BofA’s Lewis Still Making Deals, But Now Aiming For Distressed Assets

Lots to get to this morning, so I’ll be writing on several topics throughout the week, but first let me address a reader question re: BAC.

Shepherd writes:


If the wires are correct, it looks like Lewis paid a premium to purchase Merrill Lynch. I’m curious why you hold BAC, given that he seems to have an almost emotional need to acquire things, which gets in the way of negotiating the best price for his shareholders. My guess (admittedly from afar) is that he could have done better…

Shepherd, your characterization of BofA CEO Ken Lewis and his love of acquiring things is spot on. Earlier this decade BAC has acquired companies like FleetBoston, MBNA, and U.S. Trust, and paid full prices for all of them. As a result, BAC rarely traded above 10x earnings since most of their growth was coming from acquisitions, not organic growth.

During that time Peridot clients did not hold BAC shares. It was only after the subprime crisis started to bite the big banks that I invested in BAC. There were a couple of reasons I chose BAC. First, relative to their size, BAC had less subprime exposure than their large cap bank peers. They did take writedowns, but given they are the largest bank in the nation, firms like Citigroup, UBS, and Merrill Lynch had far more exposure. On that front, BAC’s losses were manageable, and they were forced to dilute shareholders far less than others via capital raises.

The second reason was that BAC is the largest bank by deposits in the country. As we have seen with the investment banks like Bear Stearns and Lehman Brothers, without deposits to fund your business, capital can dry up overnight and a freefall can result.

On the acquisition front, people have criticized the Countrywide deal, but Lewis actually bought them on the cheap. Time with tell if he gets a decent return on the investment (I suspect he will over the long term, despite short term losses), but buying distressed assets on behalf of shareholders is far better than what he used to do (pay a huge premium for assets that were already fully priced).

The Merrill Lynch deal is a similar situation. We can argue if the price he paid was fair, but at least he is buying on the cheap. That will increase the odds of a very successful deal. I’ll have more on the Merrill deal in another post to examine exactly what BAC is getting for their money.

Full Disclosure: Long shares of BAC at the time of writing

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3 Thoughts on “BofA’s Lewis Still Making Deals, But Now Aiming For Distressed Assets

  1. shepherd on September 15, 2008 at 8:14 AM said:

    Thanks for the analysis. You make a good case for BofA (especially now that it’s down another 14%). I guess if I were a shareholder, my point would not be to question whether or not the deal is fair. I’d wonder if it’s the best deal Lewis could have gotten given the circumstances. I’m guessing that he didn’t, and that Merrill played a bad hand very well. But long term, as you point out, this may work out well…

    Looking forward to your thoughts on the rest of the week’s events.

  2. MER probably got lucky indeed, but we don’t know what Lewis really got when paying premium.

    If FED was involved as rumors say then chances are good BAC got some intangible asset as well.

    One immediate I can think of is they are now clear hands when it comes to saving AIG.

    I’d like to hear Chad’s thought on why the 20% drop in BAC today.

    Either heavyweight players do not agree with him or they are focused on the immediate future and not long term.

  3. Chad Brand on September 15, 2008 at 4:03 PM said:

    Re: BAC drop

    Buyers always see stock price drops when deals are announced, and a deal like this would be no different. Here is how the big banks did today:

    JPM -10%
    Citi -15%
    Barclays -15%
    UBS -18%
    BofA -21%

    Nothing too out of the ordinary here, in my view. All were down a lot, with BAC dropping a little more since they are the ones who stepped in for MER and the risks associated with such a move, especially in the near term.

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