Update on Lehman and thoughts on financial industry, courtesy of Ockham Research
Lehman Brothers Raising Capital—Again
Lehman Brothers Holdings, Inc. (LEH) is projecting a loss of $2.8 billion for the second quarter ended May 31. The company experienced a far worse quarter than even the most pessimistic of Wall Street estimates. The $2.8 billion dollar loss breaks down to a loss of $5.14 per share, while the lowest Wall Street estimate predicted a loss of $1.28 per share. So, the loss is roughly four times worse than estimated. Meanwhile, Lehman has been actively deleveraging itself for the last few quarters in an effort to strengthen the company’s financial position amidst the credit crisis. The company has been selling risky assets—many times at a large loss—and at the same time raising capital through equity sales. This round of equity sales will total about $6 billion; $4 billion will be raised through issuance of 143 million common shares (priced about $28 per share), and $2 billion in convertible preferred shares.
The capital raise is understandably unsettling to Lehman shareholders and, since the Bear Stearns debacle, investors are wary. The stock is down more than 12% today as investors wonder what to make of the much-worse-than-expected loss. Somehow during the tough quarter, expenses rose 21% and compensation was up 22% — go figure. Lehman has been criticized by some for taking on too much risk, while not having as many assets as its bigger competitors (Goldman Sachs, Citigroup, Merrill Lynch, etc.) to cushion in case of tougher times. Lehman has taken steps to strengthen its balance sheet and has reduced its debt-to-equity ratio to 25 times from 31.7 times. Through this process, the firm has increased liquidity by 32% to $45 billion.
The huge projected loss by Lehman brings into doubt assertions by some analysts that the difficulties of the credit crisis are waning. The far-worse-than-expected quarter does not inspire confidence, but Lehman is doing the right things to insure that such a quarter will not happen again anytime soon. We have an Ockham Rating of Hold for LEH, as the stock is starting to look undervalued from a historical perspective. We are also concerned that this equity raise will dilute shareholders’ equity by increasing the number of shares outstanding by 25%. On June 3, the company said it would buy back $41 million worth of stock, or 1.3 million shares. That decision appears questionable, knowing what we know now about the disastrous quarter that just ended.
At some point in the future, there may be significant value in the financial services, but we cannot advise buying now because, as this loss demonstrates, firms are still sorting themselves out in the midst of a tough economy. We can hope that Lehman’s CEO Richard Fuld is correct in saying, "The worst of the impact on the financial-services industry is behind us," but we have no problem waiting a bit longer to make sure.
