Bear Stearns Shareholder Math

A lot of the back-of-the envelope sums surrounding the Bear Stearns shares assume that Bear's employees, who own 30% of the outstanding stock, are likely to vote against a deal. But given that New York City's comptroller has already started investigating Bear Stearns, that might not be the case.

Steven Davidoff notes today that if Bear gets bought by JP Morgan, then Morgan will pay any legal liability that Bear's executives might hold:

[JPMorgan] shall and shall cause the Surviving Company to, to the fullest extent permitted by applicable law, indemnify, defend and hold harmless, and provide advancement of expenses to, each [officer and director of Bear Stearns] against all losses, claims, damages, costs, expenses, liabilities or judgments or amounts that are paid in settlement of or in connection with any Claim based in whole or in part on or arising in whole or in part out of the fact that such person is or was a director or officer of [Bear Stearns] or any of its Subsidiaries, and pertaining to any matter existing or occurring or alleged to have occurred, or any acts or omissions occurring or alleged to have occurred, at or prior to the [acquisition].

Davidoff points out that this gives Bear executives a strong incentive to vote in favor of the deal:

Face bankruptcy and possibly no indemnification or receive JPMorgan's assurances on this? Hmm. Let me think about that one.

Now most Bear employees aren't executives, of course. But on the other hand, Bear's executives tend to have much larger shareholdings than other employees. So there could be a sizeable chunk of Bear's employee-owned shares getting voted in favor. What's more, Bear's non-executive employees might well be selling their shares right now, with the stock well above the offer price, in the reasonable assumption that it's the best price they're likely to get for the foreseeable future.

Davidoff also explains how a bondholder can buy up shares above the $2 price and not lose too much money even if he votes in favor of the deal at $2 per share:

The creditor buys Bear shares and a put at the price. Creditor then sells a call to pay for most (but probably all) of the put. Creditor waits for the record date of the Bear shareholder vote so it can vote. It votes yes. Immediately thereafter the creditor sells its shares.

Because the creditor owns a put struck at the price he paid for the shares, he's protected against downside in the stock; the only cost is the cost of the put option, less the cost of the call option that he's sold. All very clever.