Sallie Mae's high-stakes standoff

(Fortune) -- Could we soon see a rival bid for Sallie Mae, the student loan company that's in a nasty public scrap with J.C. Flowers, J.P. Morgan and Bank of America, the three Wall Street titans that agreed this spring to purchase Sallie for $25 billion?

Last week, the Flowers-led group said that a new law slashing billions of dollars in government subsidies to companies like Sallie Mae, the country's largest student lender, was grounds for renegotiating the deal. Sallie Mae, in turn, threatened to go to court to enforce the deal, saying that the College Cost Reduction and Access Act, which President Bush signed into law Thursday, has no impact on its sale.

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The latest war of words appears to be an escalation of the posturing that has surrounded the deal since summer, when Sallie Mae's buyers first voiced concerns about the adverse impact that student loan legislation would have on the company.

Some analysts speculate that the Flowers-led camp has been emboldened by private equity firms' recent aggressiveness in renegotiating a deal with Home Depot (Charts, Fortune 500), and walking away from one with high-end stereo maker Harman International (Charts). Sallie's suitors, they say, may see the new law as an opportunity to pay less than the $60-per-share brokered in April.

Indeed, Wall Street was abuzz with rumors that, soon after last week's hostile exchange, Sallie Mae asked the buyers to name their new price.

There was also speculation that the fracas sparked interest from other potential buyers, including Blackstone Group (Charts), which had reportedly pursued Sallie Mae before the Flowers-led deal was struck.

Sallie, whose official name is SLM Corp. (Charts, Fortune 500), didn't respond to calls for comment. J.C. Flowers and J.P. Morgan (Charts, Fortune 500) declined to comment. Bank of America (Charts, Fortune 500) referred requests for comment to J.C. Flowers, which is headed by J. Christopher Flowers. Blackstone declined to comment.

For all the talk of a white knight, the chances of a new bid appear remote in this climate. It's unlikely that a new suitor would pay $60 a share, a price more reflective of yesterday's bubbly private-equity market than today's newfound sobriety.

But that doesn't mean a rival bidder won't emerge - and the odds that it could happen increase the longer Sallie and J.C. Flowers are at loggerheads.

At issue in the Sallie Mae-Flowers fracas is whether the new law will have a "material" impact on the student lender's finances and, if so, whether that allows the Flowers group to seek a new deal. On this score, however, Sallie Mae appears to have the upper hand.

Wall Street analysts are predicting the new legislation will lower earnings by 6 percent at most, which would hardly put a material dent in Sallie Mae's profits.

Sameer Gokhale, an analyst at Keefe, Bruyette and Woods, thinks the impact will be much less than that. He estimates Sallie Mae's 2008 earnings will fall by five cents, or a mere 1.5 percent, from his previous estimate of $3.35 per share.

But that doesn't mean the buyers don't have a case. They say they don't need to demonstrate that the new law will have a material impact on Sallie Mae's business. Pointing to a clause in the merger agreement, they contend that they need only to show that the College Cost Reduction and Access Act is more adverse to Sallie Mae than similar bills pending at the time the deal was brokered.

On that basis, it's hard to argue against the buyers. The College Cost Reduction Act is clearly more detrimental to Sallie since the bill that became law cuts government subsidies to student lenders by more than any legislation that was pending in March.

But the buyers may be reading the merger agreement too narrowly.

That's because the developments that would trigger a renegotiation or a rescinding of the deal - such as legislation like the College Cost Reduction Act - appears in a section of the agreement titled "Material Adverse Effect." Since the word "material" is in the title, the implication is that the College Cost Reduction Act must have a demonstrably material impact on Sallie Mae in order to force everyone back to the bargaining table.

If that's the case, then the odds appear stacked against the buyers. Gokhale says the buyers' argument "just doesn't seem reasonable."

And by publicly questioning deal terms, the buyers may have made it easier for Sallie to court new suitors.

While no one would be offering $60 these days, Sallie remains an attractive target.

Even with a bunch of LBO debt on its balance sheet, Sallie is likely to increase profits for the next several years, due to growth in the market for student loans, particularly private loans. In 2008 alone, analysts expect Sallie's profits to surge 35%, to $3.39 per share, from an estimated $2.51 per share this year.

It's not publicly known what price the Flowers-led group now wants to pay for Sallie Mae. But if it's insultingly low, it may not be long before a rival bid surfaces.