Wells Fargo emerges as Wachovia winner; Rectifier holders rebuff Vishay; key Longs holder falls into line

By Paul Deckelman

New York, Oct. 10 - Wells Fargo & Co. on Friday walked away with all of the marbles in the bitter battle for control of Wachovia Corp., while rival Citigroup just walked away, period, ending its participation in the talks over how to divide Wachovia's assets to instead concentrate on its $60 billion damage suit against the other two banks. Citi claims that Wells Fargo improperly interfered with Citi's deal to buy Wachovia's branch network - and that Wachovia broke its commitment to negotiate only with Citi. Wachovia's shares jumped nearly 50% and Wells Fargo rose as well. After initially falling on the news, even Citi stock ended in the black - this on a day in which the equity markets were again mostly lower.

But sector peer Morgan Stanley got no such relief; the big investment bank-turned commercial bank's shares gyrated wildly at lower levels on renewed speculation that its deal with Mitsubishi UFJ for a $9 billion investment from the Japanese bank would fall apart, or that Morgan Stanley's credit ratings could be downgraded.

Apart from the financials, there was some activity on the merger-and-acquisition front. International Rectifier Corp. said that its shareholders had turned down efforts by would-be acquirer Vishay Intertechnology Inc. to put three directors on Rectifier's board and otherwise change the El Segundo, Calif.-based high-tech manufacturer's bylaws to facilitate a takeover which the latter company does not want. Share of both companies slid on the news.

A large shareholder of Longs Drug Stores Corp. which had initially balked at the Walnut Creek, Calif.-based regional drugstore operator's plans to sell itself to Number-Two national chain CVS Caremark Corp. seems to have had a change of heart, now that the only other serious suitor, Walgreen Corp., has pulled its somewhat higher bid off the table. Walgreen meantime announced the abrupt resignation of its chairman and chief executive officer, although it said that Jeffrey Rein's sudden exit had nothing to do with the failed bid for Longs.

Wachovia a winner as Citi withdraws

The news that Citigroup had given up what many analysts and other observers had considered a losing cause and was walking away from the talks with Wells Fargo over Wachovia, leaving the Charlotte, N.C., bank free to complete its planned $15 billion sale to Wells Fargo, caused Wachovia's (NYSE: WB) shares to shoot up by $1.55, or 43.06%, to end at $5.15, on volume of 156.6 million, nearly one third above the average activity level.

"The dramatic differences in the parties' transaction structures and their views of the risks involved made it impossible to reach a mutually acceptable agreement," Citigroup said in announcing its withdrawal from the talks with Wells Fargo.

Instead, it said that it will move forward with its lawsuit seeking some $60 billion from Wachovia and Wells Fargo, claiming that by the other parties undermining Citi's original $2.16 billion agreement to buy Wachovia's branch network and to assume some of its liabilities, "our shareholders have been unjustly and illegally deprived of the opportunity the transaction created."

Despite the bitter tone in its concession statement, Citi may have welcomed a chance to back away from the faltering Wachovia; The Washington Post reported that a source familiar with Citigroup's thinking said the New York-based banking giant "walked away from the negotiating table because it became increasingly concerned that losses on Wachovia's loan portfolios would be even larger than anticipated."

A trader said that concern about the losses "was just a Citi plan to make their exit more graceful." He said that Wells Fargo "knows what they are doing far better than Citi - Citi was happy to exit the situation because they knew that they could not raise the $10 billion in equity [that they would need] in this market."

He noted that Moody's Investors Service said Friday that it will continue reviewing Citigroup's credit ratings for a possible downgrade - even now that the company will no longer need to spend over $2 billion buying assets from Wachovia and assuming further billions of liabilities. The ratings service said that while the prospective Citi-Wachovia deal was a factor in prompting Moody's to put Citigroup's ratings on review for possible downgrade, even without it there are ample non-Wachovia related considerations that also prompted Moody's to put Citigroup's ratings under scrutiny, including concerns about Citi's asset quality and potential credit costs as a result of a weaker economic environment and a difficult housing picture.

He suggested that those concerns might become a factor as Citi tries to fight its $60 billion suit against Wachovia for breach of contract - the memorandum of understanding that the two companies had signed - and against Wells Fargo, for tortious interference in wooing Wachovia away from the already agreed-upon Citi deal. They would suggest, he said, that Citi would have had trouble getting the deal done anyway, something which the judge hearing the case might take into account.

He predicted that Citi might just "fade away - and wait for the next one [troubled bank consolidation deal]" in hopes of better success the next time.

In the meantime, San Francisco-based Wells Fargo's deal to buy all of Wachovia for about $15 billion will lift it into the pantheon of banking giants that have emerged to dominate the nation's lending industry as weaker players have fallen by the wayside. It's a group that includes Citi, as well as Bank of America Corp. and J.P. Morgan Chase & Co., which recently gobbled up the faltering top U.S. thrift institution, Washington Mutual Inc.

Addition of Wachovia's more than 3,000 retail branches in 21 states and the District of Columbia to Wells Fargo's own extensive network creates the fourth-largest U.S. bank holding company.

Analyst Andew Marquardt of Fox-Pitt Kelton Inc. said in a research note Friday that the deal is a winner for Wells, allowing it to capitalize on Wachovia's strong legacy in retail, commercial and corporate banking, asset management and retail brokerage in the U.S. Southeast, although its branch network stretches up to New York and as far west as Wells Fargo's home base of California.

Marquardt said that Citi's withdrawal from the negotiations about divvying up Wachovia - some sort of regional scheme was envisioned - "removes any confusion regarding how a potential breakup of Wachovia franchise to appease Citi and government might have worked in terms of logistics, legalities and financials."

Wells Fargo (NYSE: WFC) rose $1.06, or 3.89%, to $28.13 on volume of 122 million shares, about double the norm. And after initially falling some 7% on the morning news of its capitulation, Citigroup (NYSE: C) ended up $1.18, or 9.13%, at $14.11. Volume of 260 million shares was more than double the usual turnover.

Morgan Stanley mauled, again

But that good banking-sector news, which also lifted J.P. Morgan and Bank of America, proved to be no help to another financial giant, Morgan Stanley, whose shares (NYSE: MS) collapsed by as much as 46% intra day, before finally finding a bottom and coming about half way back, still ending down $2.71, or 22.25%, at $9.68 on volume of 206 million, over five times the average daily action.

Morgan Stanley got murdered on renewed investor fears about whether its pending $9 billion deal to sell a 21% stake to Japan's largest lender, Mitsubishi UFJ, might still fall apart at the last minute or come up for renegotiation on more onerous terms. Investors were also made jittery as Moody's said it may reduce the second-largest U.S. investment bank's credit rating on concern the financial crisis threatens earnings and investor confidence.

Fox-Pitt analyst David Trone said in a research note that Morgan Stanley's shares have been under "extraordinary pressure as of late, for no apparent fundamental reason, as we estimate liquidity, the balance sheet, and long-term earnings prospects are sound."

However, on Friday, Moody's announced that it would scrutinize Morgan Stanley's ratings for a possible downgrade, warning that it expects that "an extended downturn in global capital market activity will reduce Morgan Stanley's revenue and profit potential in 2009, and perhaps beyond this period. In addition to the depressed market environment, Morgan Stanley will need to adapt the firm's business activities and balance sheet to operate in a bank holding company structure. This could limit profit opportunities for Morgan Stanley, though the firm's risk profile could be lowered, thus mitigating this concern.

"As well, customer and investor concerns regarding wholesale investment banks have also put pressure on Morgan Stanley. Investor, counterparty and customer confidence is critical to the funding and profit generation of the firm, especially in a hostile market environment. During its review, Moody's will focus on the success of the actions that management takes to alleviate these confidence pressures and maintain customer franchises, while retaining key producers in a difficult environment."

Earlier in the week, Morgan Stanley said that Mitsubishi's investment had received the necessary key regulatory clearances. Spokesmen for both Morgan Stanley and Mitsubishi UFJ reiterated on Friday that the deal is set to be completed by Tuesday

Analyst Trone said that further details about the depth of Mitsubishi's "major" funding support for the beleaguered Morgan Stanley would likely be disclosed at or after the formal closing.

Vishay is vanquished

Apart from the still-faltering financials, International Rectifier claimed victory over unwanted suitor Vishay Intertechnology, which had launched a proxy effort to oust three management-backed directors from International Rectifier's board and replace them with nominees who would support Malvern, Pa.-based semiconductor maker Vishay's $23 per share effort to take control of International Rectifier.

Shortly after the conclusion of its annual shareholders' meeting, International Rectifier said that the three management-backed directors, Jack O. Vance, Thomas Lacey and Mary B. Cranston, had been re-elected, and that shareholders had nixed a Vishay effort to make changes in International Rectifier's bylaws.

There was no immediate word from Vishay on its plans for its $23 per share bid for the rival company, which have now been dealt a major setback.

International Rectifier had scorned that offer as inadequate and "opportunistic" and also dismissed out of hand a Vishay offer to negotiate with the California firm's management and possibly raise the $23 offer if Rectifier could make a compelling case for doing so.

International Rectifier (NYSE: IRF) lost $1.59, or 10.22%, to end at $13.97, on volume of 1.47 million shares, or 1½ times the usual volume. Vishay (NYSE: VSH) fell 47 cents, or 9.67%, to $4.39. Volume of 2.9 million shares was about 50% above the norm.

CVS offer makes a convert

CVS Caremark's effort to acquire Longs Drug Stores in a $2.7 billion deal that would pay shareholders $71.50 per share took a big step toward realization Friday, as Longs' largest shareholder - previously a critic of the CVS offer - came over to management's side and endorsed it.

Advisory Research Inc. controls 3.3 million shares, or roughly 9.2%. It had previously opposed

Woonsocket, R.I.-based pharmacy giant CVS's bid as inadequate, but now says that it will tender those shares into CVS' offer, which needs the backing of two-thirds of the holders to pass.

Advisory Research cited Walgreen's mid-week withdrawal of its $2.8 billion offer, which would have paid shareholders $75 apiece, as well as the current "turmoil in the markets" in opting for the safety of CVS's bid, which that company claims is fully financed and has already received needed regulatory approvals.

Chicago-based Walgreen, the industry leader, looking to maintain its size advantage over Number-Two player CVS and Number-Three Rite Aid Corp., proposed buying Number-Four Longs to add its 500-plus stores in California, Nevada and Hawaii to its own extensive network in one fell swoop.

But Longs, which had already accepted the CVS offer, rejected the larger offer from Walgreen, contending that it might face extensive antitrust problems because of the overlap of the two companies' competitive footprints. That annoyed Advisory Research and another large shareholder, 9% owner Pershing Square Capital Management LP, which declared their opposition, contending that Longs management had not fully indicated the real estate value of its empire of stores, some of which are company owned and others are rented.

There were also suggestions that other potential bidders might be out there, but none ever materialized.

Walgreen meantime announced the abrupt resignation of its chairman and CEO, Jeffrey Rein, who had run the company for the last two years but who had been with it in various capacities since starting as an assistant store manager in 1982 and coming up through the ranks.

His resignation was effective immediately. Walgreen said there was no connection with Rein's failed effort to win over Longs.

Alan McNally, the lead director of the Walgreen board, was named chairman and acting CEO, while the company seeks a permanent replacement for Rein.

Longs Drug Stores (NYSE: LDG) rose $1.89, or 2.74% to end at $70.82, on volume of 3.8 million shares, almost three times the norm. Walgreen fell $2.06, or 8.15%, to $23.22 on volume of 28.5 million, almost four times the usual. CVS Caremark gained 50 cents, or $1.65, to finish at $30.88. Volume of 27.6 million shares was 2½ times the norm.

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