Wachovia + A. G. Edwards Raises Retail Broker Stakes but Payoff is Risky

Implications: A. G. Edwards (NYS:AGE) has agreed to be acquired by Wachovia Securities, a larger broker/dealer and an affiliate of Wachovia Corporation (NYS:WB) for $6.8 billion. This deal continues the concentration of the retail brokerage marketplace into the top five firms. What time will tell is whether or not Wachovia can expand the combined market share of the two firms after the deal closes.

Analysis: This deal follows a frequently used strategy by both the seller and buyer. The seller has reached a point where the odds for continued success and value creation for shareholders will diminish, concluding that now is a good time to sell. The buyer is looking to expand market share and desires the potential to create additional value by leveraging other products and services into the seller's customer base. The risk to the buyer is tied to two key factors, which are presented as two groups of questions:

1. Is the A. G. Edwards franchise fragile or resilient? Are the A. G. Edwards brokers, especially the top 50%, going to stay with Wachovia for at least one year? Will the Edwards customers embrace the cross-sellling efforts and buy Wachovia's bank and insurance products?

2. How effectively will Wachovia integrate operations with A. G. Edwards? Will Wachovia's cross-selling plans require pricing concessions to achieve penetration with the A. G. Edwards customer base?

There is a reasonable amount of fragility and risk in a deal of this magnitude. Other deals in the past 7 years that offer some insight include two deals by UBS, buying Piper Jaffray in 2006 and Paine Webber in 2000. Of course, another relevant deal was the combination of Wachovia Securities and Prudential Securities in 2003. Wachovia Corp. owns 62% and Prudential Financial (NYS:PRU) owns the other 38% of Wachovia Securities.

In both UBS deals there was broker attrition from the seller's side. While 15% broker attrition may seem modest, the suggestion by Wachovia that they project a 3% attrition is a meaningful contrast. Broker attrition is directly linked with customer attrition, in part because the customer trusts the broker as much or more than the firm. Wachovia's expectation of 3% attrition is a very high standard for the brokerage industry.

Successfully cross-selling bank and insurance products is no easy task. There are many moving parts to successful cross-selling. The task starts with the broker in most cases. Higher than expected attrition can doom this objective. The market place is very competitive. All of the other major brokers and banks, such as Merrill Lynch (NYS:MER), Citigroup (NYS:C), and Bank of America (NYS:BAC) all have their cross-selling strategies too. Customers, especially those with more than $250,000 of investment assets are usually well informed about credit-related and insurance products. An expectation of meaningful incremental revenues from cross-selling is also a very high standard.

This leaves integration, consolidation of operations and expense reduction as the final opportunity to make this deal payoff. This opportunity has the best odds of success, partly due to the common back office platform used by both Wachovia and A. G. Edwards.

In summary, the deal makes sense for the seller and buyer. The odds of achieving Wachovia's targets are not favorable for broker attrition and cross-selling. Consolidating operations and eliminating expenses, which are realistic, must be achieved for Wachovia to gain any benefits from this deal.