Friday, October 10, 2008

Wachovia: A Special Situation

"Oh the Wells Fargo wagon is a comin' down the street . . ." Right to Wachovia's doorstep, delivering salvation from insolvency. (My apologies to The Music Man.)

It looks like the dust has finally settled in the Wachovia/Wells Fargo/Citigroup menage-a-trois, although this one was a bit less amorous than a typical dalliance. Federal regulators have offered an early termination of their antitrust review, which means that there is no longer any legal obstacle to the deal. Citigroup abandoned its own bid for the bank yesterday. My best guess is that once Citi saw how hard it would be to raise the capital needed to both shore up its own balance sheet and support Wachovia, they decided to tend to their problems at home.

My play: This situation is no longer as fluid as it looks, so I'm going to treat it as a special situation. I have sold uncovered Jan 11 calls on WB at 10 and 12.50. Why did I pick that date? Because I wanted to capture as large of a time premium as I could. I went out for the longest possible expiration date because Wells Fargo expects the deal to close by the end of 4Q08. Why did I pick those strike prices? Because I don't think they'll be triggered. Wells Fargo had offered Wachovia shareholders 0.1991 shares of WFC for each WB share they hold. I believe the possibility that WB will rise to $10 by Dec. 31 of this year is next to none, because that would mean that WFC would have to rise to $50.22. Such a leap would require a massively positive earnings surprise from the Wells Fargo wagon in 3Q08, and I do not believe that is going to happen in this recession. An additional factor weighing down WFC's share price is Citi's lawsuit seeking damages for horning in on WB. Even if the suit is thrown out as a nuisance, it should add enough uncertainty to this deal that Mr. Market holds WB's price under $10.
On a side note, I can't help but refer to my earlier post about the power of Goldman Sachs alumni to influence the outcomes of deals. Goldman guys won this one, hands down.

Nota bene: Anthony J. Alfidi does not hold a position in the underlying common shares of WB or WFC at the time this commentary was published. He has never ridden in the Wells Fargo wagon (sniff).