To: Mr. Ken Thompson, Chairman and CEO, First Union Corporation
From: Bill Feest, Vijay Sethi, Kevin VanderMolen
Re: First Union Bid Consideration for Wachovia Bank
Date: Monday, November 19, 2012
Based on our analysis, we recommend First Union slightly raise its bid for Wachovia Bank, and not change the breakup agreement. Our calculations show that an exchange ratio of 2.102:1 will raise our offer to match SunTrust’s, while not sacrificing First Union’s internal rate of return. We present the following areas as justification for these recommendations: the court’s likely ruling, the market view of the current offer, the internal rate of return of the current offer and an analysis of SunTrust’s counter offer.
Legal Considerations Our opinion is that the court is likely to rule in favor of First Union. The reasons supporting this are both hard and soft in nature. For the hard reasons, it is clear that Wachovia’s Board of Directors acted in the firm’s best interest. Compared to SunTrust’s offer, our analysis accounts for higher levels of synergies, and First Union is paying a premium for those synergies. First Union has also given Wachovia shareholders the flexibility to choose between their existing $0.60 per share dividend and a one-time cash payment of $0.48 per share. For the soft reasons, it should be apparent to the court that management-specific knowledge is driving this transaction. Although a qualitative measure, the organizational fit, agreement on direction of the firm, and other factors should be in First Union’s favor. First Union also has invaluable M&A experience that will contribute to the success of this transaction.
Breakup Provisions The breakup provision is reciprocal and $780 million cap is well within the industry range of breakup fee percentage range. Raising this cap will create suspicion, among shareholders and jury/judges, of board favoring First Union. On the other hand, relaxing terms of this contract will make SunTrust bank’s offer look more attractive. So it is not in best interest of especially First Union’s interest to change the breakup provision. Our opinion is that the deal is well-protected and mostly not coercive. In particular, First Union should alter the substitute option to explicitly state that the option would be redeemed. Otherwise, First Union is estimated to have a 20% stake in the SunTrust-Wachovia entity, and this inhibits the Wachovia Board of Directors from making a sound decision for its shareholders. Because First Union is able to acquire this stake (to exercise the option but not redeem it), Wachovia is essentially locked into having a major shareholder and competitor as part of its equity. Further, First Union should consider reducing the amount of time in the lock-up agreement. This has pushed SunTrust to pursue a proxy fight for control of Wachovia, which exacerbates the problem on two fronts. First, Wachovia’s Board of Directors will face less legal pressure with a shorter lock-up period – doing so would signal our intent to conduct the merger in good faith. Second, shortening the period will make it easier for Wachovia’s shareholders to compare the deals and ultimately choose our bid.
Market View of the Current Offer Based on an analysis of share price movements and expected synergies, the market appears to be converging around SunTrust’s offer (see Exhibit 1 for synergy valuation and Exhibit 2 for share price expectation). For instance, on the day of the offer announcement, First Union closed at $31.20 per share, and Wachovia closed at $62.05 per share, or a ratio of 1.989. This suggests that the market either relatively overvalues First Union’s position in the deal, or relatively undervalues Wachovia’s. Especially considering that Wachovia possesses specific assets – a strong regional infrastructure and customer base in the southeastern US – it is highly unusual for the target to capture so little value from the transaction.
In light of
