Tuesday, June 3, 2008

Lehman on the Ropes, Nevertheless Buys Shares Back

This is one of the most irresponsible financial actions I have seen in quite a while.

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 [tonight] "Lehman is Seeking Overseas Capital", 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". 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 ratios 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.