Softbank Stake May Muck Up E*Trade-Telebanc Merger

An online merger won't happen until the Office of Thrift Supervision is satisfied.
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Forget respect. The Internet revolves around control -- controlling eyeballs, controlling customers, controlling companies.

Indeed, control has been one of the biggest questions in the online financial services world for the past six months, and it's gotten particularly intense around governmental approval of the planned merger of

E*Trade

(EGRP)

and

Telebanc

(TBFC)

.

At the center of this ongoing battle is

Softbank America

, the U.S. unit of Japanese venture capital and technology firm

Softbank

, which owns 26% of online trading power E*Trade. The combatant with the most heft, however, may be the

Office of Thrift Supervision

, which regulates Telebanc and is wrestling with another control issue, that of potential control by an unregulated, foreign shareholder over a U.S. thrift. (

TheStreet.com

explored these issues in a

Nov. 24 story.)

OTS documents show that the agency has deep concerns about Softbank's unwillingness to become a thrift holding company, which would require it to become part of the application process (thus opening itself up to regulation by the OTS). E*Trade and Telebanc have repeatedly said they're working to close the $1.1 billion stock swap deal by year-end.

As late as two weeks ago -- and more than six months after the deal was announced -- the government and the betrothed firms were far from agreeing how to resolve the large ownership stake held by Softbank, according to documents obtained under the

Freedom of Information Act

. And this week, the government agency is expected to provide another response to the firms' petition.

According to OTS documents, months of apparently fruitless correspondence led to a Nov. 4 meeting to discuss the companies' contention that Softbank won't control Telebanc after the merger. Prior to that meeting, the OTS was not inclined to accept Softbank's explanation of control, according to a Nov. 20 document, which features responses to 48 OTS questions about the deal.

Among them:

Q: "With respect to the Softbank rebuttal of control filing, OTS is not inclined to accept the rebuttal of control. This topic is scheduled for discussion at a meeting between Softbank and the OTS on Nov. 4, 1999.

"Pending the outcome of that meeting, we are unable to find sufficient support for the proposition that Softbank has contributed less than 25% of the capital of E*Trade. ... Moreover, we are not inclined to recommend that OTS accept the revision to the rebuttal of control agreement. ... Given the conclusive control situations, Softbank is required to join in the application and file an H-(e)1 application, rather than filing for a rebuttal of control."

A: "Softbank and E*Trade have addressed these issues in materials previously submitted to the OTS."

It's unclear whether more correspondence passed between the parties between Nov. 4 and Nov. 20, or if the companies are referring back to their rebuttal of control document or a previous document on control.

Back on Sept. 3, E*Trade wrote to the OTS a follow-up to the rebuttal detailing why Softbank owns on a pro-forma basis less than 25% of the company and therefore should be able to rebut control, a factor the firms also discussed at the Nov. 4 meeting with OTS.

Whether the OTS changed its view at the Nov. 4 meeting is only known to the agency, says Telebanc President Mitchell Caplan. The meeting's goal was to make the OTS "more comfortable" with the fact that Softbank doesn't intend to exercise control over Telebanc, he explains. "What they needed to do is understand that it is not the intent of Softbank to control Telebanc."

On a pro-forma basis, including the dilution that will accompany the Telebanc merger and that has occurred with E*Trade recent acquisitions, Softbank would hold a 22.6% stake in the company. If for some reason it doesn't meet OTS requirements, Caplan says that he believes Softbank would be willing to sell some of its E*Trade stake.

"We have not had discussions with Softbank on dropping its stake simply because there has been no need to have that discussion. To date, Softbank has been very supportive to getting this deal done," he says.

Softbank didn't return a call requesting comment. Neither did E*Trade.

Some sell-side analysts anticipate that Softbank would be willing to cut its stake. Tim Butler, an analyst at

Pacific Crest

, says that because Softbank is primarily a venture capital firm, it could easily reinvest that money in another business. Softbank's initial $400 million investment in E*Trade is now worth $2 billion.

But it may not be as simple as Softbank selling a few shares.

"The controls are pretty complicated," says Todd Betke, a lawyer at

Weil Gotshal & Manges

, and the rule of thumb goes as follows: "If you are below 5%, then you are in a safe harbor, and if you are above 25%, then you do control the company." In order to avoid having to submit filings and rebut controls, companies often drop stakes to, say, 9% from 14%. But a move to, say, 9% from 25% would be unusual, he says, because it's so drastic.

The OTS could do a couple of things now. It could ask for more information from E*Trade about the answers to those 48 questions. Or it could decide that, after six months of back and forth, it finally has enough information about E*Trade and Telebanc to deem the application complete.

After that application closes, the OTS then allows itself 60 days to make a decision, putting the estimated decision due date at Feb. 5, 2000, according to the OTS Web site.

All this is complicated by the fact that the merger agreement expires on Dec. 31 and the companies so far haven't addressed whether they will extend the agreement. Recently E*Trade said that the companies are focusing on closing the deal before the end of the year.

E*Trade spokesman Patrick DiChiro wasn't available to comment. Recently, he pointed out the firms could continue working on the deal without an extended agreement.

Or not.