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[pages 9-10]

Analyst Opinion:

On news of the initial funding agreement with JPMorgan on Friday, March 14, even after shares had fallen 47% on trading volume of more than 20 times average daily volume, equity analysts in reports compiled by Reuters had already begun to question whether share prices would have a hard floor in what amounted to a run on the bank. Oppenheimer & Co., Inc., lowered its rating on the company’s shares to Underperform “as this investment simply is mired in too much risk, even at these levels.” Noting that “a company is only as solvent as the perception of its solvency,” Oppenheimer predicted that the company’s equity “could become worthless as forced sales create asset deflation, which could cause cannibalization of remaining capital.” Other firms, such as Wachovia Securities, suspended ratings entirely.

Even amid that backdrop of uncertainty, however, many equity analysts echoed the response of HSBC Global Research to the news of the sale the following Monday, calling the loss of 97% of market value in one week “decidedly unsettling” both for the company’s shareholders specifically, and for sector investors generally. Credit Suisse, noting that the deal carried a price-to-book multiple of 0.0, remarked that the “price paid is well below what we would have expected.” Banc of America Securities calculated the price should be nearer $40.00, even including $6.0 billion for litigation costs, the costs of deleveraging and integration, loss of 25% of the firm’s clients, and substantial markdowns on all assets, concluding that the deal “had little to do with maximizing value for shareholders and more with stemming a potential financial crisis and the cascade effect that could ensue given the breadth of counterparties” to the firm’s daily transactions. Oppenheimer & Co., Inc concluded that “we believe that [JPMorgan] is acting as the stability agent for the Fed in this transaction, and that the concern for the $2.5 trillion in notional counterparty exposure trumps the interest of the existing [Bear Stearns] shareholder.” Even given the extraordinary circumstances under which the company was driven to a sale, Oppenheimer conceded that equity holders had simply avoided a slightly worse outcome.

(Subsequently, in a gesture signaling the limitations of quantitative analysis, the firm suspended its morning newsletter for one day.  Contending instead that “in times of crisis, great verse is a sanctuary like none other,” the firm offered subscribers a reprint of the Tennyson elegy “In Memoriam A.H.H.”)

Fox-Pitt Kelton Cochran Caronia Waller offered the relatively uncommon opinion that “liquidity had been quite sufficient, and credit exposure was no worse than its peers,” contending that the liquidity crisis and subsequent sale were not driven by fundamental economic weaknesses at the company. Shareholder value evaporated in the liquidity crisis because the company was “light on friends, first due to its unwillingness to participate in the bailout of [Long Term Capital Management] in 1998 and second due to its refusal to bail out its troubled funds last summer; JPMorgan itself may have played hardball with Bear in a form of retaliation."

Proof of the argument, the analysis concluded, came during the conference call announcing the merger, in which JPMorgan management asserted “they were getting great businesses [and] assets, they believed Bear had strong risk management and had marked [its] credit exposures in line with [JPMorgan], and if we take their write-downs projections and factor out the fire-sale context, additional write-downs over time would not have been so severe as to warrant a panic.” The firm held out hope of a higher valuation, observing that “since 30% of the shareholders are employees, a “no” vote is quite plausible, as emotion is involved and they may insist the stock is worth more.… Bear’s balance sheet appears marked correctly in a non-fire sale context. So a buyer that could keep the assets could pay far more than $2.00, while even one that planned a fire-sale could probably beat $2.00, which reflected the shortterm crisis at hand this weekend.”

With the announcement one week later of the merger amendment, which quintupled the merger consideration, analysts seemed to accept if not quite embrace the deal. Fox-Pitt Kelton Cochran Caronia Waller observed that “the sweetened offer is intended to win over shareholders, including some of Bear’s largest, who were considering voting down the original deal. It also avoids criticism that JPMorgan took advantage of a troubled situation over the prior weekend… Although JPMorgan is paying more, with Bear Stearns now valued at $1.2 billion, the buyer is still making out quite well—last Monday, when the original deal was announced, JPMorgan’s market cap increased by $14 billion on a big down day for financials.” Under the headline “What Are We Missing Here? Bear Stearns Is Cheap…,” HSBC opined that “the U.S. government is clearly interested in getting Bear Stearns merged into America’s new favorite bank, JPMorgan Chase. And now, a freshly amended merger agreement that provides a more palatable price for shareholders, a bear hug provision giving the acquirer a 39.5% head start and a remarkably fast April 8 targeted closing date have driven deal risk to extremely low levels.” Fox-Pitt summed up analysts’ consensus that the amended agreement “will substantially end the drama at Bear Stearns with virtually no chance of independence or another bidder snatching the company away.”

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[pages 12-13]

Summary

We note that, largely as a consequence of the share exchange upon which the quintupling of the merger consideration was conditioned, JPMorgan directly controls approximately 49.4% of the voting power, and the approval of the merger agreement is virtually guaranteed.

As this vote will be shareholders' final but definitive opportunity to voice a judgment on the performance of their board and executive management team, and the role of regulators, in the destruction of 86% of market value over two weeks, we believe shareholders should be undeterred by the apparent inevitability of the sale itself. In particular we believe shareholder value was destroyed by:

• Poor oversight of inherent business risks which left the company with few alternatives as the liquidity crisis escalated, some of which could credibly be argued to have fueled the crisis itself. In nearly nine months since the subprime credit crisis began to unfold (an event largely identified in the public consciousness with the meltdown of two of the company's subprime funds), the company failed to substantially improve its capital position relative to peers, and despite the strategic alliance with China's CITIC Securities announced in October 2007 (but still not closed when the meltdown began five months later), apparently failed to develop sufficient and strong contingencies to support its capital position. While we do not necessarily believe that management could have foreseen this particular liquidity crisis, we do believe the risks to which the company succumbed in the last two weeks of March 2008 are recognizable, inherent risks of its business segment and its business model, and management's culpability in failing to plan for those risks is no less significant for their rarity.

• A seat-of-the-pants Fed intervention which ultimately extended rather than quelled the liquidity crisis, causing substantial and unnecessary damage to shareholders in the process. The primary role of the Fed was to prevent one bank's liquidity crisis from escalating into a broader market meltdown, which it initiated with the 28-day funding mechanism on Friday morning, stabilizing the company sufficiently to enable a rushed but credible sale process over the next 28 days. The question is not whether the Fed should have intervened with the loan in the first place - it did intervene - but whether, having made the initial loan, the Fed acted in the best interests of any of its constituents by summarily pulling that funding later the same day, forcing a frenzied weekend fire sale well below the valuations of even a spooked financial market, which in turn fueled the liquidity crisis for another week. That the Fed subsequently amended its policies - on Monday, March 17, within hours of the merger announcement - to lend directly to distressed financial firms in such instances only reinforces the point that while a sale of the company may have become necessary, the fire sale forced by the Fed's withdrawal of the initial funding mechanism late on March 14 was not.

As there are real economic consequences attached to the outcome of the vote, however, we believe shareholders are better served by voting not on the failures which drove events to this point, but on the relative strengths of the alternatives. In particular, we note that:

• The sale process was successful, despite long odds, in salvaging meaningful value for shareholders. Once the Fed funding mechanism was revoked the ensuing sale process was never truly a negotiation - as Treasury Undersecretary Robert Steel later affirmed to the New York Times, recalling Treasury Secretary Henry Paulson's directive during the negotiations that the price should be low because the deal was being supported by a taxpayer-funded Fed loan. Given the 48-hour timeframe in which to construct a deal, the absence of any real leverage short of a bankruptcy filing, and the near-certain loss of 100% of shareholder value in a bankruptcy (to say nothing of the much larger risks to shareholders from the economic tsunami such a filing could well have unleashed), the standard measures of a deal's fairness to shareholders - multiples of book value, revenues, etc - are largely irrelevant. What is relevant is that even the initial agreement was better than the next best alternative - bankruptcy; that it bought time for further due diligence and a second round of negotiations; and that the board successfully negotiated a substantial increase in valuation during that second round.

• Shareholders will receive equity interest in a much stronger company with significant potential. Lost in the post-mortem analysis is the contrast between the strategic responses of the target and the acquirer over the preceding eight months, as the crisis in the financial markets deepened: JPMorgan positioned itself to leverage the opportunities the crisis would produce, rather than become one of them. The transaction carries significant execution risk, but in a rational market the assets JPMorgan will acquire should be worth a multiple of the acquisition price, even net of litigation costs, writedowns, customer losses, etc.

Rationale/Conclusion:

We recognize the proposed transaction represents a significant loss of value versus such standard metrics as book value per share or share prices prior to the announcement. We also recognize, however, that events immediately prior to the sale of the company – including an escalating liquidity crisis and the sudden revocation of a Fed-backed funding arrangement – made a bankruptcy filing the only viable alternative. As the proposed transaction salvages meaningful value for shareholders, and enables participation in the future success of a stronger surviving entity with significant potential, we recommend shareholders vote to approve the transaction.

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