Arohan’s investing life

Believe it or not, the best way to buy Bank of America today may be to buy Countrywide Financial

Bank of America’s previously announced deal to buy Countrywide was a stock deal. For every share of Countrywide stock, the holder will receive 0.1822 shares of Bank of America stock when the deal closes. The deal is expected to close in 3rd quarter of this year.

As of the time of this writing, BAC was trading at $44.14 per share and CFC was trading at $6.83 per share. 0.1822 shares of BAC represents a value assigned to CFC by BAC of $8.04 per share at these prices. Countrywide stock is therefore trading at a 15% discount to the acquisition price. In the past week the stock has traded as much as 25% below the price offered by BAC

What this means is that an investor buying Countrywide stock today can expect atleast 18% appreciation by Q3 IF the stock price of Bank of America stays at $44.14

Here are two points worth noting:

1. If you believe as I do that Bank of America is undervalued today, you can expect that the Bank of America stock will actually appreciate quite a bit by the time this deal closes
2. If you decide to purchase Countrywide stock today, Countrywide will pay you 9.5% dividend (annualized) for you to wait until the deal closes. Buying Bank of America stock today directly will only give you a 6.1% annual yield

That being said, there are certain risks involved. Countrywide can actually cut or eliminate their dividend in the interim. This is likely but even if this happens the discount on offer today is simply too attractive.

The bigger risk of course is that Bank of America may decide to pull out of the deal. Apparently this is what many in the market are afraid of and that is why this discount exists. However, Ken Lewis (BAC CEO) has reiterated that there is no question of BAC pulling out. Truthfully, since BAC is hitting the deposits cap in US, this acquisition is probably one of the few ways the bank can continue its growth domestically. Bank of America has also coveted Countrywide franchise for a long time and it is not likely to just give it up

The rate cuts of the last two weeks also work to make the Countrywide asset quality a little less risky and will function as a trigger to bring the mortgage buyers back in the market. I believe that the deal just became less risky for Bank of America with the rate cuts

There are many ways to play this discount. One is to arbitrage on the  pricing gap by selling short the BAC stock and buying CFC. This is apparently a riskless way to capture the spread assuming the deal will close as it is immune to how the BAC stock price performs. Another variation would be to use options to get the same result. I however am of the opinion that the BAC stock is keepers for the long term (and also I tend to be a long-only investor) and therefore would like to keep it simple and just buy CFC at current prices, let it convert to BAC stock and let it ride

You read this headline and say, Duhh!

But really, the economy was kind of stalled for some time now with many institutions taking a wait and see approach. Not that the basic industrial sectors were suffering much, they were still humming along, albeit at a reduced pace. However, what had really taken a hit was the consumer confidence and the risk appetite of the financial firms

A total of 1.25% rate cut is nothing to sneeze at. All of a sudden, many homeowners who were looking at unaffordable resets on their adjustable mortgages will get some room to breathe. The more money that is left in the consumers pockets, the more the American consumer is willing to go out and spend. At this point though I really hope that the consumers have learnt the lesson and start putting some money towards savings and building an emergency cash portfolio

Look for increased mortgage refinancing activity in the coming months. 1.25% drop in ARMs (or close to it, depends on the lender on how much will actually flow through to the consumer) should be enough to make re-financing the mortgage an economical proposition for many homeowners

What this also means is that for many lenders, this will be an opportunity to replace riskier loans with more traditional and discipline-infused product. Should do wonders for their asset quality

Another effect of the rate cut would be to bring the liquidity back in the credit markets. Many institutions were having difficulty syndicating debt as there were no buyers. This situation should ease

And finally, CD and money market rates should decline. This along with the juicy yields now available on many stocks should help investors slowly come back into the stock market

Is inflation still a risk given the scale of the interest rate cuts? Probably, but with everything else going on in the economy and the stress on the housing sector (a house is probably still the most prominent part of any American’s net worth), I really think that the consumers are not likely to embark on a shopping spree anytime soon. I think we will start seeing a fundamental change in how the public spends their money. There will be a move towards smarter spending. That is my hope anyway

My best stock play for a recovering economy remains Bank of America. In the next post I will outline the best way to buy Bank of America today. Stay tuned

At the first blush it appears that as goes the US economy, so goes the world market. If the hiccups in the US economy can have such an effect on the markets elsewhere, than it would appear that the markets are now highly correlated. Does this mean that there is no value in diversifying internationally?

I would say that is not true. What we are seeing is how the markets act on a daily basis. True, that over a short horizon, the markets may be correlated. After all, we now live in a global economy where many companies are traded on exchanges in many different countries. However, over a longer term, each market performs based on its own fundamentals. Many emerging economies are growing today based on the fundamental changes in the business processes and political environment. Unless there is a drastic change in these, which I do not see happening any time soon, these markets will continue to do well

At the same time, do not write off the US economy. There have been countless such cycles in the past. It is true that the baby boom factor may not be present anymore, but the US economy is now driven by innovation, risk taking, and generally sound economic principles. These are still here (although one may question the soundness of economic principles involved in the subprime situation, but that is just a small component of the economy, it will probably do some damage in the short term but it will soon pass)

Regardless of the macro-economic picture, the basic value investing credo of finding value at a cheap price has stood the test of time and will likely continue to yield market beating results over a long investing horizons

It appears that Leucadia National (LUK) is acquiring a 11,316,200 share stake in AmeriCredit (ACF) which represents 9.9% of AmeriCredit’s outstanding stock. AmeriCredit Corp is an auto-financing company providing financing services to retail consumers as well as dealers. Leucadia’s cost is roughly $12.9 per share, with ACF shares now trading at $11.2 per share as of market closing on Jan 16th, 2008

This has to be viewed in the backdrop of a growing concern in the market that the credit crisis is ready to move into automotive credit sector

Leucadia National is probably one of the best investors in North America today, and for the last two decades an investment in Leucadia stock has outperformed Berkshire Hathaway stock by a wide margin. Leucadia has a propensity to take more ‘risks’ than Berkshire Hathaway and is known to buy deeply troubled companies and turn them around. While their bets may be risky, they have shown remarkable ability to make profits. I have great respect for Steinberg and Cummings, the two partners who run Leucadia National and have own the stock for a while

So does Leucadia think that the credit worries in the auto finance sector are overblown? Possibly. However, they do appear to think that now is a good entry point. ACF is currently trading close to its low for the last 3 years

Something to keep in mind. Automobiles have always been and will always be a depreciating asset and so a typical automobile lender has to consider the credit worthiness and income of the buyer. It is not solely based on the asset value. Therefore, it could be argued that auto loans on average are of much better credit quality than some of the housing loans that were made in the last few years

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