The Company

The News

Wachovia's

A.G. Edwards

Raymond James Financial

In a brief statement issued in response to the run-up, Raymond James Chief Executive Tom James tried to rein in the rumors. "As usual, the announcement of one regional firm acquired by another larger firm in this case, A.G. Edwards by Wachovia has caused a plethora of rank speculation about 'Which firm is next?'" said the CEO of the Tampa, Fla.-based brokerage. "Raymond James has consistently proven that remaining independent has rewarded our clients, employees and shareholders."

Not that the Wachovia deal doesn't offer much to like. The merger with A.G. Edwards will create the second-largest retail brokerage in the country behind Merrill Lynch. The combined operation, which will be known as Wachovia Securities and based in A.G. Edwards's St. Louis home, will have about 15,000 financial advisors and manage $1.1 trillion in client assets, according to the Charlotte, N.C.-based bank. Wachovia will pay the equivalent of $89.50 a share for A.G. Edwards in a combined stock and cash deal expected to close in the fourth quarter of this year.

Oppenheimer & Co. analyst Jennifer Thompson wrote Thursday that A.G. Edwards could add two cents a share to Wachovia's 2008 earnings per share, and five cents by 2009.

"Bottom line, it is a relatively small deal for Wachovia, but in our opinion makes a lot of strategic sense and the financials look reasonable," she wrote.

The Analysis

Changes to the banking industry, a cash-rich merger market and tightening credit are all factors that make Raymond James a plausible takeover target, but that's nowhere near the same thing as actually being on the block.

Thompson says bank revenues are faltering as less money is being made off loans in the wake of the collapse of the subprime-lending sector. While the fallout from mortgage defaults hasn't affected bigger banks to the degree it's crushed smaller lenders, credit standards have tightened.

"The revenue story for banks in general is lot more challenged than it was even a year ago, given the interest-rate environment and turn in credit quality," she says. "Loan growth has slowed and the bottom line is that revenue growth is under pressure. Banks are looking for ways to generate more stable sources of revenue."

Retail brokerages offer those stable cash flows as they shift to fee models based on client assets under management, rather than commissions on individual transactions, says Morningstar analyst Patrick O'Shaughnessy.

"They can make money even when their customers aren't trading," he says. Also, he says Raymond James's expansion of banking services, much like online and discount competitors E-Trade Financial, TD Ameritrade and Charles Schwab, has encouraged clients to leave more money with the company and generate more income from those financial services.

With a business model that's more akin to the bulge-bracket brokerages of large potential acquirers like

Citigroup

Bank of America

Except, of course, for the fact they say they're not interested.

"There's been speculation out there for a while that they'd be a takeover target," says O'Shaughnessy. "But Raymond James has never said they were looking to sell."

On its own, though, the stock's not a terrible bet. Fox-Pitt Kelton analyst David Trone wrote Tuesday that commissions rose 18% in April from a year ago, and total client asset climbed 19% in the same period. Raymond James stock is up only 2.4% for the year to date, but he called the rebound in activity encouraging, and noted that it outpaced the online competition.

The Bottom Line

Mergers and acquisitions activity keeps roaring along, and the encouraging climate can't help but fuel speculation in a sector that's just seen a big deal.

Raymond James shares got the biggest lift Thursday, but shares of Jefferies Group, Stifel Financial and Piper Jaffray also rose as investors rode a wave of postmerger sentiment.

It's a reasonable gamble, considering the pace of merger activity, which "remains extremely robust with no slowdown in sight," according to Robert W. Baird director of M&A market analysis Steven Bernard, writing in his May monthly report. Though U.S. deals in April dropped numerically by about 10%, to 818 transactions, the dollar volume of those mergers rose 183.5% from the year-ago period to $202.1 billion.

"Banks, in general, are pretty well capitalized, and the possibility of using that excess capital to do deals is probably more at the forefront of management's thought process than maybe it was a year ago," says Thompson. "This seems like a deal-happy space right now."

That may well be the case, but buying on merger speculation is far more risky than buying on fundamentals, which in the case of Raymond James appear solid, if uninspiring.

"With A.G. Edwards getting bought up today, this is certainly rising on increased speculation about a potential takeover," says O'Shaughnessy. "I haven't heard of any potential moves to consolidation, but that doesn't mean those discussions aren't going on behind closed doors."