Wachovia wells fargo presentation Jian Arthur Guan, Jan Lam Wong, and Tip Piumsomboon
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The Merger between Wells Fargo and Wachovia.
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Wachovia wells fargo presentation Jian Arthur Guan, Jan Lam Wong, and Tip Piumsomboon
- 1. Presenters: Arthur, Jan, Tip
- 2. • Synergy Calculations • Simple (operational and financial) • DDM (theoretical) • Exchange ratio • Ethics • Post-merger performance • Conclusion
- 3. • Why did Wells Fargo decide to acquire Wachovia? • Unparalleled market position and larger market share • Stronger retail distribution and customer base • Higher combined competitive advantage
- 4. • Synergy benefits: operational and financial - Operational - $5 billion annual cost saving for 5 years, starts end of 2010, WACC=7% “Majority of cost synergies achievable by end of 2010” NPV = $17.91 billion > $10billion - Financial – Tax saving, approximately $20 billion Cost of integration = 10 billion Net synergy = 17.91 + 20 -10 = $27.91 billion > $15.1 billion
- 5. Synergy (In billions) Discount rate 4% 6% 7% 8% 10% 4 16.78 15.42 14.79 14.20 13.10 5 20.58 18.74 17.91 17.12 15.66 T 6 24.23 21.88 20.82 19.82 18.00 7 27.75 24.84 23.54 22.32 20.12 8 31.12 27.63 26.08 24.63 22.05 Perp. 112.19 71.37 59.85 51.27 39.39 T: number of years of cost savings last since 2010 Discount rate: WACC = 7% according to our calculation
- 6. • DDM Valuation assumptions: • Long term bond rate: 4.50% • Risk premium for the market: 8.50% • Length of high growth period: 5 years • Estimated cost savings from economies of scale by merger: $5 billion p.a. • Estimated increase in ROE accruing from merger: 1% • Estimates increase in the length of high growth period: 1 year
- 7. Value of Synergy based upon these inputs costsavings 5000 bilp.a. ROE by 1% and 1 yr more RGP 87,413$ Value of Synergy based upon these inputs No costsaving, ROE by 1% and 1 yr more RGP 7,680$ Value of Synergy based upon these inputs No costsaving, no ROE increase, 1 yr more RGP 2,201$ Value of Synergy based upon these inputs No costsaving nor ROE and extention 2,181$
- 8. S A 3,308,961 S B 2,158,855 E A 5,935,400 E B 495,900 PE AB 15.862 P A 28.452 EPS A 1.794 ER A 0.128 ER A = -(S A /S B ) + [(E A +E B) PE AB] / P A S B • Exchange ratio assumptions: - S A or S B is the # of shares outstanding on 30 September 2008 - E A or E B is the 10-year average of historical earnings - PE AB is PE multiple = P A / EPS A, assuming P Ab = P A and EPS AB = EPS A - P A is the average of monthly share prices before September 2008 - EPS A is earnings per share = E A / S A
- 9. Pre-Deal Facts on September 30, 2008 Wells Fargo Wachovia # of Shares outstanding 3,308,961 2,158,855 Market price $37.53 $3.5 Pro-forma earnings $4,362,000 Exchange ratio 0.1281 0.1991 Implied Wachovia price $4.806 $7.472 Premium/(Discount) 0.373 1.135 # of new shares 276,462.20 429,828.03 Total # of shares 3,585,423.20 3,738,789.03 EPS after merger 1.217 1.167 Wells Fargo EPS before merger 1.629 1.629 Wells Fargo PE 23.044 23.044 Expected new Wells Fargo price $28.035 $26.89 Accretion/(Dilution) $(9.495) $(10.645)
- 11. 2. The regulators informed Wachovia on 26th Sept that it would be shut down if it were not acquired. At the time of the show (15th Sept), Bob Steel may not have been under the same pressure to sell Wachovia’s shares. Did Bob Steel intentionally mislead the market to avoid negative reactions? • There are some evidence which suggests his misleading statements were unintentional: 1. Steel personally held Wachovia’s shares and did not hedge against the fall in price.
- 12. 29th 30th 1st and 2nd 3rd Citigroup agrees to buy Wachovia, exclusivity signed Wells Fargo became interested in Wachovia again Wells proposed new deal and Wachovia accepted, new legislation passed (see below) Wells and Wachovia announced merger $1.85 $3.50 $3.91 $6.39Wachovia’s share price (closing)
- 14. • “Wells Fargo's acquisition of Wachovia late last year helped the bank generate a surprisingly healthy $3 billion in earnings for the first quarter.” -Wells Fargo CFO Howard Atkins told CNBC (2009) • "It was a very good decision by Wells Fargo. Wachovia could not have survive on its own. They had a run on deposits.“ -Banking Industry Consultant Ken Thomas (2009) 0 10 20 30 40 50 3/10/2008 3/10/2009 3/10/2010 3/10/2011 3/10/2012 SharePriceUSD Date Wells Fargo Monthly Share Price Open Share Price
- 15. • Positive synergy results from the merger • Absent synergies, proposed exchange ratio is dilutive • Synergies cause a positive impact on EPS • Ethics of negotiation is debatable • Performance after acquisition shows the merger decision was the right one
Editor's Notes
- But there are also some other issues with the previous analysis. The WACC and life of the cost savings might be affective to the synergy result. So we also did a sensitivity analysis in which we use different discount rates and lives of the cost savings to see how sensitive the synergy is to the change of these two numbers. Discount rate is the WACC used to discount cash flows and T stands for the no. of years the costs saving will last and the cost saving starts the end of 2010. At the center of the table is the discount rate and T we used for the previous slide and we think our calculation is conservative with respect to the time the cost saving will last. If 8 year is a good estimation, the operational synergy will be arount 26 billion, which is a huge benefits.
- Besides the simple method we used before, we also used DDM model to calculate the synergy for Wachovia and Wells Fargo. DDM stands for dividend discount model and it has been used by many mergers in history. The parameters we used for this model is as follows. We looked online and found that the long term bond rate in that year was 4.5% and the market return 13%, which makes the risk premium for the market to be 8.5%. The length of the high growth period for both banks is 5 years. After the merger, the cost savings from economies of scale by merger is 5 million per annum. The ROE is estimated to increase by 1% and the length of high growth period will be increased by 1 year as well.
- Here is our result, under the assumptions we made before, we figured out that the fair price for Wells Fargo and Wachovia are $28.58 and $23.09, respectively. And the third column shows us the new Wells Fargo without synergy. Finally, the New Wells Fargo with synergy is shown on the fourth column. Then we see three factors that affect the synergy, So the synergy based on this model would be 87 billion based on our calculation. This means if our assumption is right, this acquisition is worth much more than the price Wells Fargo paid billion, which is ridiculous. If there is no cost saving claimed by Wells Fargo, the value of synergy will be around 8 bil only. If we take ROE increase out, the synergy comes down to only 2 bil. The And we think this model is far from a good one for several reasons. First, like other models, it does not consider the volatility of future dividends. Second, it assumes a constant growth rate after the rapid growth period which is a bold assumption. Third, it does not reconcile well with reality. The stock price for Wells Fargo was approximately 6 dollars above our calculation and Wachovia way lower than our result. This indicates this model misses something important to company valuation. Now I will pass you to Jan to talk about the exchange ratio.
- To calculate exchange ratio, we make several assumptions regarding the calculations. The subscript A refers to Wells Fargo and B is Wachovia. Speaking of assumptions, I’ll only pick earnings which is E, PE multiple, and price which is P to talk about. First of all, earnings is the 10-year average of historical earnings. The reason we use 10 years is that we want to get rid of the negative earnings which Wachovia incurred before the merger deal. Second, for PE multiple of the combined firm, we assume the share price of combined firm is equal to the share price of Wells Fargo which we assume to be the average of 6 monthly share prices before September 2008. Based on these assumptions, we plucked these number in and get the 0.128 as the exchange ratio. Based on the calculation, the maximum exchange ratio from Wells Fargo’s perspective is 0.128. And since the proposed ratio is 0.2, it suggests that Wells Fargo is paying more than it should. But one thing I want to mention is that the exchange ratio is particularly sensitive to the earnings assumption. We haven’t done the sensitivity analysis because 3-year or 5-year averages result in negative earnings and thus negative exchange ratio. So, we suspect that the companies use the forecasted earnings rather than historical earnings.
- Nevertheless, we stick with the 0.128 ratio and use it for the accretion and dilution analysis. First, some pre-deal facts. # of shares outstanding and market prices of Wells Fargo and Wachovia are based on the number on September 30, 2008. The pro-forma earnings is the combined firm earnings on September 30 2008 which comes from the S-4 filing. Then based on these information, we compare between the exchange ratio from previous slide and the actual exchange ratio used in merger. A few notable points arise. First the lower exchange ratio results in lower implied Wachovia price which is just the exchange ratio times the market price. If we compare that to the market price as of Sep. 30, 2008, 4.8 is a much closer value than the implied Wachovia price using the actual exchange ratio. In fact, the actual exchange ratio means that Wells Fargo pays two times the Wachovia price of 3.5 and the exchange ratio of 0.128 only results in premium of 0.37. It’s hard to reconcile this but we believe that it has something to do with synergies, geographical and tax benefits as a result of the merger. The exchange ratio also impacts on the earnings per share after merger differently which is pro-forma earnings divided by total number of shares. In particular, lower exchange ratio gives rise to higher EPS. What this means is that the expected new Wells Fargo price after the deal would be higher at about $28. With the benefits of hindsight, we found the average of 3 monthly share prices after merger to be about $30.8 which is a closer price to $28 than $26. This is interesting since it suggests that the market seems to also agree on lower exchange ratio than 0.1991. All in all, the analysis seems to favour the exchange ratio of 0.128 in terms of premium paid and the market price after merger. Lastly, both exchange ratios result in dilution of Wells Fargo shares which is just the market price minus the expected new price. In particular, the lower exchange ratio will result in dilution of $9.5 per share whereas the actual exchange ratio will result in dilution of $10.65 per share. In other words, the proposed deal will be dilutive to Wells Fargo.