A Letter to Warren Buffett

Dear Mr. Buffett:

First off, I would like to thank you for meeting with me and my Lehman Brothers (LEH) team earlier this week. The opportunity to outline our plan to you personally was the highlight of my professional career. I know that it has been a few years since you had an office in Manhattan, and we aren’t asking you to take a chair and a desk, but your steady hand at Salomon Brothers is an example of what all of us on Wall Street are so desperately seeking in these difficult times.

As I clearly outlined during our meeting, I firmly believe that an investment in Lehman Brothers by Berkshire Hathaway is a classic opportunity for your great company to, once again, buy a fabulous global franchise at a very fair price. This isn’t at all like the situation that John Gutfreund put you in, and I recognize that you are wary given your previous experience. Wall Street has changed dramatically since 1991; it is far more of a franchise business that relies on capital than the “people” business that you were once used to. As you mentioned, the $700 million Salomon deal was the single largest commitment of your career at that point; and I take your point that such sums are now just the bonus pool for the commodity division

However, much has changed. Over the past year, our firm’s market capitalization has shrunk by more than $30 billion (about 75%). All of the shareholder wealth that we’ve created over the past 10 years has been completely erased in a matter of months, and yet our firm has never had brighter opportunities or a stronger safety net. This is the investment opportunity that we see for you and the rest of the Berkshire family. You have the opportunity to invest in the brokerage industry at prices not seen for a decade.

Our firm is poised to return to greatness, and many of Bear’s clients are coming our way.

Just the other day, a survey of U.S. institutional investors by Greenwich Associates found that “among the largest players, [Lehman and JP Morgan] scored highest in providing their [fixed income] clients the best support and understanding during the market turmoil.” This survey, conducted between February and April, also found that while JPMorgan (JPM) was found to have slightly more institutional trading relationships, Lehman Brothers had slightly more market share.

What this survey will confirm for you is that our trading desk has continued to serve our many international clients, even when other brokerage firms were pulling back. This bodes well for the next Bull Market.

I have spoken to both the Treasury Secretary and Chairman Bernanke, and they are prepared to assure you personally that Lehman will continue to have access to the Fed’s discount window for many years to come, if so required. As such, our firm cannot fail in the traditional sense. The federal government’s balance sheet is impregnable. This is an investment circumstance that rarely presents itself in the lifetime of any investor; even one as successful as your own.

We are very reluctant to raise capital at this juncture. Our recent $6 billion equity raise was intended to help us weather even the worst storm. I understand that some intermediaries reached out to you at that time, and that you rightly advised that your modus operandi was not to invest in a club format. I regret that anyone troubled you with the idea back in May, and recognize that by passing then, as you said in our meeting, you avoided suffering the 44% drop in our shares since that deal was announced on June 10th.

Your wisdom is clear. However, this time it will be different.

As we discussed, approximately $145 billion of long-term debt is outstanding including current year maturities of $18.5 billion with $8 billion of commercial paper. We have a plan to deal with these debt tranches, but recognize that a partnership with you would be a tremendous asset when we return to the debt markets. My Treasury team advises that we could save in excess of 200 basis points on our medium term paper if Berkshire agreed to be our strategic investor prior to commencing our current year debt refinancing activities.

The investors who joined our shareholder group in June recognize that much of what has happened over the past five weeks was unforeseen. But no one likes losses, paper or otherwise. That being said, they will be elated if you join their ranks, let me assure you of that. That old saying, “dilution is your friend”, rings even more true when the name “Buffett” is involved in the dilution.

My partners and I are prepared to consider a $5 billion convertible preferred investment, paying an 8% annual cash yield, with redemption and retraction rights in, say, 20 years. Our stock rallied yesterday on the back of the positive news out of Wells Fargo. However, with a sensible discount to yesterday’s closing price of $16.65, your firm would own approximately 33% of our Company, at closing. Naturally, we would very much want you to consider joining our Board of Directors at the earliest opportunity. Other names would be welcome as well.

As we both know, an announcement that Berkshire had agreed to invest capital in our firm would propel both LEH shares and the broader bank index. If yesterday’s rally is any indication, you could earn a 25% return in a single day merely on the news of your financial commitment to me and our franchise.

I appreciate that you have been displeased with the role that you believe Wall Street has directly played in the credit crisis of the past 12 months. I noted that, during our meeting, you specifically named Lehman and Bear Stearns as two of the financial institutions that were at the forefront of the growth in the CDO, CLO, ABS, subprime and credit swap markets.

As you know, the job of an investment bank is to bring to market the products that the market wants to buy. Although we pride ourselves in our Top Five ranking in the M&A tables, the fees generated on advisory assignments pale in comparison to the revenue that flows from the underwriting side of our industry, whether it is equity, structured products or debt. I took your point that Wall Street must play a “quality control” role in the process of selling products to our clients, and I strongly believe that we did our utmost on that front.

We were so convinced that these vehicles were money machines that we bought them for the accounts of our own captive hedge funds. We put our money where our mouths were.

I understand that  you are also dubious about the long-term capability of the hedge fund industry to produce returns that exceed your sense of market norms. I have two points to make on that front.

Hedge Funds are a key revenue driver on our trading desks, and excellent Prime Brokerage clients as well. Up to 40% of our daily block trades are done for hedge fund clients. Moreover, our ability to create our own hedge funds has generated substantial fees from institutional investors and pension funds around the world. Although the recent SEC push to curtail some of the more attractive trading strategies of hedge funds such as ours may hamper our ability to beat the index, the fee streams that our funds generate are extremely valuable. Particularly at times, such as now, when the underwriting and advisory revenues are weaker than we would like.

However, if you would like a commitment from me to exit the hedge fund business, I will certainly recommend such action to the Board should you agree to our investment proposal. Although I am the leader at Lehman, I am always open to well-reasoned perspectives.

In summary, let me again thank you for agreeing to meet with us. I believe that you’ve been presented with a unique investment opportunity, and one that is sure to be successful. Your hallmark is to invest in top-notch management teams, and I humbly submit that we’ve demonstrated that we can navigate difficult waters.

With your financial commitment to our firm, the sailing will be smooth, and the entire U.S. financial services industry will benefit from the rising tide that would surely follow a commitment from Berkshire. The positive impact that would have on the economy is clear, which would directly benefit the rest of the Berkshire Hathaway portfolio of companies. This is a sure route for America to exit the recession that you believe we are experiencing right now.

Thank you, in advance, for your time and consideration. As Senator McCain said privately to me, and I passed along to you, “the country needs you,” and we are honored that you are considering this opportunity.

Yours Sincerely,

“signed”

Richard Fuld,
Chairman and CEO
Lehman Brothers Inc.

[Author's note:  With my apologies to Mr. Fuld, who I can only assume has a great sense of humour given the lack of fun he’s had this year]

Comments

[Redman]

Mr. Fuld has rightfully acknowledged Mr. Buffet's skepticism of the business visa vie his past experiences with Solomon..time notwithstanding. But I believe there is no fundamental difference between the mentality that existed in 1991 and today's circumstances in that "human nature drives market psychology". This fundamental fact hasn't changed since the days of Jesse Livermore 100 years ago. And, sadly..it will never change no matter how Mr. Fuld "dresses it up". Traders are and have always been..risk takers, and to say that Mr. Buffet fits into that catagory is a bit ludicrous given his modis operendi for longer term investing.
And make no mistake...from what I remember about him trying to "rein in" Solomon's desk..it ultimately did nothing to diminish the "Solomon Mentality".
Maybe some of us remember that originally Philip Brothers (Phibro) took over Solomon only to have their roles reversed.
All of this seems a bit rhetorical given the timing. Where was this offer a year or two ago if Lehman was such a great investment?
With respect to both parties..yes..such an investment could bolster confidence in the financial sector...BUT...and this is a very large BUT..these investment banks, who, many times, have tried to "re-invent" the financial wheel so to speak...are/were supposed to know what they were doing. After all..it is their business to know! So why should Mr. Buffet, or anyone else for that matter plunk down huge amounts of money to bail these guys out? "Your country needs you?" I think that's re-packaging a financial company like they re-packaged and called-in the mortgages that this countries foundation is based on!

[LoganFlatt, CFA]

Uh, I think you may have misunderstood that the letter was not actually written by Mr. Fuld...

[Redman]

I totally knew that!! Yet when Mr. Fuld reads this "joke"..alon... with whoever else comments on it, maybe...just maybe...he and all the other CEO's will finally get the picture...it's your mistake and the taxpayer ain't gonna bail you out!

[contender]

Taxpayer isnt gonna bail em out ?

Itd be real nice if the taxpayer even had a CHOICE !

[iThinkBig]

'As such, our firm cannot fail in the traditional sense. The federal government’s balance sheet is impregnable.'

I am just guessing here, but I believe Warren Buffet would feel more comfortable with this statement if there was government focus and investor focus on innovation. It is a necessity but the liquid market chasing the next billion+ deal overlooked the entire entrepenuarial and start-up space for the last five years. Also, Main St. will always firmly drag down Wall St. during a banking crisis. Because the consumers themselves were overleveraged along with the banks and as Americans, we all have NEVER in history been so overleveraged. Tells you something.

To jumpstart an economy from the abyss when the financial institutions are in tatters, innovation leading to skilled job creation is what fixes it. In the Great Depression, it was WWII and 75% of our GDP spent on the war machine, in other words innovation and jobs that fixed it. We don't want another Emporer Hirohito reminding us of our weak economic position so I assume this new war should be the energy war that can be fought with millions of lives lost. Right now, jobs destruction is accelerating so if investors are fleeing banks and the consumers are tapped, how besides forcing the taxpayer to bail out the banks (leading to further perpetuating downward spiral) besides a world war or energy independance war could we recover even in a decade from what has transpired and keep in mind, we have just begun our journey down this dark road.

Multinationals can get more affordable labor overseas and government needs to cut budget, not add personell as it did these last two years to missapropriate more money. The last part of our GDP (49%) is made up of 70% small business. Wage inflation some are asking? How? I am not concerned, I am vastly more concerned we have become a nation of paper pushers and burger flippers.

The foreigners coming here will eat burgers, but the paper pushers? Perhaps we should be selling more of what the globe needs in terms of raw materials and to do that we must have an energy independence policy that remains until at least two products can compete directly with oil to reduce transporation costs? Nuclear for plug-in electrics and biodeisel for shipping industry are my choices. Hydrogen is a distant third, but likely still a decade away from being affordable enough for mass production.

Even if oil drops to $60 a barrel, the jobs must be created here! This is the second painful lesson two in thirty years in what happens when an empire has no energy policy (comes from bad government of course). Why am I mentioning this on a bank related letter kissing Buffet's ass? Because this second wave of market crash seems spurred on by plummeting consumer spending on non-discretionaries do to energy costs and trickle down effect.

I assume bad government will change (and NO I am not talking the Obama kind!!), it always does. If history teaches us something, it is that this takes 6-8 years. To me, banks may be in much better shape in a year or so but then again, they a large batch of them could fail en masse.

[iThinkBig]

meant to say 'without' millions of lives lost on an energy independence war.

[GerrySullivan]

Dear Mr. Fuld

Thanks so much for the lovely letter. Only thing is, the meeting you mention must have taken place in a dream.

I am sitting with my pile of cash waiting for a call some Friday night or Saturday during the day from either Chairman Bernnake or Sec'y Paulson. Perhaps the call will be about Lehman. Not at $18, but at $2 per share. My lawyers won't be as careless as Mr. Dimon's.

So, I think I'll wait a while longer. Good luck to you. If it isn't Lehman, maybe it will be Merrill or Morgan Stanley. Maybe AIG or Wachovia. I do love insurance and banking.

Best always,

Warren

[iThinkBig]

Mr. Buffett, is it just me or do you find it unnerving that Mr. Fuld published extremely sensitive information to the entire world? Mr. Paulson and Mr. Bernanke's expressely guaranteed Mr. Fuld that his firm has a blank cheque from the taxpayers?

Why would he do deal structuring over a public Internet forum?

Mr. Buffet, (and I am serious) is this really the leadership of our entire financial industry? My excellent mentors in Boston (and thank you gentlemen for your patience in teaching me!) never seemed to behave this way when they taught me the tools of the trade. Is the code of honor I learned non-existent in the Empire City?

I suppose I should no longer wonder, your response to Mr. Fuld's letter nets it out for me.

[Budlab]

When is it a good time to invest? The simple answer is when we can find QB, quality bargains. My book "The Four Filters Invention of Warren Buffett and Charlie Munger" examines the basic behavioral finance steps they perform in making an investment decision. It attacks the questions from both practical as well as behavioral finance points of view.

Lehman Brothers Holdings Inc. (Lehman Brothers) serves the financial needs of corporations, governments and municipalities, institutional clients and high-net-worth individuals worldwide.
The Company operates three business segments: Capital Markets, Investment Banking and Investment Management. Lehman Brothers generates client-flow revenues from institutional, corporate, government and high-net-worth clients by advising on and structuring transactions; serving as a market maker and/or intermediary in the global marketplace, including having securities and other financial instrument products; originating loans for distribution to clients in the securitization or principals market; providing investment management and advisory services, and acting as an underwriter to clients.

Lehman Bros. Holdings, LEH has a (5-year annual average) net income growth rate of 35.41 . What competitive advantages does it have? Brand, Technology, Cost of Production, Distribution Network? Are possible advantages sustainable? Does LEH have a solid mix of Product, Pricing Power, Placement, and Promotions? When buying companies or common stocks, look for understandable first-class businesses, with enduring competitive advantages, accompanied by first-class managements.

LEH has a current market price of 18.9 Using an assumed growth rate of 5 percent, the estimated Intrinsic Value is 10.87 per share from ValuePro.net, and there does not appear to be a bargain or 'margin of safety' present here. The current price/earnings ratio = Unavailable. It's current return on capital = negative .13
Using a debt to equity ratio of 6.54, Lehman Bros. Holdings shows a current return on equity = negative 3.4

Some industries have higher ROE because they require no assets, such as consulting firms. Other industries require large infrastructure builds before they generate a penny of profit, such as oil refiners. Generally, capital-intensive businesses have higher barriers to entry, which limit competition. But, high-ROE firms with small asset bases have lower barriers to entry. Thus, such firms face more business risk because competitors can replicate their success without having to obtain much outside funding.

Growth benefits investors only when the business in point can invest at incremental returns that are enticing; only when each dollar used to finance the growth creates over a dollar of long-term market value. In the case of a low-return business requiring incremental funds, growth hurts the investor. The wonderful companies sustain a competitive advantage, produce free cash flow, and use debt wisely. Automatic Warning, ( above 0.5 ) on this current debt to equity level of 6.54

Does Lehman Bros. Holdings make for an intelligent investment or speculation today? Time is said to be the friend of the wonderful company and the enemy of the mediocre one. Before making an investment decision, seek understanding about the company, its products, and its sustainable competitive advantages over competitors. Next, look for able and trustworthy managers who are focused more on value than just growth. Finally ask: Is there a bargain relative to its intrinsic value per share today? Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be misapraised. In terms of Opportunity Cost, is LEH the best place to invest our money today? What about growth in Free Cash Flow? This author's book is at frips.com

These days, Warren Buffett mentions the Four Filters this way: "Charlie and I look for companies that have a) a business we understand; b) favorable long-term economics; c) able and trustworthy management; and d) a sensible price tag." These Four Filters can enhance the probability of our investment success. I think they will help you in your search for intrinsic value and sensible investment.

[notsosmart]

"able & trustworthy management".a dream for our times.not much of this around.pay me big to ruin the business & i will make sure the bod will keep their positions.now im awake.

[warrenlivermore]

warren will get paid to wait.

[iThinkBig]

I agree with your point Notso, The mere fact that Mr. Fuld told an outright lie to to this investment community here on Seeking Alpha is telling and it is outright disturbing.

I advise the President through contacts. That's like me coming here to Seeking Alpha and saying I had breakfast with the President the other day and he guaranteed he will put his weight behind my agency. Would Mr. Bush want to do some business with me afterwards?

To me, it appears Mr. Fuld just destroyed his permanent credentials. He resorts to lying to cover for his ack of honor that led to his companies downfall?

I have found that true humility and recognizing past failings to others you are asking help from goes a long way. Then do what you say and stay humble to learn or re-learn principles and new methods. We're all human and make very big mistakes in our lives, but it is taking accountability that restores confidence to give someone a second chance. I saw the exact opposite occur here.

[iThinkBig]

Patience is a virtue

J


On Jul 18 11:54 AM warrenliverm ore wrote:

> warren will get paid to wait.

[problembear]

until we retire the national debt all talk of turning things around any time soon are meaningless. all accross america, families are sitting in their kitchens with calculators and checkbooks open trying their best to stay within their budget, but the glaring fact that this country does not pay it's bills or stay within any semblance of a budget dooms any argument for prudent behavior. I think there is a plan which will work. It will take revolutionary war type volunteerism but check it out and see what you think at:
problembear.wordpress....