A Growing Spread Shakes Up E*Trade's Bank Deal

Investors are doubting the planned marriage of the online broker and the cyberbank.
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The sound you heard Wednesday was the door slamming behind

Telebanc

(TBFC)

investors.

Their march for the exit came Wednesday amid waning confidence in the pending acquisition of Telebanc by

E*Trade

(EGRP)

as investors latched onto a Monday night regulatory filing that said neither company had decided how to proceed if the deal isn't completed by Dec. 31. (

TheStreet.com explored this issue in a Sept. 3 story and again on Nov. 8 and on Tuesday.

)

The brokerage-bank merger has run into regulatory snags almost from the beginning. First, issues surrounding Japanese technology and venture capital firm

Softbank's

27% stake in E*Trade came up as the companies argued that Softbank doesn't actually control the U.S. thrift and therefore shouldn't be regulated as a thrift holding company. Then there were concerns about Telebanc's responsibilities under the federal

Community Reinvestment Act

, which mandates that banks and thrifts make loans in poor areas.

On Wednesday, Telebanc shareholders bailed out in droves, pushing the stock down more than 10% while E*Trade was off just 1% at one point during the day. The difference between the two stocks should only account for a ratio of 1.05 E*Trade shares for every Telebanc share. Instead, Telebanc was trading at 26 3/8 and E*Trade at 31 3/8, a spread of about 25% of the value assigned to Telebanc by the agreement.

Just two weeks ago, investors were blessing the deal with a spread of only a few percentage points. Now they're wondering what the companies will do if their agreement deadline passes on Dec. 31.

Telebanc President Mitchell Caplan says that the companies aren't addressing what will happen after that date because they are too busy working on fulfilling their commitment to get the deal done this year.

In the filing, E*Trade and Telebanc say that they haven't decided what they'll do when that year-end date arrives. There is no financial penalty either before or after Dec. 31 for walking away from the deal, he says. A $54 million fine mentioned in the filing is only associated with a takeover of Telebanc by a third party.

"There's so much speculation out there it's ridiculous," says Caplan. "We are singularly focused on trying to get the thing closed by year-end."

E*Trade spokesman Patrick DiChiro reiterated that Wednesday saying, "The various parties, as the

S-4

says, have not made any decisions on that." In the interim, he says, "We are all committed to do everything we can to finish by year-end."

Greg Smith, an analyst at

Hambrecht & Quist

, in a note Wednesday called "E*Trade/Telebanc Merger -- A Waiting Game," says investors are speculating because they don't know where the deal is headed.

"Since it is possible that the deal won't close by the end of the year, both companies are essentially leaving shareholders hanging by not discussing their strategic plan," he writes. (H&Q has done underwriting for both E*Trade and Telebanc. He rates E*Trade buy and doesn't cover Telebanc.)

Investors aren't exactly sure what it all means for them. One arbitrage trader who got out of the stocks earlier this month when the merger failed to close says there's still a 50-50 chance for success.

Announced in June, the deal was supposed to close by Sept. 30. Now, the companies concede in the filing that, in order to get to the Dec. 31 date, the

Office of Thrift Supervision

will have to move faster than the time period it has allowed to deem the application complete and then render a decision. As part of its application procedure, the OTS can request more information from the company, allowing 30 or 45 days for responses. At the moment, it is still considering whether it has enough information to close the application, after which it has 60 days to render a decision. That puts the deadline into February 2000, according to the OTS Web site.

Last one out, turn off the lights.