Saturday, May 9, 2009

Wells Fargo Raises Capital

Wells Fargo raised capital on Friday at $ 22/share with the stock closing at $ 28.18/share.

The rest of the capital will apparently be built up the old fashioned way. My expectation was for the regulators to push for much more capital and greater dilution (even though I think time will reveal they did not need it).

Some things to keep in mind:
  • The post-dilution market cap of Wells is roughly $ 130 billion and will likely have an $18 billion growing income stream once the economy recovers. That makes the normalized P/E of what is probably the best banking franchise in the US equal to $130 billion/$ 18 billion = 7x earnings at friday's closing price. So Wells Fargo is by no means expensive today as a long-term investment but it was easier to buy back when I first mentioned it on April 9th. Its average share price on that day was $ 18.69 and it has been available at prices as low as $ 16.14 since then.
  • Wells Fargo more than doubled its assets when it acquired Wachovia without raising much capital. After absorbing the Wachovia balance sheet, Wells ended up having capital ratios on the lower end of the spectrum. Since Wells can build capital faster than others through its exceptional earnings power those ratios are not a concern to me.
  • Yesterday's capital raise effectively increased the net price Wells paid for Wachovia (in stock net of the tax benefits) from ~$ 7 billion to ~$16 billion*.
  • I estimate that the Wachovia part of Wells Fargo will have normalized earnings of over $ 8 billion/year once Wells integrates it and the economy starts to recover. Here's the bottom line: Wells paid only $ 16 billion ( stock net of tax benefits) for an $ 8 billion growing stream of income (cash). ~2x earnings. So this so-called dilution is completely reasonable.
Wells is just about as good as it gets among banking franchises. The Wachovia side will likely soon benefit from Wells Fargo's superior banking model.


Long position in Wells Fargo

* Wells initially paid $ 13.8 billion in stock and subsequently raised $ 12.6 billion. If you add the most recent $ 8.6 billion together the total amount of stock was $ 35 billion. Wells will get an estimated $ 19 billion tax benefit from the deal. I subtracted that tax benefit from the $ 35 billion to get the $ 16 billion. This is not meant to have false precision but it does give a more meaningful estimate of what the actual net cost to Wells shareholders have been for the deal.

While Wells did not pay all that money to Wachovia shareholders the total cost of gaining control includes the subsequent capital raises and tax benefits.
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