Wall Street Already Back to Its Criminal Ways?

There was a time on Wall Street when insider trading was rampant, when sell-side analysts would pump stocks under the guidance of their superiors only to have their corporate finance colleagues do an equity offer shortly after, when the amount of money a bank's corporate clients paid would determine its rating, and when analysts said in internal emails a company is worthless, only to issue reports claiming the company was the next sliced bread. Then things changed for the better briefly, when Eliot Spitzer came on the stage. However, with his thunderous fall from grace in an act of utter hypocrisy, the behavior he fought so hard to curb gradually started coming back.

Friday, Wall Street's shadiness came back with a vengeance.

As Zero Hedge disclosed Friday, mall REIT Kimco (KIM) decided to dilute its equity holders by issuing over $700 million (including the green shoe) in new shares which would be used to buy back the company's debt, as KIM has $735 million in debt maturities over the next 3 years, and a $707 million currently drawn on its secured credit facility. One look at the company's equity prospectus (click to enlarge) reveals that the lead underwriter is none other than "scandal-central" investment bank Merrill Lynch.

There is, of course, nothing wrong with being a member of an underwriting syndicate - in fact, absent generating profits from AIG (AIG) structured finance liquidations forever, banks like ML (better known these days as Bank of America's (BAC) slam dunk acquisition if one listens to Ken Lewis) will need it if they want to generate revenues. However, what Zero Hedge has a major problem with, is what ML equity research analyst Craig Schmidt did hours if not minutes after the offering was announced. In a research note update, Schmidt, who now gets his paycheck from Bank Of America (this will be relevant in a second), raised KIM's rating from Underperform to Buy (click to enlarge).

This is where visions of Jack Grubman should resurface. While Zero Hedge will not speculate over the efficiency of the Chinese Wall at Merrill Lynch, aka Bank Of America, something in this transaction stinks to high heaven.

Let's walk through the sequence of events:

1) First Merrill Lynch/BofA gets clients to subscribe to a massively diluting equity offering (105 million new shares out of 271 million pre-offering shares, or 39% dilution). The offering prices at $7.10/share, a 6% discount to the previous day closing price of $7.49. In the process Merrill pockets an underwriting fee likely equal to 3% of the offering or around $20 million.

2) Minutes after the offering, Merrill REIT analyst Schmidt comes out with a report, changing the recommendation on the stock from a Sell to a Buy, thereby getting the vanilla money which makes critical fiduciary decisions merely based on what some sell-side analyst will recommend. As a result Kimco stock rises throughout the day and closes at $9.40, a 25% premium to the closing price, and a 30% premium to offering price of $7.10, which closed that very same day.

3) Notable here is that Schmidt had come out with a Sell (aka Underperform) report on the company less than two months ago, on February 5, titled "Write-downs drove the miss." Among Schmidt's concerns were the following very salient points:

Write downs, not Q4 operating metrics, are the issue

KIM’s Q4 operating metrics took a back seat to write downs in the quarter as the company reported a sharp drop in FFO as it booked $111.8mn in non-cash impairment charges. These write-downs included $83.1mn for securities investments, $22.2mn for the equity investment in JVs with Prudential and $6.5mn for development projects in addition to $4mn of severance charges due to a reduction in headcount. While Kimco’s shopping center operations held up reasonably well in Q4 (rent spreads remained positive and same-store NOI was +1.4%), the company expects far weaker results in 2009 which is common theme running through the REIT industry.

Transaction income non-existent; lowering estimates

With the extensive write-downs, KIM’s reported 4Q08 FFO of $0.04 was $0.21 below our estimate. Looking to ’09, we expect NOI to decline 3% which includes a 300bp decline in vacancy by YE09. Given the impact of deteriorating operating metrics combined with a sharp reduction in transaction activity, we are reducing our ’09 FFO estimate from $2.15 to $1.74 while our ’10 estimate drops from $2.14 to $1.60.

Lowering PO to $12.50

Due to lower projected NOI growth for ‘09, we reduced our forward NAV for KIM from $17.04 to $14.13 and as a result our PO falls from $15.50 to $12.50 which is roughly a 10% discount to forward NAV. Given the weakness in retail spending and cautious leasing environment combined with a sharp erosion in Kimco’s noncore business segments we are maintaining our Underperform rating until we gain better visibility on the retail landscape.

4) Even assuming Merrill's Chinese Wall is fully operational, it would be curious to see how the company managed to "sell" to its clients a stock offering in which its very own analyst had a Sell rating: the cynics among us would presume these very clients would have no problem buying into the offering if they knew or anticipated a change in recommendation (especially one from a Sell to a Buy), and knew they could flip the stock they bought through the offering for a 30% gain in one day!

5) And now for the piece de resistance. The company said in its prospectus it would use the offering proceeds to pay down its revolver. "We intend to use the net proceeds from this offering for debt repayment and for general corporate purposes. Our U.S. revolving credit facility is scheduled to mature in October 2011 and accrues interest at LIBOR plus 0.425% per annum. Affiliates of certain of the underwriters are lenders under our U.S. revolving credit facility and will receive their pro rata share of repayments thereunder from the net proceeds of this offering." That last bit is critical. The company's $1.5 billion credit facility, on which it had $707 million outstanding as of December 31, will be the direct beneficiary of the offering as the entire $707 million amount would be paid down with the proceeds. And what entity benefits from this paydown: none other than Bank Of America, otherwise known as Merrill Lynch!

Ah, good old circular conflicts of interest. To summarize: i) Merrill, which is probably not too happy with having loaned Kimco $707 million on its credit facility, underwrites a $720million (including a 15% overallotment) stock offering for which it gets $20 million, ii) Merrill's analyst changes the stock from a Sell to a Buy, causing it to pop 30% in one day, and allegedly allowing participants in the offering to sell their shares at a 30% gain in a day, a mindblowing annualized return, iii) Kimco uses the proceeds to repay Merrill's credit facility, cleaning out any credit risk exposure Merrill might have with respect to Kimco's underperforming properties and operations.

At least Schmidt can sleep with a clean conscience after putting the following disclaimer in his report: "I, Craig Schmidt, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject securities and issuers. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or view expressed in this research report."

Zero Hedge, for one, hopes that Cuomo is reading Zero Hedge, as this kind of conflicted circularity would never have been allowed in the Spitzer days. Additionally, on a recent trip, this author stumbled upon a mall in a major metropolitan area where a Michael's store (another LBO special) had recently vacated thousands of square feet of retail space: the beneficiary of this lack of future cash flow: Kimco Realty Corporation.

In conclusion - to those that managed to get in on the stock offering: congratulations. The 30% return in one day is nothing to sneeze at. To all those other retail and institutional accounts, who piggybacked, and all day were buying the shares sold by the follow-on participants (likely using Merrill's brokerage desk as an intermediary, thereby generating even more profits for the company), hopefully you see something about the dreary mall REIT space that Zero Hedge is missing. Then again, as these purchasers are likely the very same people who are convinced that all the bad news in this market are lagging indicators, with all the seasonally adjusted "good" news are leading, the fair price of KIM to them is likely much, much higher. We hope they are right: in the meantime it never hurts to look at a cash flow or FFO model, and determine just how much cash a 38% equity-diluted KIM will be generating in the future as the bulk of its mall tenants either go bankrupt or decide they simply cannot afford the rising rents that retail REIT operators hope to charge.

Comments

[Jasper M:]

Thank you for the story. I had heard the basics earlier, but you presented enough ugly details to make it truly damning.
Tyler, I am a little saddned that one of the few straight shooters out there has nothing but grim news for us.
As for why anyone would buy the diluted offerring, well, obviously they were tipped off, part of the scam.
When I think about where this will end up (and by "this". I mean this sort of practice), I am reminded of a quote from General Sherman:
"We cannot make (them) love us. What we can do, is make the memory . . .so terrible, that generations will pass away beofe they resort to it again!"

Apr 05 03:35 AM

[EGGBEATER:]

ML/BOFA LEGALLY ENGAGED IN "CROOKED CAPITALISM", JUST LIKE THE MAFIOSI MOB, EXCEPT THAT INSTEAD OF KILLING PEOPLE WITH A WEAPON, THEY ARE KILLING THE ENTIRE ECONOMY WITH THEIR DEALINGS AND STARVING THOUSANDS OF HONEST SAVERS. THAT'S WHY WE ARE SEEING STREET RIOTS IN LONDON AND STRASBOURG BY WAGE EARNERS WHO HAVE LOST THEIR SAVINGS AND ARE JOBLESS BECAUSE OF SIMILAR BANKING CROOKS IN THEIR COUNTRY. DIDN'T THE COLLAPSE OF AIG ORIGINATE AT ITS LONDON OFFICE WITH THEIR GREEDY CREDIT DEFAULT SWAPS? HOPEFULLY THE G20 (PARTICULARLY THE U.S.) WILL ENACT NEW REGULATIONS THAT WILL PROVIDE JAIL SENTENCES FOR SUCH CROOKS.

Apr 05 04:35 AM

[RAJS:]

I think this is time that we start sending e-mails to Obama telling him to do the real job that he was sent (to White House) to do make "CHANGES". The administration (White house, congress, senate, treasury and SEC) are supporting the same companies that are BLACK_MAILING the nation. People (owners) of the nation sent Obama to make changes but seems like he is going along with the old system.

Apr 05 06:11 AM

[Leftfield:]

So far Obama is "small change" (courtesy of Gene Inger) and signaled it as far back as choosing Biden for VP and has paraded insider retreads ever since. Integrity not required.

Spitzer's departure was due to breathtaking hypocrisy, but with the money and power involved and the threat he represented I've always wondered whether it was a setup. At least the timing, just as Wall St. was coming apart, smells to me.

Thanks for the great information. Corruption is rampant top to bottom and is now consuming and destroying everything. Only serially voting out incumbents gives the average person a chance now.

Apr 05 08:45 AM

[Dave Wrixon:]

Perhaps, it is not so much they believe that the Gravy Train will roll forever, so much as they are One Trick Ponies. Lets face it, the hitherto revered Madoff, obviously had no real investment experience at all. What makes you think this lot are any better?


On Apr 05 03:18 AM Gary A wrote:

> There is an addiction t stealing money from the small investor, and
> the consumer. These people don't think that this flood of fools will
> ever stop. They believe that the consumers will continue to spend
> like madmen, that investors will not sour on the stock market, and
> that they will be able to get away with scam after scam. Problem
> is, they may be wrong this time. And they may be hurt badly this
> time. But then, they deserve to be hurt, financially, because they
> have hurt the less fortunate than themselves.

Apr 05 08:51 AM

[REITBull:]

I am all for weeding out corruption and conflicts of interest. However, as Alan Young alluded to, I'm not sure that the upgrade to BUY was the cause for the stock popping 30%. And if it was, shame on the investors who blindly bought a stock based on an analyst's recommendation.

Apr 05 09:55 AM

[malach hamo...:]

conspiracy theories abound. yet the increase in the price of Kimco was so great that there must be a lot more to it. The Kimco equity raise changed the whole game on the company. While it may have diluted the equity, it also guaranteed that the company has sustainability and that it wouldn't face liquidity or debt crises. Note that three equity REITs have recently raised 500-700 million each in secondary offerings, and each has had a major price increase subsequent to the raise (KIM, SPG, AMB). The markets perceive these companies a lot differently when their two to three year outlook isn't subject to the cloud of major debt maturities.

The further accusation that these issues are "dilutive" only holds true if one wants to live on the wire. Many of these REITs are so debt-heavy that an infusion of capital is a corporate imperative, and that isn't dilutive, it's curative.

Apr 05 10:15 AM

[Chezfrederick:]

Excellent investigative reporting... Excellent write up, and very well laid out... Well done.

I wish there was more of this calibre of questioning and reporting in the financial press... but they seem to prefer to hire analysts(????) and reporters who are lazy or prefer to be fed the content.

Apr 05 10:24 AM

[Mary LaRue:]

Of course Wall Street is back to it's criminal ways. This "fake it til you make it" pyramid scheme was seemingly created overnight by the exact same money managers, analysts, and CEOS who recently claimed that the market was facing a potential "depression." Isn't it obvious to the common investors that the fundamentals don't support the market's recent acceleration and that the market is being manipulated? Or does it even matter? Has the bandwagon of hyped illusion prevailed? Should we expect to see cooked books during earnings' season for the purpose of maintaining the pseudo rally?
Sooner or later, the reality of our economy and the fundamentals of these companies (or the lack of) will clash with the baseless/emotional aspect of this rally and the truth will prevail- it always does! I just feel sympathy for the ones who will be left holding the bag! Not me.

Apr 05 12:05 PM

[thotdoc:]

Seeking Alpha: Investigativce reporting. Hmmmm. I like it.

Thanks.

This is the second time in 2 weeks that an SA article either was or wil be picked up by more mainstream media, like Barrons.

Apr 05 12:13 PM

[prescient11:]

Malach,

You sound as if you believe that garbage. Read the reasons behind the sell rec again and then tell me what changes, let alone the dilution of 80-90 MILLION shares. Are you kidding me? And they pay back the revolver with that????

Guess what slugger, GGP did the exact same thing and paid back their revolver. Stock will eventually be worthless. Awesome. But KIM can pop 30% on BS, nothing news. Wonderful.

Full disclosure: I'm underwater on SRS by about 8 points. At least I have the decency to give you my bias. These bastards should be prosecuted for this absolute nonsense. This country is run and dominated by thieves and liars. SPG above $40 is laughable, IYR should be trading around $15 and it will eventually. IYR will be the next XLF.

Apr 05 04:46 PM

[Jake Blues:]

Asking if Wall Street is back to it's criminal ways insinuates that they stopped being criminals in the first place.

It pains me that my retirement ebbs and wanes due to the whims of these fucking crooks.

Where's my pitchfork?

Apr 05 05:13 PM

[LarryS12:]

Kimco and SPG picked the perfect time to do a secondary offering, which is toward the end of a bear market rally, and before earnings season. I think that they know that something is up, and this is the last chance to get it done before the mean reversion turns into another rout. I won't be surprised to see a flood of insider selling soon.

Apr 05 05:33 PM

[ex- bond tr...:]

Fantastic framing of Merrill Lynchers, Tyler.
This article should be sent to Rudy Guiliani who knows how to clean
up the streets.

Apr 05 08:45 PM

[User 389260:]

Fantastic article.

Apr 05 09:21 PM

[chleoku:]

Great article!

Apr 05 11:45 PM

[LarryS12:]

Get ready for the "dump" part of this "pump and dump" game.

Apr 06 01:12 AM

[predictorma...:]

REIT stocks are all manipulated. Just follow buying in the space as well as buying of IYR. The whole think moves like a school of fish, almost perfectly in sync.

Apr 06 09:35 AM

[PainfullyAware:]

You Rock Tyler.

The Shell Game Runs Unabated In Many Sectors.

All you need is a few players and a Patsy or two to make the money shuffle profitable by fees and manipulation.

If you are a Top 20 financial institution it is much easier to Game the system. Too Big To Fail Is Also Too Big To Regulate And Supervise.

The Corprotocracy Must Be Revised.

Complexity Favors The Sinister. Simplification Is Well Overdue In Many Areas Of Finance And Government.

Better Review The Constitution Before It Is Labeled As "Militia Propaganda".

Be Kind To Your Neighbor - We Are In This Together.

Apr 06 02:17 PM

[Richard Woon:]

Sakwa and the gang run the Churn & Burn well. Last year they had a ProLogis report with a BUY rating titled "Perception Becomes Reality."

Here is a link to the report at tradethepicture:

www.tradethepicture.co.../

I like your style.

Apr 09 02:12 AM