Value of Lehman Ex Asset Management Business May Be Negative

According to reports in the New York Times and Wall Street Journal, Lehman is shopping its asset management business, which includes Neuberger Berman (purchased for $2.6 billion in 2003), its private client brokers, and Lehman Brothers Asset Management.

Now look at the valuation of the asset management business versus Lehman as a whole. From the New York Times:

There has been widespread speculation that Lehman was contemplating a sale of Neuberger Berman, whose value is estimated by analysts to vary from less than $7 billion to as high as $13 billion (Lehman’s entire market capitalization is about $10.5 billion).

Connect the dots. The stock market is saying that the value of current Lehman operations ex the asset management business is close to zero, or maybe even negative (which would hold if liabilities exceed the value of the remaining assets). Note that the Journal story puts a narrower value on the asset management operations, $8 to $10 billion.

Of course, the deal-minded would contend otherwise, that Lehman is in effect suffering from a conglomerate discount, and as can happen with public companies, the breakup value is higher than the public market price. If that were true, Lehman should sell its asset management business in toto and use the proceeds to take the rest of the firm private.

A more curious disparity between the two pieces is the spin they put on Lehman’s sales activities. Both articles say the firm has sent letters to possible buyers last week. But there was a marked difference in how each paper characterized the move. First, from the Journal:

As it tries to overcome mounting losses on soured mortgage-related assets, Lehman has begun circulating a detailed book of financial information about the investment-management unit to a group that includes private-equity firms Carlyle Group, Hellman & Friedman LLC and General Atlantic LLC, people familiar with the situation said. Blackstone Group LP also has expressed interest in the business in recent weeks, other people familiar with the process said.

Sending out an offering memo means the business is for sale, period. That does not mean a deal will go through; the offers may be deemed to be inadequate. However, oddly, the New York Times article gives an entirely different report on the state of play:

Lehman Brothers, the troubled investment bank, is considering the sale of all or part of its prized money management division to private equity firms…

Lehman sent letters last week to a number of financial companies, including private equity firms like Kohlberg, Kravis & Roberts, J. C. Flowers, the Blackstone Group, the Carlyle Group and Apollo Management, to test interest in its money management division, according to several people briefed on its contents.

The letter, a so-called memorandum of understanding, did not put a value on the division. It said that interested parties could bid for all or some of the pieces but encouraged bidders to make an offer for the whole business…. Lehman’s current talks with private equity are an attempt to put price tags on Neuberger and other pieces of its asset management unit, which should provide flexibility for Lehman executives when they sit down to review third-quarter earnings and calculate if they need to raise capital.

This gives the impression that Lehman is price-shopping to get inputs as to whether it should sell all or part of the operations or not. The reason I doubt this interpretation is you don’t circulate “detailed” information to buyers casually. First, the process of shopping a company is time consuming and rattles employees and often leads to defections (although in this case, with Lehman’s stock at such lousy levels, the Neuberger principals are believed to be on board with this move). Second, the prospective buyers are all major clients. It would be ill advised to jerk them around.

However, another oddity is the buyer list. Why, for instance, are no Japanese banks included? They are cash-rich, keenly aware of the advantage that confers to them now, (I was at a closing party of sorts for a large loan that one Japanese bank that the borrower, a big financial firm I guarantee you heard of, said European and US banks simply were not doing) and looking for equity investments.

A crude rule of thumb in M&A is that having another bidder in the mix will add 10% to the sales price. That’s why, unless there is a need for secrecy or speed, businesses for sale are shopped widely. So the fact that the buyer list includes only private equity firms seems unduly narrow. The Times does offer a possible explanation: “At the same time, many bidders are not interested in buying the whole business because it does not fit with their own model.” Many, if not all of the firms already being solicited apparently see this as a strategic purchase, not a portfolio investment. But again, that fact would seem to favor possible buyers with fewer conflicts in terms of existing operations, like the Japanese.

Of course, the assumption may be that now that the sale has been de facto announced in the Times and Journal that other interested parties will contact Lehman.

The Times also indicates that a sale of the entire business may not be viable:

….one of the complications to any potential sale of Lehman’s investment management business is that ratings agencies could determine that the division or its parts are too important to Lehman’s business to sell.

and quotes analysts like Richard Bove of Ladenberg Thalmann that would prefer that 20% of the fund management operations be sold in a public offering