Sometimes baseball analogies work as well as anything to help explain something. With Bank of America (BAC) buying Countrywide (CFC) for $6.1 billion ($4.1 billion in stock plus the $2 billion in cash they invested last year), one came to mind. I think this is a lot like when a major league pitcher hurts his arm badly and elects to have "Tommy John" surgery. You have to sit out a full year, but the club is banking that an extended period of time off will result in maximum recovery, resulting in the player pitching like this old self when he returns the following year. You sacrifice the near-term in order to maximize long term upside potential.
Bank of America was already the largest mortgage player among the big diversified banks. Adding Countrywide (the largest independent mortgage company) makes them the Goliath in the industry. In the short term, this will hurt them. More losses, more write-downs, more delinquencies until the cycle hits bottom and stabilizes. It won't be pretty. But when the cycle does turn, losses have largely been absorbed, and we (hopefully) get back to a time when you put money down and get a fixed rate mortgage to buy a home, the BAC/CFC combo could be a home run.
To put the purchase price of $6 billion in perspective, Countrywide earned between $2.2 billion and $2.7 billion in profit every year between 2003 and 2006. Obviously the later years were more "bubbly" in nature, but if you look out several years, when the overall mortgage market will be larger in volume terms (despite lower margins most likely as ARMs dissipate), the CFC deal could easily add $2 billion in annual profit to BAC's business after you factor in cost savings from the merger and cross-selling to a new customer base. That puts BAC's cost basis at 3x earnings, even after factoring in the $2 billion convertible preferred investment last year. Clearly that is what Bank of America CEO Ken Lewis is banking on, pun intended.
Full Disclosure: Long shares of Bank of America at the time of writing
Friday, January 11, 2008
BAC/CFC Baseball Analogy
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4 comments:
"home run"
yea, then we can do this all over again. Maybe the next liquidity crisis will be more like the panic of 1907. Glass-Steagal had a purpose.
"Countrywide earned between $2.2 billion and $2.7 billion in profit every year between 2003 and 2006."
And I hear the Stankees need pitching! Why not sign Gibson, Koufax and Seaver? They all used to be 20 winners!
Just wanted to point out purchase price is 4.1 Billion,which would make the deal sweeter for BAC. :)
-Alex
http://www.lacontra.net
Alex,
I included the $2 billion they already invested in CFC's convertible preferred stock. The media has been wrongly reporting for a while now that BAC lost most of that investment because the preferred was convertible at $18 and now the stock is $6.
They ignore that BAC has the option to convert at $18 but doesn't have to (and they won't). However, while they are buying all the shares for ~$6, they also will not really get all of their $2 billion plus interest back, because when they own CFC they'll just be paying themselves the principal and interest out of their own pocket. Hence, in reality, their purchase price is more than $4.1 billion.
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