Too chicken to peek at Lehman Brothers (NYSE: LEH ) these days? Welcome to the club. Not only has the investment bank been hammered into the ground, but the onslaught of rumors has also caused investors to worry that it'll suffer a fatal blow.
Well, for once, diehard Lehman investors have a bit of rumor news to smile about -- sort of. Lehman shares surged on confirmation that a South Korean bank is in talks to buy a large stake. Some reports put the number at around $6 billion. A deal of that size would certainly squelch some of the chatter that Lehman's books are hanging on by threads of hope and that it's the next bank to implode.
Good news, right? Short-term, absolutely. Lehman reports earnings later this month, and what better way to start off a conference call than by reassuring investors there's more than enough capital to feed the hungry writedown monster? It would also become a lot easier to sell mortgage-backed collateralized debt obligations, wipe the slate clean, and start over on a new path to victory.
Woo-hoo! No complaints, right?
Eh, I can think of a few.
First, $6 billion is half of Lehman's current market cap. Shares have fallen by around 75% year to date, and 50% of that drop has come in just the past 90 days. Whatever capital the company is able to raise would dilute the skivvies off existing investors. Plus, in all likelihood, the capital would come in the form of preferred shares carrying enormous yields. Citigroup (NYSE: C ) , for example, had to pay 11% on a $7.5 billion capital injection last November, when fear from the credit crunch was merely an annoyance. Help isn't cheap these days.
Second, as mentioned, raising capital would give Lehman the green light to organize a yard sale of some of its mortgage-backed assets. Problem is, those assets aren't just distressed -- they're downright deplorable. Last month, Merrill Lynch (NYSE: MER ) "sold" a slug of CDOs for $0.22 on the dollar, but it financed the majority of the sale with nonrecourse loans, a signal that the actual going price for these assets is probably closer to pennies on the dollar. For Lehman, raising capital might just give it the room it needs to show the world just how utterly dreadful its books really are, and that could mean more writedowns in the quarters to come.
Lastly, although this is more of an industrywide observation, it still troubles me that banks have to cross the Pacific in search of capital. There are several U.S. companies that could afford a Lehman buyout or capital injection -- Goldman Sachs (NYSE: GS ) , JPMorgan Chase (NYSE: JPM ) , Berkshire Hathaway (NYSE: BRK-A ) (NYSE: BRK-B ) , and an army of private-equity firms, to name a few. Since there seem to be few domestic takers, we're left thinking either that our capital markets are so fraught with worry that they can't recognize opportunity if it sat on their lap and called them mama, or that domestic investors know something foreign investors haven't yet come to terms with. Neither is cause for much celebration.
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