Lehman's Preferred Offering: What Does It Indicate?

After hours on Monday, shares of Lehman (LEH) took a nosedive, down another 7% to $34.80 before recovering toward $36.60 by the end of trading.

Why? At exactly 4:39pm, Lehman announced a share offering to help them with a much needed capital infusion. Moreover, it is very troubling that on a daily basis, new information is uncovered that is verifying what is on top of most investors' minds: The problems are much worse than we are being led to believe.

Coming off a rather limp reception for “Paulson’s Package,” the market is in no mood to hold on to gains today, another sign that investors are not committed and institutions are doing some spring cleaning of their own. I thought that a quick translation of the press release would be a good idea as it seemed rather cryptic.

According to PRNewswire:

Lehman Brothers to Offer 3.0 Million Shares of Convertible Preferred Stock — Lehman Brothers Holdings Inc. today [Monday] announced that, in response to investor interest, it intends to offer 3,000,000 shares of Non-Cumulative Perpetual Convertible Preferred Stock. Lehman Brothers also expects to grant the underwriter for the offering an option to purchase up to 450,000 additional shares of the Preferred Stock to the extent the underwriter sells more than 3,000,000 shares of the Preferred Stock in the offering. The proceeds from this offering will be used to bolster the Firm’s capital and increase financial flexibility.

Translation: We need cash. We need it now and we are doing it in a way that will be perceived as beneficial.

“Given the challenging environment and our previously stated view that it will likely continue the balance of the year, issuing convertible preferred is appropriate as it optimizes our funding and accelerates our plan to reduce leverage, and at the same time minimizes dilution to our shareholders,” said Erin Callan, managing director and chief financial officer of Lehman Brothers and a member of the Firm’s executive committee. “We also felt this was the right time as there was a window of opportunity in the market, as we have received significant interest from several key institutional investors, who have been strong supporters of the Firm over time.”

Translation: OH CRAP! We are in deep. Even though we have access to funds through the Fed’s Discount Window, that will look as if we really NEED the money. Maybe we should come up with a plan that seems less desperate. A great way will be to offer bonds, but who would buy those? Hey...what about a preferred stock issue, as it will offer upside if we pull through and a yield? We will not be required to pay dividends as we are with bonds, so if the need arises, a cut is possible. The best part: No worries about ratings! No one really pays close attention to the ratings on a preferred, especially a convertible preferred.

The Non-Cumulative Perpetual Convertible Preferred Stock, Series P, carries a par value of $1.00 per share and a liquidation preference of $1,000 per share (the “Preferred Stock”). Upon conversion, the Preferred Stock will be convertible into shares of Lehman Brothers’ common stock, plus cash in lieu of fractional shares.

The non-cumulative dividend rate, conversion rate and other terms are yet to be determined. An application will be made to list the Preferred Stock on the New York Stock Exchange. The offering of the Preferred Stock is being conducted as a public offering registered under the Securities Act of 1933.

Translation: Get it out there…Don’t worry about the details. Look strong, business as usual.

Lehman Brothers Inc. is serving as sole book-running manager of this offering. The offering will be made under Lehman Brothers Holdings’ existing shelf registration statement filed with the Securities and Exchange Commission.

Translation: Who can we get to help with the offering? What other firm in good-faith would present this to their clients? Maybe we should do it ourselves.

Even thought this is not dilutive and may actually be beneficial to LEH, it is hard to imagine how investors will react to this offering, especially after they have seen the slide that Fannie Mae (FNM) and Freddie Mac (FRE) took after a similar preferred offering was consumed.

Note: There are rumors that call for the issue to have a 7% yield and a 30-35% premium upon conversion.

Disclosure: Horowitz & Company clients do not hold positions in stocks mentioned but they do own put options on LEH.

Comments

[Vikram]

Another person confusing liquidity with equity. The Fed window gives liquidity by allowing LEH to borrow against assets. The preferred offering gives LEH the capital (equity) to buy those assets or deleverage their books. And with the current state of the markets, and the Feds backstoping, the IBs can make a huge amount of money just buying high quality bonds at distress prices and parking them with the Fed. But to do that they need capital and LEH has just raised some at pretty decent terms.

[drmalaka]

Well if the bulls who are buying today are right, hopefully they will get the same return they got when Citi got its investment from the Arabs. I believe Citi was trading at over $30 that day.

Companies do not do things like this becuase they are in good shape. They do this becuase they are desperate. And from a stock valuation, if a company is that desperate they must be near financial collapse.

Accordingly this would be great news if the stock was actually trading at the value it was worth based on how horrible their financial situation actually is. Lehman should be up $5 today, the real problem is that it should be up $5 to $20.

We have a market that refuses to fully discount the severity of the problems out there but fully values anything that can be considered good news.

CTX is another example. They just sold $900mil in property for 18 cents on the dollar and that is good news. Who in their right mind would do this? A desperate company. Well how can a desperate company be selling at only 50% off their inflated 52 week high? If things are so bad for CTX that they had to do this deal wouldn't you think that $24 is a little high for the stock? Its high is $49, if things are as bad as they really are I would expect that the stock would have to be trading at $10 for this to be considered good news.