Portfolio manager Cale Smith on investing, Spoke Funds®, and Islamorada in the Florida Keys.

Quick note: the below will probably make little sense to most readers, but I wanted to put some more thoughts down for a couple of guys on Twitter…and it’ll take longer than 140 characters to do it. It deals with evaluating a potential merger arbitrage investment among a couple of small banks in Pennsylvania. I passed on investing in it in Tarpon, and below is why.

Adam and Plan,

Here’s where I’m coming from on that last tweet about FCEC’s exchange ratio in the merger with Tower:

Net charge-offs for the six month period ended June 30, 2010 for FCEC were $2.3 million, and during the fourth quarter of 2009, net charge-offs were $16.6 million, which were obviously huge. So right now…

$16.6M plus $2.3M plus whatever charge-offs will be through August (assuming this is the month prior to the transaction closing) puts the cumulative net charge-offs at around $19M to $20M, ballpark. Add that to Delinquent Loans of $57M (Total NPAs from Q2 ‘10) and you get at least $77M as the Value for Charge-offs Post 9/30/09…and if you plug that in as per the line-item in slide 5 here, you get the adjusted exchange ratio. Based on that math, the ultimate ratio could be considerably lower than the market appeared to expect – at least up until yesterday.

I say that because with an exchange ratio of 0.291 multiplied by a recent TOBC price of $18.70, FCEC investors will only effectively get $5.44 in deal value per share. Until the big drop in FCEC yesterday, shares were priced well above this expected closing price. So perhaps someone else was doing the same math I was late Wednesday night – though now the gap seems to be narrowing as I type.

In any case, I may have missed something in the above, as I did not review every filing after the initial agreement. Did not talk to the management teams, either, though the deal at first glance seems highly probably to go through. I suspect perhaps because both stocks are so thinly traded the values have been out of whack…but as is, unless FCEC continues to drop and/or TOBC spikes, I’m passing. At least on the merger arb angle. Tower is probably worth a closer look post-merger, regardless.

Would appreciate any other insights you might have.

Thx.

Cale

Apologies for the delays between posts. Been in the cave on companies lately, among other things. Back in a while to pick up on that CRBC series. In the meantime, here was the most attention grabbing lede I read all week:

“Over the last two years of the housing bubble, Wall Street bankers perpetrated one of the greatest episodes of self-dealing in financial history.”

Great article from ProPublica – “Banks’ Self-Dealing Super-Charged Financial Crisis.” Here it is in its entirety. Also includes these great graphics (click to enlarge).

Two words: “flash crash.”

Good article today in the WSJ about what happened on May 6th.

“…the Dow Jones Industrial Average suffered its biggest, fastest decline ever, and hundreds of stocks momentarily lost nearly all their value. So many things went wrong, so quickly, that regulators haven’t yet pieced together precisely what happened.

A close examination of the market’s rapid-fire unraveling reveals some new details about what unfolded: Stock-price data from the New York Stock Exchange’s electronic-trading arm, Arca, were so slow that at least three other exchanges simply cut it off from trading. Pricing information became so erratic that at one point shares of Apple Inc. traded at nearly $100,000 apiece. And computer-driven trading models used by many big investors, apparently responding to the same market signals, rushed for the exits at the same time.”

Read it in its entirety here.

I have no idea what any of the above has to do with long-term investing, but it’s going to make one helluva cyborg movie.

Previous posts on High Frequency Trading include this one, and this video. Sadly, there will probably be more posts in the future.