This is one of the most irresponsible financial actions I have seen in quite a while. You can argue about the merits of paying dividends when a company is losing money. It’s usually a bad idea, although a defense can be made that if you are going to have to go sell equity, your stock price might be sufficiently higher by virtue of the dividend support to offset the cash outflow (look, it’s an argument, I’m not saying I agree with it).
However, for a firm which is overlevered, rumored to be on the heels of Bear Stearns, with a large short interest, to go out and buy its own shares? This is a ludicrous short-sighted use of scarce funds. How could it need to sell shares last night, and per the Wall Street Journal story, still be looking for new equity, yet simultaneously be buying back its stock? Oh, but wait, Lehman says it has plenty of liquidity for this exercise. Remember, Bear thought it had plenty of cash until the run started.
The Wall Street Journal story also indicates that the article it ran last night that the investment bank would sell new shares (which had the earmarks of being a leak timed to bolster the stock) has been scuttled due to the 15% fall in price today (which was clawed back to 10% by virtue of the purchases). The new story is that Lehman is in talks with “a group of investors”. {Update: a later version of the Journal piece says at least one target is in South Korea.] The objective clearly is to get a higher price than the public markets now offer, but pray, why would anyone sign up for that? Lehman had better stitch up something quickly, because without new capital, its days are numbered. Its only hope is that pressure is applied behind the scenes by the powers that be for someone to step forward. But with financial institutions around the world under stress, and the few unaffected players (sovereign wealth funds, Japanese banks) cool on US banks, it will take quite a lot of arm twisting to get a transaction in place.
Lehman now has the look of a company that is desperate, groping for options, and hoping that its purchases might punish shorts. It’s highly unlikely that the firm can win that game (remember the wisdom of that old Wall Street saying, “Don’t fight the tape”). But note that the Journal blandly says that Lehman can borrow from the Fed to buy its own shares. Is this what the TSLF was intended to do? Lehman has had to deny using that facility to shore up confidence; it isn’t clear that accessing it is an option.
And note while buying shares at below book value will normally improve the cosmetics of a balance sheet, it doesn’t work with a highly geared enterprise. Shrinking the equity base makes all the leverage rations worse. And the idea that Lehman’s shares are a buy at these levels presupposed that its published finacials present an accurate picture. But does anyone believe them? As we noted in an earlier post, their marks on CMBS and leveraged loans at the end of first quarter were simply not credible, nor was their claim that servicing rights were an effective hedge to Alt-A exposures. Lehman also increased its Level 3 assets from year end to the end of the first quarter, made inconsistent statements between its 10-Q and related conference call, and those Level 3 assets are roughly 2.4 times common equity.
From the Wall Street Journal:
Lehman Brothers Holdings Inc., facing a sharp decline in its stock that will make it more difficult to raise fresh capital, did an about-face and began using its own money to buy back its plummeting shares.
After opening only slightly down Tuesday, the Wall Street firm’s shares had tumbled nearly 15% by midday as investors fearing that their stakes would be diluted sold their shares and rumors flew around trading desks that Lehman had gone to the Federal Reserve for funds. Lehman said that wasn’t true.
But a second rumor, that Lehman was buying back shares, turned out to be true, people familiar with the situation said.
Lehman’s shares, which topped the New York Stock Exchange’s most active list, bounced back to close down 9.5%, or $3.22, to $30.61 in 4 p.m. trading on the New York Stock Exchange….
On Tuesday, The Wall Street Journal reported that Lehman, which is set to post one of the biggest quarterly losses in its history, was considering raising fresh capital. Analysts and Wall Street executives believed the capital the firm raises could top $4 billion…..
Over the past year, the announcement of a capital raising by financial firms has been a buy signal for investors. Lehman, which has already raised $6 billion in capital during the crisis, met a different reaction. But given the stock decline, selling shares may turn out to be prohibitively expensive for the firm, according to a person familiar with the matter. Instead, the firm may look to sell a bigger stake to a smaller group of investors and has had talks in recent days with at least one foreign entity, according to a person familiar with the matter….
In the wake of the stock fall, the company began using its capital to buy back its shares, according to a person familiar with the matter. It was unclear how much stock Lehman bought back, but with shares trading at roughly 22% below its book value at the end of the first quarter, the buying could be seen as a vote of confidence by management.
Alternatively it could be viewed as a waste of precious capital, though Lehman has about $40 billion in liquid assets on its balance sheet and has access to funding from the Federal Reserve, so short-term capital issues aren’t a major concern for Lehman.
Update 6/3/08, 12:15 AM: There is a simply appalling article at the New York Times on Lehman. It turns the “Lehman is in trouble, how bad is it?” story into a personality drama: evil, ambitious short David Einhorn versus a noble institution:
For eight months now, Mr. Einhorn, a rabble-rousing hedge fund manager, has pilloried the venerable Lehman Brothers in an effort to drive down the bank’s stock price, which he is betting against.
The adjectives used to describe the combatants broadcasts the article’s slant.
Now that tone would be warranted if Einhorn’s charges were overstated or worse, incorrect. But does the author Louise Story deign to determine whether the hedge fund manager is on target or not? This is the sort of thing we get:
Lehman’s management has spoken with some analysts about Mr. Einhorn, but they have declined to comment publicly beyond a statement that says Mr. Einhorn “cherry picks” and misconstrues information.
“They’re furious,” Mr. [Brad] Hintz [of Sanford Bernstein] said. “If you get distrust of your accounting, then it affects the valuation of the company forever going forward.”
If Einhorn is wrong, make a substantive, public response. It would be easy to make this go away if the shorts were off base. But what do we see from Lehman instead? They’ve said that Einhorn cherry picks. Accounting is about getting details right, and if there are significant elements that are wrong (for instance, the unrealistic marks on the CMBS and leveraged loans), that’s hardly cherry picking, those are real issues.
In fact, he article smacks of being a Lehman plant, with calls made to the Einhorn side to give the appearance of balance. The only one of the specific charges made by detractors that that article mentions is that Lehman is very highly geared, which it then undercuts, quoting an unnamed source who maintains that that will be all taken care of in the earnings release:
Lehman, like its counterparts, is racing to use less leverage. The bank had a gross leverage ratio of 31.7:1 at the end of the first quarter, meaning it had borrowed $31.70 for each dollar of equity. Lehman has whittled that ratio down to 25:1 through its more than $100 billion in asset sales, said the person close to the company who was given anonymity because he was discussing a pending financial filing. A small amount of the sales were to two hedge funds set up by former Lehman executives.
That sort of leak is not kosher; and may be an SEC violation. But it’s precisely the sort of tactic a desperate player resorts to.
Put it another way: when a company’s strongest argument against its detractors is ad hominem attacks, and the ones rallying to its defense seem to be mainly ones in its circle (Mr. Hintz quoted above is Lehman’s former CFO), it sends a loud signal that your case is weak.
Second Update 6/3/08, 12:30 AM: David Merkel in comments helpfully provides some useful detail:
“It is time. It is time for Lehman to put up its defense. Not the talking one. But the one it used in 1998 when everyone thought it was a goner. It needs to go in and start buying its stock.”
Who said it? Cramer. When did he say it? 5/28 over at RealMoney, a site to which I occasionally contribute. The article was called: “LEH Has One Play.”
I don’t agree with Cramer’s logic here, because I am risk averse, and a loss of confidence has a way of snowballing, no matter what you do. Better to keep your powder dry, survive, and then buy back when things have turned.
When will investment banks realize that they have taken on too much operating leverage (asset risk), which means they have to decrease their financial leverage?
Now, all this said, Lehman survived LTCM because of a private rescue effort where they offered favorable terms to finance their inventories. It was a desperate gamble, but it worked. I know of a firm that still gets a premium rate to finance Lehman’s prime residential mortgage inventory, because they stood by Lehman in 1998.
Unlike Bear, Lehman has friends. I’m not sure that will be enough to protect them, but it gives them a better chance.
PS — Note to Dick Fuld: yes, lightning can strike twice in the same place. Why were you running your leverage so high during an overheated market?
Third Update, 6/4/08, 4:10 AM: The Journal’s Heard on the Street column says that Lehman may have to sell itself:
The problems in Lehman’s balance sheet could force the firm to issue a large amount of equity — or to sell part, or all, of itself to a larger financial firm.
While such options would be excruciating for the company’s management and existing shareholders, that may be what it takes to bolster confidence in the investment bank — and to stop concerns about the firm affecting the wider financial system…. investors may want to see Lehman raise even more than $4 billion to cover any future losses from marking down the value of its assets. Lehman is likely to report large losses on trades made to hedge assets in the second quarter. And critics argue that Lehman has lagged behind in marking down the value of assets backed with distressed residential and commercial mortgages.
There is another important reason why Lehman may need new capital: It likely needs extra cash to forestall another downgrade by ratings agencies.
Candidates include Citadel, Blackstone, and J.C. Flowers.
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The fly is in the ointment.
The horses are out of the barn.
The cat is out of the bag.
The chickens are coming home to roost.
Yves, it is is incredible that LEH came out mid day when the stock began to sell off and annoucned it had not accessed the Fed facility but to test it last week or something. If my memoery serves me this is exactly what Dick Fuld said the week it was announced. I suppose LEH just wants to keep the Fed on its toes. Also, let no one forget that Dick Fuld is on the board of the NY Fed. Mr taxpayer you own LEH at $30.
What stands out for me, and I just saw this tonight (and could care less) is that LEH, has a huge change in accounts receivable during the last year or so, and that looks very suspect on first glance:
Recall: Companies can use their accounts receivable as collateral when obtaining a loan (Asset-based lending) or sell them through Factoring (finance). Pools or portfolios of accounts receivable can be sold in the capital markets through a Securitization.
I’ll look more, but if that rings a bell, let me know (more)!
One more thing to ponder:
On a company’s balance sheet, accounts receivable is the amount that customers owe to that company. Sometimes called trade receivables, they are classified as current assets. To record a journal entry for a sale on account, one must debit a receivable and credit a revenue account. When the customer pays off their accounts, one debits cash and credits the receivable in the journal entry. The ending balance on the trial balance sheet for accounts receivable is always debit.
“It is time. It is time for Lehman to put up its defense. Not the talking one. But the one it used in 1998 when everyone thought it was a goner. It needs to go in and start buying its stock.”
Who said it? Cramer. When did he say it? 5/28 over at RealMoney, a site to which I occasionally contribute. The article was called: “LEH Has One Play.”
I don’t agree with Cramer’s logic here, because I am risk averse, and a loss of confidence has a way of snowballing, no matter what you do. Better to keep your powder dry, survive, and then buy back when things have turned.
When will investment banks realize that they have taken on too much operating leverage (asset risk), which means they have to decrease their financial leverage?
Now, all this said, Lehman survived LTCM because of a private rescue effort where they offered favorable terms to finance their inventories. It was a desperate gamble, but it worked. I know of a firm that still gets a premium rate to finance Lehman’s prime residential mortgage inventory, because they stood by Lehman in 1998.
Unlike Bear, Lehman has friends. I’m not sure that will be enough to protect them, but it gives them a better chance.
PS — Note to Dick Fuld: yes, lightning can strike twice in the same place. Why were you running your leverage so high during an overheated market?
Great article. I am at a loss as to what to say. They are using a lifeline from the Fed to repurchase stock at the same time they are trying to float a new equity issue? Is there no end to the gall?
Yah,
Bear Stearns Changes in Accounts Receivables exploded 3 fold from 2005 to 2006, then from 2005 to 2007, we see a nice jump from (552,783) up to (17,136,000)
http://uk.finance.yahoo.com/q/cf?s=BSC&annual
By contrast, LEH, between 2005 to 2006 had receivables double, while between 2005 and 2007, we see a bump from (3,700,000) to (16,411,000).
They look like twins!!!!
My fortune cookie says this: Watch for accounts receivables rising faster than sales. Accounts receivable measures the amount of outstanding bills a company has to collect. A buildup here signals that a company is booking revenue more aggressively or relaxing credit standards to meet its earnings numbers.
My crystal ball sees LEH with operating cash flow of -42.17B and growth decline as far as the eye can see in terms of years, … I imagine The Fed is waiting to bail them out
Ask yourself this: from 17 Mar 08 to today, what if anything has LEH been able to do to _improve_ cash flow or profitiability? Little of substance; if you can find something, post it friends. Yes, they have presumably tried to gear down—at a loss, there is no other way to clear craptastic ‘assets’ from their books. That amounts to sawing off a shattered limb at the knee or elbow. LEH was dead in March, but the Fed said “That’s our favorite son!” so the flesh eating zombies held off. Nothing has changed in the seven weeks since except that the gangrenous books at LEH stink more now than than. Treasure continues to flow out faster than treasure flows in: what’s the trajectory on that, pray? Prey.
LEH trying to defend its stock price prior to a massive, fool’s-hazard equity flotation has the look of sheerest desperation, but it’s not wholly irrational. Shorts on BSC were the incoming tide that cut the sand out from under their feet. If LEH can’t get capital now, they, too, are going to go feet first into the zombie maw, so they might as well burn their cash in a mad frenzy to scare off the unclean horde whilst screaming for a rope ladder to make it into the Fed’s castle. This has an ugly look to it, though.
. . . Personally, I’m of the view that the world would be a safer, more level place is ALL of the ibanks were et by raptors. They are too big for the safety of the financial system, add no value, and act for no one but themselves. The US gov can find another way to float it’s debt—and should. Leave speculation for small piggy hedgies, and let the ibanks find the ‘returns’ they have earned. But one at a time: it’s better theater this way. “A Carnivore’s Progress,’ an allegory for Our Times.
Who can buy LEH? Surely not JPM. Wells Fargo?
http://www.nytimes.com/2008/06/04/business/04lehman.html?ref=business&pagewanted=all
the “nytimes” says that leh just reduced its leverage ratio from 31.7 times to 25times by a “more than $100Billion” asset sale. when did that happen? that’s quite a chunk of change to trade hands on the q.t. and to whom was it sold(besides the amount “nyt” detailed as “A small amount of the sales were to two hedge funds set up by former Lehman executives.”)? one of those clever financial engineering re-packagings they’ve presented to the fed’s hoover(which then should be a repo and not a sale)? lastly, should we presume it was sold at cost or a profit? if so, does that mean they’ve sold off the family silver?
ok, say we believe the party line and then stock is undervalued. so at what price does it become a takeover target? surely it should be around there now? why aren’t the barbarians at the gate?
if they sold assets it is highly likley that they put the off to a related entity and financed the vehicles. Kind of similiar to the C deal on leveraged loans. Or the UBS deal on the Alt A. This is mere window dressing, The Fed needs to stand down and allow the market tot clear prices. This is becoming sureal. Lets hope the tide comes in and brings with it new leadership.
In the “great Depression” companies attempted to save themselves by buying there own stock it didn’t work then i see no reason to think it will now even with the ppt manipulating the market it just prolongs the agony
Re: “say we believe the party line and then stock is undervalued”
LEH is priced to perfection and seriously NOT undervalued, at least according to The Fed Model, or greenspan model, i.e, LEH earnings yield is spot on and in line with what fair value is, however, that is based on old metrics, like trailing earnings and one can almost best with out a doubt that LEH will have continued poor EPS reports, so future value is not priced into the current overvaluation and thus a current value discount needs to be in place ASAP!!