The best way to buy Bank of America
January 31, 2008
By: 
Arohan
Category: BAC, CFC, Investing
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:
- 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
- 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
Related posts:
- Countrywide sellout too cheap?
- Is Countrywide a contrarian/value play
- Investments update …
- Sterlite Industries - banking deal is off
February 1st, 2008 at 5:28 pm
Interesting article. Cheers^^
forexdiscover’s last blog post..FED cut Interest Rate to 3.00% on 30th January 2008
February 2nd, 2008 at 3:43 am
Those are nice plays from the play book
Thanks for laying it out with the pros and cons for us to mull over 
mariam’s last blog post..Memories for money
February 2nd, 2008 at 6:25 am
@forexdiscover: Glad you like it. Thanks for visiting and do keep your comments coming
@mariam: You are welcome. Looks like the pricing anomaly is closing fast now
February 2nd, 2008 at 1:41 pm
Great article. I wish it would have been earlier!
February 2nd, 2008 at 6:21 pm
Mike, these sort of anomalies are generally fleeting, although you are right that this one has existed for more than a few days now and the gap is shrinking quickly
Love to have you here on this site!
February 6th, 2008 at 4:32 pm
How much of risk is it that the buy-out doesn’t get approved? This seems like a great idea though. I bought E-Trade at the end of the year with the thought that either it would bounce back or gt bought by a bigger fish.
February 6th, 2008 at 4:52 pm
Freefrombroke, Thanks for visiting!
There are risks, but I think they are minimal. BAC really covets the Countrywide franchise and needs a growth vehicle. They were willing to take a large stake at 18.
Now if the buyout is derailed in situation where the CFC stock rises above the offer price, the strategy should still work but you will have a gain on your hand off CFC stock which you may want to liquidate.
The bigger risk would be either BAC trying to get even cheaper or CFC going bankrupt before the buyout is closed. Its every investor’s judgement call but I personally feel comfortable that this is a minimal risk
Additionally, there doesn’t seem to be any antitrust implications.
February 12th, 2008 at 6:47 pm
[…] This is getting interesting and even if buying CFC may not work out as a way of getting BAC cheap as suggested in an earlier article (that is if the sale does not go through. If the sale goes through at the current or higher prices […]
February 22nd, 2008 at 12:32 am
Another good option would be CFC Jul 08 puts. You can sell the $6 strike for 0.85.
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