly outside of all of these firms regarding their risk exposure.

According to some recent 10Ks/Annual Reports:

Goldman Sachs - 11.9% of their portfolio is held in Mortgage-related. Add Derivatives, and 35% is in these two security types.

Merrill Lynch - 11.9% of their portfolio is held in Mortgage-related (no, that's not a typo - it's also 11.9%....). Add Derivatives, you get 43% in these two securities.

Lehman Brothers - 28.4% of their portfolio is held in Mortgage-related. Add Derivatives, and you get 42.7% of their portfolio.

This is a fairly cursory analysis, but looking at the most recent and pending results of the firms above, perhaps there's a linkage in there somewhere? There are many-a-bankers asking themselves what sort of business strategy that Bear Stearns was undertaking, and certainly comparing results might yield some cause and effect in retrospect.

Or maybe Bear Stearns just missed the memo....

$236 million? Bear Stearns, Valuations, and Train Wrecks

An astonishing train wreck. That’s all that comes to mind in reading about Bear Stearns’ collapse and J.P. Morgan’s purchase of the Wall Street mainstay since 1923.

According to the Wall Street Journal – “J.P. Morgan Rescues Bear Stearns.” "Rescues?" Seems more like Cousin Vinny bailing out the “two youts” somewhere in Alabama after being charged for murder…

Part of me feels like the $236 million price tag might still subject J.P. Morgan to the “winner’s curse,” but seeing that no other bidders were evident, I guess not...

To put the $236 million number into perspective, the latest Bear Stearns balance sheet is showing over $600 million in Plant, Property, and Equipment, so at least J.P. Morgan can have a sidewalk sale to liquidate the remaining office equipment and cover the legal fees associated with the acquisition. And the $236 million would have been pocket change for the LBO equity firm about a year ago.

Or if you started with $200,000 in 1923, earning the market return of 8.66% per year would have yielded you $232 million by now.

The latest venture capital investment-based valuation of Yelp is somewhere around $200 million. So Web 2.0 companies with revenues at $10 million a year are worth more than Bear Stearns in its current state?

When I introduce the concept of fundamental analysis to my finance students at the University of San Francisco, we do an exercise to illustrate the difference between “market value” and “intrinsic value” of a firm. Guess I have a new company to use for next semester’s lecture.