Download Bear Stearns

BUY RECOMMENDATION
Firm: Bear Stearns Companies, Inc.
Sector: Financial Services (Investment Bank)
Anne Rife Cox Endowment Fund
Spring 2003
Past 5-Year Performance
Analyst: Cameron W. George
Contact at [email protected]
NYSE Ticker: BSC
Moody’s Debt Rating: A2↑
Analyst: Pierce L. Lowrey
Contact at [email protected]
This Bear Never Hibernates
Summary Findings and Other Highlights
I. Diversification: We inherited the financial services sector to find that the previous class
had placed bets on certain sub-sectors. We would like to refine the sector as we make our
own bets, so we have sold off portions of the sector and replaced them with the intention of
diversifying our holdings. As part of the process, we need to buy an investment bank to
enhance our diversification strategy.
Relevant Performance Data
(On April 2, 2003)
Market Price:
Shares Outstanding:
Market Capitalization:
52-Week Low:
52-Week High:
Price/Earnings:
Industry Price/Earnings:
Price/Book:
Industry Price/Book:
Price/Sales:
Industry Price/Sales:
EPS Estimate:
Beta:
Industry Beta:
$69.48
96.2 M
$6.68 B
$50.50
$70.00
9.37
15.70
1.16
2.16
1.38
1.84
$6.33
1.47
1.75
Corporate Profile
“The Bear Stearns Companies Inc. is
an investment banking, securities and
derivatives trading, clearance and
brokerage firm serving corporations,
governments,
institutional
and
individual investors worldwide. The
Company is a holding firm that
operates through its subsidiaries,
principally Bear, Stearns & Co. Inc.,
Bear Stearns Securities Corp. (BSSC),
Bear Stearns International Limited and
Bear Stearns Bank plc. The Company
is primarily engaged in business as a
securities broker/dealer operating in
three principal segments: capital
markets, global clearing services and
wealth management. Certain capital
markets products are distributed by the
wealth management and global
clearing services distribution networks
with the related revenues of such
intersegment services allocated to the
respective segments.”
Graph Source: Yahoo! Finance
Performance Data Source: Multex
Profile Source: Yahoo! Finance
II. Industry scandals: Many recent scandals involving investment banks have left us with
few viable options for a solid growth opportunity. We eschewed banks that had been
numbed by fines and disciplinary actions, and focused on Bear Stearns, the 223rd largest firm
of the Fortune 500.
III. Higher debt rating: Fitch, among other agencies, recently upgraded Bear Stearns’ debt
rating to A+, citing that “liquidity, funding, and capital are prudently managed.”
IV. High bear market performance: Bear Stearns has performed exceptionally well
during the economic downturn, increasing net income by 42% in 2002 and outstripping all of
its major competitors in capital gains over the same time period.
V. Private client strategy: In an effort to bolster its private client group, Bear Stearns very
recently hired one of the industry’s most successful brokers to its New York office. Richard
Saperstein brings with him more than $5.5 billion in assets under management and rich
opportunities for Bear Stearns to expand its access to high-net-worth clients.
VI. Valuation: We used a flow-to-equity method because the cash flows from Bear Stearns’
significant debt activities have an unjust and inaccurate impact on the firm’s free cash flows.
Additionally, free cash flow valuation is difficult because of an uncertain cost of debt.
Our bet: We expect M&A and equity issuance activities to pick up in the near future as
companies seek growth opportunities through mergers and acquisitions and rebalance
Key Competitors and Approximate Market Caps
Closest competitor: Merrill Lynch ($35 B)
Others: Morgan Stanley ($46 B), Goldman Sachs ($34 B), CSFB ($21 B)
BSC Performance Relative to Merrill Lynch, Dow, NASDAQ, and S&P 500
Orientation to the Industry
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Market Cap ($ billions)
Top Investment Banks by Market Capitalization
Orientation to the Firm
Bear Stearns'
Composition of Revenues
2002
Other Income
3%
Commissions
16%
Interest and
Dividends
32%
Investment
Banking
12%
Principal
Transactions
37%
Origin of Bear Stearns
Partners Joseph Bear, Robert Stearns, and Harold Mayer founded bear Stearns in 1923 with $500,000 in
capital. The Company survived the stock market crash of the late-1920s by promoting government
bonds, and exhibited strong management by weathering the storm without employee layoffs. An
international department opened in 1948, and over the next few years, branch offices popped up around
the globe: Geneva (1963), San Francisco (1965), Paris (1967), and Los Angeles (1968).
Formerly of Salomon Brothers, Cy Lewis headed the company during the 1950s-1960s, and later
fashioned himself into a colorful Wall Street legend as Bear Stearns’ chairman. During Lewis’ tenure,
Jerome Kohlberg, Henry Kravis, and George Roberts left the Company to start a firm that would
become leveraged buyout powerhouse KKR.
Alan Greenberg replaced Lewis in 1978, and over the next three years he created the government and
mortgage-backed securities divisions. In 1984, he formed Bear Stearns Asset Management and
Custodial Trust. The next year Greenberg took Bear Stearns public as The Bear Stearns Companies,
Inc. and thereafter brought investment banking under the corporate roof—by 1991 Bear Stearns had
become the leading investment underwriter in the Latin American market. Concurrently, Greenberg set
up Bear Stearns Securities Corporation to handle new clearing business.
Bear Stearns was slow to recover from the 1994 bond market crash, since its fiscal year does not align
with the calendar year and decreased earnings from the crash were not reported until mid-1995. The
securities industry is so competitive that when employees’ bonuses took a hit from reduced revenues,
several senior bond executives left for other firms.
In 1997, Bear Stearns teamed up with National Mortgage Bank of Greece to bring mortgage- and assetbacked securitization to Greece. Also, it opened a branch office in Ireland to gain further access to the
European market. The year also marked the beginning of Bear Stearns’ investment in high-tech,
communications, and media businesses.
Although Bear Stearns was not involved in any major accounting scandals or other fraud during the late
1990s and early 2000s, some legal “ghosts from the past” cropped up in 1998 relating to proceedings
initiated in the 1980s. Three noteworthy jury awards and settlements reached approximately $200
million in total.
Current Status of Bear Stearns
James Cayne is now Chairman and CEO following Greenberg’s unofficial retirement in 2001.
Greenberg remains active in the company as a director and Chairman of the Executive Committee.
Bear Stearns operates three divisions: (1) Capital Markets, (2) Global Clearing Services, and (3) Wealth
Management. (1) Capital Markets, by far the largest component of the Bear Stearns brand, serves
institutional clients and offers fixed income, equities, and investment and merchant banking services.
(2) Global Clearing Services offers prime broker and broker-dealer clearing services, such as margin
lending and securities borrowing and is one of the largest clearing operations on Wall Street. (3) Wealth
Management represents Bear Stearns’ private client group and asset management business and focuses
on high-net worth clientele. In total, the asset management subsidiary manages more than $20 billion in
Sources: Hoovers, Bear Stearns
assets.
Top 10 Investment Banks by Sales
Morgan Stanley
Merrill Lynch
Goldman Sachs
Salomon Smith Barney
Lehman Brothers
UBS Warburg
Credit Suisse First Boston
Nomura Holdings
Bear Stearns
UBS Paine Webber
Industry Outlook
Political volatility, in addition to the timing of economic recovery, remains a key force on the future of
the financial services industry. Questions remain about accounting scandals and corporate fraud, and
only time will tell whether enough political measures have been taken to alleviate these concerns. The
judicial system is expected to have an impact as risk of litigation should dissuade companies from
engaging in suspicious financial transactions and courts may address the conflict of interest between
research and investment banking. In the short-term, we look for additional problems among financial
services as these new rules take effect, but we expect the long-term perspective to improve as the rules
are tested and the companies learn how to apply them appropriately. In an industry where reputation is a
firm’s biggest asset, we believe Bear Stearns—unlike many of its competitors who have received more
than their share of negative headlines—has managed to shield itself from costly scandals and will likely
emerge relatively untarnished.
Towards the end of 2003, mergers and acquisitions (M&A) and equity issuance activities should pick up
if corporate profits continue to recover. In a sustained period of equity market stability, we believe
corporations will need to rebalance their capital structures following recent record levels of debt
issuance. Further, we expect that Bear Stearns and other firms within the industry will receive the
benefits of an upturn in capital markets in their specialist and wealth management units as more high-net
worth investors return to professional brokerage from self-managed accounts. Bear Stearns recently
hired one of the most successful brokers on Wall Street, Richard Saperstein, who brings with more than
$5.5 billion in assets under management and tremendous opportunities for the company to expand its
access to wealthy individuals. Bear Stearns has been actively seeking ways to improve its private client
services, and Richard Saperstein may very well be the key.
Across the industry, many investment banks are reporting that M&A assignments have become more
strategic as compared to the “out-of-the-box” merger mania that defined the irrational exuberance of the
1990s. For example, instead of an acquirer targeting a business outside its own core competencies,
companies are reexamining their motivations for merger activity to find more practical corporate
pairings since those “out-of-the-box” transactions typically resulted in higher historical failure rates.
Ultimately mergers completed in the late 1990s that were based on doubtful synergies and overzealous
senior management have brought about detrimental effects on capital markets. We anticipate future
prosperity within the financial services industry as M&A activity continues and picks up in the shortterm.
Despite these potential increases in M&A and equity issuance activities, we acknowledge that a
significant number of uncertainties grip the world and the economy. Bear Stearns has still positioned
itself to weather the lingering storm—should traditional investment banking activities not immediately
increase—through its institutional activity in the areas of equity derivatives, convertible arbitrage, and
interest rate and credit products.
Sources: Yahoo! Finance, Hoovers, Grant Thornton, LLC
Comparative Analysis: Bear Stearns in a Greater Context
Bear Stearns’ Performance Relative to S&P 500:
Bear Stearns has clearly outperformed the Standard & Poor’s 500 for the last year despite well-known
skepticism in the broad equity market. With uncertainties, such as corporate scandals, deregulation
within the banking industry, war in Iraq, and global crises, weighing on investors, Bear Stearns has still
managed to increase its net income over the past year by 42%. We believe Bear Stearns will benefit
greatly if the economy stabilizes in the next year, since characteristically banks have significant
operating leverage and attract positive early cycle performance in an economic upturn. Even if the
economic rebound eludes investors, we expect that Bear Stearns has still positioned itself appropriately
within the industry to remain profitable despite ongoing concerns of war, e.g., the timeliness and
outcome of war and the effect on M&A and equity issuance activities, and other relevant issues because
of the Company’s positive performance over the past, unstable year.
Bear Stearns’ Performance Relative to Top Competitors and Industry:
Exhibit 1: Competitive Landscape
P/Earnings
ROA
ROE
Net Profit
Margin
P/Sales
ST EPS
Growth
LT EPS
Growth
PEG
Source: Multex Investor Services, Hoovers, Yahoo! Finance
BSC
9.37
.5%
17.1%
13.87%
GS
16.18
.6%
11.9%
9.69%
LEH
17.02
.4%
11.9%
6.86%
MER
13.79
.6%
11.2%
8.89%
Industry
15.7
.6%
11.3%
8.48%
.98
60.1%
1.47
13.0%
.90
(8.8%)
1.25
361.4%
1.91
(7.7%)
11.9%
(9.8%)
(14.4%)
(21.8%)
(11.8%)
1.10
1.26
1.23
1.18
1.87
Competitive Landscape
As seen in Exhibit 1 on the previous page, Bear Stearns has a lower price/earnings ratio than its
competitors and other companies within the industry; the low price/earnings metric means Bear Stearns’
investors pay relatively less for earnings than do investors in competing companies. While this lowerthan-average price/earnings figure might represent lower expected future growth, we believe that Bear
Stearns defies a low-growth stereotype in its expected short-/long-term earnings per share (EPS) growth,
return on equity (ROE), and return on assets (ROA) numbers. With the exception of Merrill Lynch in
the 12-month EPS growth, analysts predict Bear Stearns will reward investors relatively better than will
its competitors. As seen in the following graphs, Bear Stearns is clearly outperforming its rivals and has
successfully weathered the current economic downturn.
Bear Stearns vs. Lehman Brothers (LEH) and the Dow Jones 30
Bear Stearns vs. Morgan Stanley (MWD) and the Dow Jones 30
Bear Stearns vs. Merrill Lynch (MER) and the Dow Jones 30
Bear Stearns vs. Goldman Sachs (GS) and the Dow Jones 30
Bear Stearns vs. Credit Suisse Group (CSR) and the Dow Jones 30
COMPARABLE COMPANY VALUATION ANALYSIS
(On April 2, 2003)
Financial Data for Valuation
Industry
Bear Stearns
Firm Name
BSC
Ticker
96,186,960
Shares Outstanding
$69.48
Price
15.7
9.37
Price/Earnings
2.16
1.16
Price/Book
1.84
1.38
Price/Sales
$842,739,000
Net Income
$7.18
Earnings Per Share
$6,890,816,000
Sales
$6,683,069,981
Market Capitalization
$6,382,083,000
Book Value of Equity
$66.35
Book Value/Share
1.75
1.47
Beta
$0.68
Dividends Paid
1.51%
1.01%
Dividend Yield
22.03%
8.42%
Payout Ratio
$70.00
52-Week High Price
$50.50
52-Week Low Price
Theoretical Value based on Comparable Industry Ratios
Key Valuation Ratios
ACF Value based on industry Price/Earnings ratio
ACF Value based on industry Price/Sales ratio
ACF Value based on industry Price/Book ratio
Merrill Lynch
MER
876,157,083
$38.26
13.79
1.4
1.21
$2,513,000,000
$2.69
$28,253,000,000
$33,521,769,996
$22,875,000,000
$26.11
1.55
$0.64
1.77%
22.29%
$55.20
$28.21
Firm Values (Equity)
$13,231,002,300
$12,679,101,440
$13,785,299,280
$12,955,051,870
Averages
Financial Data of Closely Competing Firms
Morgan Stanley
Goldman Sachs
MWD
GS
1,039,046,651
453,824,586
$41.80
$72.40
14.53
16.18
1.98
1.75
1.37
1.57
$2,988,000,000
$2,114,000,000
$2.75
$4.34
$32,450,000,000
$22,854,000,000
$43,432,150,012
$32,856,900,026
$21,885,000,000
$19,003,000,000
$21.06
$41.87
2.11
1.83
$0.92
$0.48
2.30%
0.69%
32.92%
10.65%
$57.29
$89.45
$28.80
$58.57
Firm Name
Ticker
Shares Outstanding
Price
Price/Earnings
Price/Book
Price/Sales
Net Income
Earnings Per Share
Sales
Market Capitalization
Book Value of Equity
Book Value/Share
Beta
Dividends Paid
Dividend Yield
Payout Ratio
52-Week High Price
52-Week Low Price
Stock Prices
$85.51
$81.95
$89.10
$85.52
Note:
Net income, sales, market capitalization, and shares outstanding figures approximated for consistency among firms.
Metrics from trailing twelve month periods, except Price/Book. Price/Book from most recent quarter.
Source of information: Multex Investor Services
Key Explanations:
Although Bear Stearns does, in fact, pay a dividend, we do not believe that a valuation based on discounting dividends would accurately reflect Bear Stearns' intrinsic price.
Notice that Bear Stearns' payout ratio is very small in comparison to the payouts of its closest competitors and the industry in general--therefore a dividend-related
discouont model would naturally price Bear Stearns excessively low.
Instead, we have presented this comparable company valuation analysis which shows Bear Stearns as it compares to its three closest competitors.
We have also presented a discounted cash flow analysis using the flow-to-equity method, which appears in the following pages. We believe the intrinsic value of Bear Stearns
to be within the range of prices depicted in both the comparable company and discounted cash flow analyses.
DETERMINATION OF FLOW-TO-EQUITY CASH FLOWS
(Note: All numbers in U.S. dollars and to correct decimal place as presented, unless otherwise indicated.)
Finish here:
Net Income
Non-Cash Items Included in Net Income:
Depreciation/Depletion
Deferred Income Taxes
Employee Stock Compensation Plans
Other
Changes in Operating Assets and Liabilities:
Cash, Clearing Organizations/Federal Regulations
Securities Purchased Under Resell Agreements
Securities Borrowed
Receivables from Customers
Receivables from Broker/Dealers, et al
Financial Instruments Owned
Other Assets
Securities Sold Under Repurchase Agreements
Payables to Customers
Payables to Broker/Dealers, et al
Financial Instruments Sold (Not yet purchased)
Accrued Employee Compensation/Benefits
Other Liabilities and Accrued Expenses
OPERATING CASH FLOWS
-Capital Expenditures
FLOW-TO-EQUITY CASH FLOWS
2001
Actual
624,965,000
2002
Actual
878,345,000
2003
Forecast
1,116,030,358
2004
Forecast
1,172,947,906
2005
Forecast
1,232,768,249
2006
Forecast
1,295,639,430
2007
Forecast
1,361,717,041
208,822,000
-232,916,000
355,612,000
16,423,000
161,879,000
-24,374,000
533,240,000
16,043,000
185,350,500
-128,645,000
533,240,000
16,043,000
185,350,500
-128,645,000
533,240,000
16,043,000
185,350,500
-128,645,000
533,240,000
16,043,000
185,350,500
-128,645,000
533,240,000
16,043,000
185,350,500
-128,645,000
533,240,000
16,043,000
-5,514,441,000
-6,243,253,000
9,848,739,000
-243,724,000
-2,038,030,000
-4,424,247,000
584,722,000
-1,552,833,000
6,804,906,000
3,431,849,000
5,743,264,000
-191,910,000
-105,665,000
7,072,283,000
-185,300,000
6,886,983,000
2,187,535,000
5,237,038,000
-1,205,175,000
-546,240,000
1,469,704,000
-5,130,001,000
-217,640,000
-5,665,881,000
223,888,000
673,646,000
-327,767,000
-120,267,000
487,722,000
-1,368,305,000
-126,620,000
-1,494,925,000
-1,970,450,000
5,665,881,000
-1,205,175,000
-394,982,000
-284,163,000
-5,884,111,147
183,541,000
-5,665,881,000
3,656,783,000
2,052,747,500
2,707,748,500
-156,088,500
191,028,500
618,897,711
-126,620,000
492,277,711
-1,970,450,000
5,665,881,000
-1,205,175,000
-394,982,000
-284,163,000
-5,884,111,147
183,541,000
-5,665,881,000
3,656,783,000
2,052,747,500
2,707,748,500
-156,088,500
191,028,500
675,815,259
-126,620,000
549,195,259
-1,970,450,000
5,665,881,000
-1,205,175,000
-394,982,000
-284,163,000
-5,884,111,147
183,541,000
-5,665,881,000
3,656,783,000
2,052,747,500
2,707,748,500
-156,088,500
191,028,500
735,635,602
-126,620,000
609,015,602
-1,970,450,000
5,665,881,000
-1,205,175,000
-394,982,000
-284,163,000
-5,884,111,147
183,541,000
-5,665,881,000
3,656,783,000
2,052,747,500
2,707,748,500
-156,088,500
191,028,500
798,506,783
-126,620,000
671,886,783
-1,970,450,000
5,665,881,000
-1,205,175,000
-394,982,000
-284,163,000
-5,884,111,147
183,541,000
-5,665,881,000
3,656,783,000
2,052,747,500
2,707,748,500
-156,088,500
191,028,500
864,584,394
-126,620,000
737,964,394
2004
Forecast
7,611,602,244
2,740,176,808
4,871,425,436
1,217,856,359
3,653,569,077
1,902,900,561
1,750,668,516
577,720,610
1,172,947,906
2005
Forecast
7,999,793,959
2,879,925,825
5,119,868,134
1,279,967,033
3,839,901,100
1,999,948,490
1,839,952,611
607,184,361
1,232,768,249
2006
Forecast
8,407,783,451
3,026,802,042
5,380,981,409
1,345,245,352
4,035,736,056
2,101,945,863
1,933,790,194
638,150,764
1,295,639,430
2007
Forecast
8,836,580,407
3,181,168,946
5,655,411,460
1,413,852,865
4,241,558,595
2,209,145,102
2,032,413,494
670,696,453
1,361,717,041
DETERMINATION OF NET INCOME
Start here:
Revenues
Cost of Revenues
Gross profit
Operating Expenses
EBIT
Interest Expense
Income before taxes
Income tax expense
NET INCOME
2001
Actual
8,701,033,000
2,865,464,000
5,835,569,000
1,107,127,000
4,728,442,000
3,793,998,000
934,444,000
309,479,000
624,965,000
Sources: Yahoo! Finance, Multex Investor Services, Bear Stearns
2002
Actual
6,890,816,000
2,705,463,000
4,185,353,000
1,111,810,000
3,073,543,000
1,762,580,000
1,310,963,000
432,618,000
878,345,000
2003
Forecast
7,242,247,616
2,607,209,142
4,635,038,474
1,158,759,619
3,476,278,856
1,810,561,904
1,665,716,952
549,686,594
1,116,030,358
Key Assumptions Necessary to Determine Net Income
"Revenue" includes fees from commissions, principal transactions, investment banking, interest and dividends, and other activities.
"Revenue" will grow by 5.1% every year through 2007.
"Cost of Revenues" includes employee compensation and benefits, floor brokerage, and exchange and clearance fees.
"Cost of Revenues" is assumed to be 36% of Revenues.
Tax rate is calculated to be 33%.
"Operating Expenses" include communications and technology, occupancy, advertising and market development, professional fees, and other expenses.
"Operating Expenses" will be 16% of Revenues.
Key Assumptions Necessary to Determine Flow-to-Equity Cash Flows for Years 2003 Through 2007
"Depreciation/Depletion" is an average of the 2001 and 2002 levels.
"Deferred Income Taxes" is an average of the 2001 and 2002 levels.
"Employee Stock Compensation Plans" kept constant at 2002 level until 2007.
"Other" kept constant at 2002 level until 2007.
"Cash, Clearing Organizations/Federal Regulations" refers to cash and securities deposited with clearing organizations or segregated in compliance with federal regulations,
and is estimated to be an average of the 2000, 2001, and 2002 levels because of recent volatility.
"Securities Purchased Under Resell Agreements" is estimated to decrease by the same amount by which "Securities Sold Under Repurchase Agreements" decreased in 2002.
We noticed that these accounts fluctuated by a similar amount in 2002, and we expect this trend to continue through 2007.
"Securities Borrowed" kept constant at 2002 level until 2007.
"Receivables from Customers" is an average of the 2001 and 2002 levels.
"Receivables from Broker/Dealer and Others" is an average of the 2001 and 2002 levels.
"Financial Instruments Owned" is expected to increase by 14.7% in 2003 and remain there until 2007, based on the geometric mean return of the 2000, 2001, and 2002 levels.
"Other Assets" is an average of the 2001 and 2002 levels.
"Securities Sold Under Repurchase Agreements" kept constant at 2002 level until 2007.
"Payables to Customers" is an average of the 2000, 2001, and 2002 levels because of recent volatility.
"Payables to Broker/Dealer and Others" is an average of the 2001 and 2002 levels.
"Financial Instruments Sold (Not yet purchased)" is an average of the 2001 and 2002 levels.
"Accrued Employee Compensation/Benefits" is an average of the 2001 and 2002 levels.
"Other Liabilities and Accrued Expenses" is an average of the 2001 and 2002 levels.
"Capital Expenditures" kept constant at 2002 level until 2007, then we expect it will increase according to the terminal growth rate.
DISCOUNTED CASH FLOW (DCF) ANALYSIS: FLOW-TO-EQUITY METHOD
Key Assumptions:
$69.48
96,186,960
-$1,494,925,000
5.10%
3.00%
$23,681,399,000
1.47
A2
6.50%
0.78
0.22
33%
1.5%
0.2
3.90%
3.47%
Market stock price on April 2, 2003
Common shares outstanding
Flow-to-equity cash flows at Time 0
Forecasted 5 year sales growth rate
Terminal growth rate
Long-term liabilities (book=market)
Equity Beta
Moody's Bond Rating
Market Risk Premium
=Wd
=Ws
Tax rate
Risk-free rate
Debt Beta
Return on 10-Year Treasury Bill
Weighted average cost of capital
Unnecessary in the flow-to-equity analysis. (FYI only)
Unnecessary in the flow-to-equity analysis. (FYI only)
Unnecessary in the flow-to-equity analysis. (FYI only)
Unnecessary in the flow-to-equity analysis. (FYI only)
Unnecessary in the flow-to-equity analysis. (FYI only)
Unnecessary in the flow-to-equity analysis. (FYI only)
Information Contained Herein Unnecessary in the Flow-to-Equity Analysis and Presented for Your Information Only.
Equity financing=
$6,683,069,981 Current market capitalization.
Debt financing=
$23,681,399,000 Book value of long-term debt from 2002 balance sheet.
0.78 =Wd
0.22 =Ws
Weight of debt financing in corporate capital structure.
Weight of equity financing in corporate capital structure.
1.98% =Kd
Cost of debt financing. Derived from CAPM-based cost of debt equation, using debt beta of .20.
11.06% =Ks
Cost of equity financing. Derived from Capital Asset Pricing Model.
Discount PV of flow-to-equity cash flows by this cost of equity.
2002
Time
CFs
2003
-$1,494,925,000
$492,277,711
2004
2005
2006
$549,195,259
$609,015,602
$671,886,783
Terminal Value
2007
$737,964,394
$9,436,416,211
CFs
Disregard
$492,277,711
$549,195,259
$609,015,602
$671,886,783
$10,174,380,605
PVs
Disregard
$443,273,793
$445,297,797
$444,645,672
$441,716,510
$6,023,062,885
Present value of flow-to-equity cash flows, discounted by the cost of equity = Value of firm's equity
$7,797,996,657 =Value of firm (equity only)
Find the value of equity on a per-share basis:
Sensitivity Analysis With Respect to Various Costs of Equity
$81.07 =Intrinsic value of BSC stock
Ks of 10.95%
$82.18
Ks of 11.00%
$81.65
Ks of 11.05%
$81.12
Ks of 11.10%
$80.60
Key Explanations:
We used a flow-to-equity valuation method instead of a free cash flow method because cash flows from the firm's debt activities,
such as interest income and interest expense, have a significant and unjust impact on the free cash flow calculation. We believe
that a flow-to-equity method presents the most unbiased valuation of the firm because it excludes from consideration the fact that
financial services companies are often debt-laden. Accordingly, debt aspects are not included in the valuation model.
However, in determining the WACC--although the flow-to-equity method does not discount by the WACC--we made these choices:
We calculated the cost of debt to be 1.98% based on a CAPM-based equation that considers the risk-free rate, the return on the
10-Year Treasury Bill, and a debt beta. We believe this to be a more accurate method than comparing the yields-to-maturity (YTMs)
on BSC's most recent debt issues. Reason: Investment banks like BSC issues a variety of debt instruments, and the YTMs can
vary among them. Since we cannot know specifically for what purpose all the bonds were issued, we have calculated the cost of
debt based on prevailing market rates and a debt beta that reasonably describes the riskiness of BSC's A2-rated long-term bonds.
We used the book value of long-term debt since BSC's credit rating is high (recently upgraded) and the bonds are non-callable. We
expect BSC to continue as a going concern, so BSC's long-term debt obligation should be fairly close to the book value of the debt.
Bear Stearns in the Headlines
“Bear Stearns Lures One of Industry’s Top Brokers”
Source: Dow Jones Business News (4/6/03)
Synopsis: Bear Stearns hires superstar broker Richard Saperstein, who brings $5.5 billion in assets under management
and the opportunity for the Company to expand its private client group with new access to high-net-worth clients.
“Fitch Revises Bear Stearns’ Outlook Up, to Stable”
Source: Reuters (3/8/03)
Synopsis: Citing prudently managed liquidity, funding, and capital resources, Fitch upgraded Bear Stearns’ debt rating to A+.
“Bear Goes Bull”
Source: Motley Fool (3/19/03)
Synopsis: Bear Stearns has outperformed its competitors during the bear market through huge bond trading and underwriting operations.
Growth in fixed income and mortgage-backed securitization have helped fuel Bear Stearns’ profits.
“Record Bond Results Boost Bear Stearns”
Source: Reuters (3/19/03)
Synopsis: Bear Stearns posted its fifth straight quarterly profit increase and has outperformed peers such as Goldman Sachs and Morgan
Stanley as its mortgage-backed business has benefited from low U.S. interest rates. Executives were upbeat on the future of the mortgage
business.
“Bear Stearns Wallops Street with 52 Percent Profit Jump”
Source: CBS MarketWatch (3/19/03)
Synopsis: Bear Stearns blew out analysts' expectations by announcing a 52% jump in net income to $274 million on strong fixed-income
trading results.
“Bear Stearns Comfortable with Staffing Levels”
Source: Dow Jones Business News (3/19/03)
Synopsis: Bear Stearns is "comfortable" with its staffing level and has no plans for further layoffs, said Chief Financial Officer Sam Molinaro.
The Company’s staffing level rose 1.6% to 10,506 at the end of February compared with a year earlier. Bear Stearns also plans to add more
brokers that cater to wealthy investors.
“Bear Stearns Braves Downturn, Opens UK Private Bank”
Source: Reuters (3/17/03)
Synopsis: Bear Stearns has set up its first European private bank in London, bucking the retrenchment going on at many of its rivals hit by
tumbling equity markets.