The Strategy of Capital Injection

At the risk of repeating the mistake

I made with the Bank of America – Countrywide deal, I have to say I like

this Citadel

– E*Trade deal a lot. The total cash infusion of $2.5 billion is actually

larger than E*Trade’s market capitalization, yet Citadel will end up with only

20% of the firm; the rest will be made up of E*Trade debt and lots of asset-backed

securities. Citadel should make money on all three legs of the deal –

the cash infusion is big enough that E*Trade’s solvency is no longer in doubt,

which in turn means that bonds paying 12.5% are going to be very valuable over

their lifetime. And Citadel has proved itself an expert in buying distressed

assets, so one assumes they’re getting a good deal on the other bonds they’re


In fact, if you read Valerie

Bauerlein’s piece on the BofA deal, even that one doesn’t necessarily look

quite as idiotic as some might think given the continued implosion of Countrywide’s

share price.

If Countrywide’s stock goes all the way to zero, then BofA is in a prime position

to convert its debt to equity and acquire the company on the cheap – it

even has an official right of first refusal on the firm.

Bank of America also has the right to meet any competitor’s bid. Some analysts

say Mr. Lewis is prepared to sacrifice some of his initial investment if it

meant he got a better deal on buying Countrywide assets, such as its product

suite and loan-processing technology.

"He did it to plant a flag and keep others away," said bank analyst

Nancy Bush of NAB Research in Aiken, S.C. She compares the Countrywide strategy

to the bank’s snapping up credit-card giant MBNA Corp. in 2005, largely to

keep it out of the hands of competitors such as cross-town rival Wachovia


Indeed, BofA has more than pole position in terms of buying Countrywide. Its

deal also acts as a bit of a poison pill for anybody else who might be interested:

Bank of America points out that if Countrywide were to seek bankruptcy-law

protection, the bank would be in line to be repaid behind bondholders but

ahead of common shareholders. If any other party purchased Countrywide, the

new owner would still be on the hook for the full $2 billion obligation.

All the same dynamics are likely to be in place with the Citadel investment.

Ken Griffin is not the kind of person who shies away from taking over underperforming

companies, and if E*Trade continues to struggle, he’ll be very well placed to

simply absorb the whole thing.

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