IN HINDSIGHT, we all have perfect vision. But there are a handful of M&A transactions concocted at the height of the credit bubble - and even after it burst - that looked ill-fated from the get-go. With few exceptions, they proved downright deadly for the executives who engineered them and for the shareholders who supported them.
We have, therefore, assembled a list of the Five Dumbest Deals of the Credit Bubble and Beyond. This is by no means comprehensive - indeed the process of stripping leverage from the global financial landscape will almost certainly provide further fodder. But the following deals are emblematic of an era fuelled by cheap credit and corporate animal spirits gone wild.
1. Lehman Brothers constructs a bridge to bankruptcy
Lehman's deep involvement in buying Archstone-Smith Trust for US$22.2 billion was not the reason the investment bank filed for bankruptcy in September, terminating Richard Fuld's run as the longest-serving titan on Wall Street. But the May 2007 deal was emblematic of the concentrated risks Lehman had taken in the property market. These in turn fuelled questions from investors about the way Lehman valued many of its assets and whether the firm had sufficient capital against potential writedowns.
Here's how the deal landed in trouble. Hot on the heels of private equity kahuna Blackstone's successful swoop on Sam Zell's Equity Office Properties - and quick piecemeal sale of many of its assets at a profit - Lehman kicked off its own version of the deal. Alongside New York's Tishman Speyer Properties, the investment bank took this portfolio of residential properties private, injecting a slug of equity and cobbling together a US$4.6 billion package of so-called 'bridge equity'.
This insidious creature of the credit boom reared its head in the EOP transaction. Unlike an old-fashioned bridge loan - like the one that brought Federated Department Stores down in 1990 - the Lehman-led group put up equity, placing it at the bottom of the capital structure and in a highly vulnerable position in the event of an Archstone bankruptcy. The idea was to hand off the risk to investors later, as happened in the EOP deal. But Lehman couldn't pull it off and, alongside billions of dollars of debt linked to the deal that had also fallen in value, wound up with more than US$2 billion of Archstone equity on its balance sheet. It had written this down to less than US$1.8 billion by the time it went bust last month.
2. ABN Amro battle ends in a Pyrrhic victory for buyers Fortis, Royal Bank
Barclays kicked off a banking scrum of epic proportions in March 2007 when it entered talks to acquire ABN Amro, the flagship bank of the Netherlands. Thankfully for the British bank's shareholders, it was beaten in the bidding by a consortium including Fortis, Royal Bank of Scotland (RBS) and Spain's Santander. The triumvirate carved up the Dutch bank among them, paying US$98 billion in total, largely in cash.
When the credit crunch hit, it became clear how badly timed their purchase was. Just this past week, the government of the Netherlands nationalised the Dutch arm of Fortis, while Belgium shepherded the transfer of its Belgian assets to BNP Paribas.
RBS has fared better, though the ABN purchase left it short of capital. It was able to replenish its coffers with a US$24.4 billion rights issue earlier this year. Even so, its shares have been battered and the market's view of its creditworthiness has suffered. Santander, the junior partner in the deal, escaped relatively unblemished. It flipped ABN's Italian assets for a 3.2 billion euro (S$6.4 billion) profit only a month after buying them.
3. Merrill Lynch's binge on sub-prime lender signalled bad things to come
Just as the housing market was hitting the skids, Merrill Lynch forked over US$1.3 billion for a business that lent money to homebuyers that other banks wouldn't touch. Like the Archstone deal at Lehman, First Franklin was not the straw that broke Merrill Lynch's back. Nor was Merrill the only Wall Street firm picking up mortgage originators, even those specialising in sub-prime loans like Franklin. Both Lehman and Morgan Stanley had done so in the weeks leading to Merrill's September 2006 deal.
But Merrill's purchase was the largest of the crop and the price it paid stood out, given mounting evidence of a housing slowdown. Merrill, led at the time by Stanley O'Neal, made clear its strategy was not to hold these mortgages from sketchy borrowers for long, but rather to repackage them and sell the risk on to someone else.
Within a year, it became obvious this was not happening any more. Demand dried up for subprime loans and the complex securities that Merrill and others packaged them into. Merrill was left holding billions of such dross on its books, though most of it sourced before its First Franklin deal. The end result: O'Neal was fired, Merrill took more than US$30 billion of writedowns and was forced to raise capital on dilutive terms; and Merrill last month sold itself in a hurry to Bank of America.
4. Wachovia stuffed its face with dodgy California mortgages
California dreaming did not get G Kennedy Thompson very far. In May 2006 the Wachovia boss engineered the US$26 billion purchase of Golden West Financial, a huge savings-and-loan with the bulk of its business in the Golden State. At the time the deal looked fraught with risk. Wachovia had paid three times Golden West's book value just as the California housing market was starting to turn.
Moreover, most of Golden West's mortgage book was comprised of riskier option adjustable rate mortgages. Two years on, Wachovia ousted Thompson after taking stinging writedowns on many of these assets. Wachovia's future is still up in the air.
Citigroup snapped the bank up as part of a rescue package agreed with regulators. But Wells Fargo has since made an offer to buy the bank without any federal assistance. Even so, the US$7 a share Wells is offering is a far cry from the US$60 at which it traded before buying Golden West. But shareholders are lucky to receive anything at all. Wells said it would write down Wachovia's US$122 billion book of option ARMs - the legacy of the Golden West deal - by US$32 billion.
5. TPG thought it snagged a US$2b sweetheart deal - and lost instead
TPG's failed attempt to recapitalise Washington Mutual in April is unlikely to bring the private equity group run by David Bonderman down in the way other deals wounded Lehman, Merrill, Wachovia, Fortis and others. But it serves as a painful lesson for an industry struggling to prove its worth at a time when credit is scarce.
Bonderman led a US$7 billion capital-raising for the struggling West Coast thrift that saw him and his investors sink US$2 billion into Washington Mutual. While risky, it looked as if TPG was receiving some protection against further deterioration at WaMu. The bouquet included WaMu stock at a discount, in-the-money convertible securities and warrants, lots of fees and an anti-dilution 'ratchet' that made it punitive for WaMu to raise additional capital. Two weeks ago, regulators declared WaMu insolvent and sold its carcass to JPMorgan for US$1.9 billion. TPG's investment was entirely wiped out.
This article was first published in The Business Times on October 09, 2008.
