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With J.P. Morgan Chase & Co.'s federally supported bailout of Bear Stearns Cos., the risk arbitrage business hub that is Bear Stearns is now a risk arbitrage situation to weigh.
The fixed exchange ratio of 0.5473 was designed to offer $2 per share, but J.P. Morgan investors have greeted the deal with such enthusiasm that it is now worth about $2.34 per share--a 17% gain in two days.
For those who rode the stock down from $57 in two days, however, even that looks painful, and Bear Stearns shares are trading for roughly $5.91. Both federal and major foreign regulators preapproved the deal--almost certainly a record for regulatory approvals obtained on a Sunday. J.P. Morgan thinks it can close the merger in roughly 90 days. Unless the Securities and Exchange Commission has already committed to approving the proxy, that schedule is aggressive. Bear Stearns shareholders must approve the merger, but the bank does not have the right to terminate if they vote the deal down. The mutual termination date comes only one year after the merger agreement was signed, and Bear's board must make its best efforts to win shareholder approval until then. That suggests the board would have to adjourn a meeting and retry later if approval appeared unlikely. Given the losses already incurred by well-capitalized investors in the company, the proliferation of hungry hedge funds and activist prowlers and the relatively small investment needed to buy a significant stake in Bear Stearns, 13D filings could come from almost anywhere. There is no breakup fee payable to J.P. Morgan if a better bid surfaces. However, because the Federal Reserve is backstopping $30 billion of troubled mortgage holdings, other parties may not step forward, either, because the investment risk is unfathomable or because they do not want to antagonize the Fed. In addition, in exchange for agreeing to the bailout, J.P. Morgan acquired an option to buy Bear Stearns' New York headquarters tower for $1.1 billion less any debt on the property, even if someone else ultimately buys Bear Stearns. In practice, that could act as a kind of breakup fee. Still, J.P. Morgan seems to want Bear Stearns' prime brokerage and clearance businesses, and the bargain basement price reflected in part the speed with which the complex deal was struck. A day and a half of due diligence is bound to leave some unknowns. But unknowns beyond the $30 billion protection provided by bank regulators is a lot of unknowns. The bet on Bear Stearns from here on out is that, over time, if the mortgage picture brightens and Bear Stearns' outlook with it, J.P. Morgan will have to sweeten its offer. The next key event is the issuance of the proxy, hot off the presses in record time. Will it reveal enough details of the $30 billion arrangement with the Fed and approvals from other regulators to allow other potential bidders--and shareholders--to assess their alternatives before the first shareholder vote? Apart from the arb situation, the merger could affect arbs on a day-to-day basis because Bear's risk arbitrage department has long been a leading source of deal research and the firm has disclosed its largest proprietary positions each week. That provided a fascinating and often provocative insight into a major market player's thinking. How will J.P. Morgan run this show? - Scott Stuart Related coverage:
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