Lehman Brothers Holdings Inc faces painful decisions ahead of its expected announcement of another big quarterly loss later this month.
Lehman (LEH) has already taken $7 billion in credit-related write-downs and losses since the start of the global credit crisis. It has raised about $12 billion in capital this year through common equity, preferred stock and convertible securities offerings, but analysts and money managers say that may not be enough.
Lehman, the smallest of the major U.S. investment banks, could post pretax write-downs of $3.5 billion when it reports its third-quarter earnings, according to a Morgan Stanley analyst.
Lehman may have been dealt another blow on Tuesday, when hedge fund Ospraie Management LLC, in which it owns a 20% stake, said it will close its flagship fund due to losses -- a move that could affect the value of Lehman's investment management business. A full or partial sale of the unit could be one option for raising capital.
Lehman has been weighing several possibilities to get through the crisis -- shedding problem assets, selling individual businesses, or a stake in the parent company.
But none of the choices are easy. Problem assets, such as its commercial real estate-related investments, may find buyers, but only at low prices.
Merrill Lynch & Co Inc discovered that in July, when it sold a $30.6 billion portfolio of repackaged debt for 22 cents on the dollar.
Other alternatives, such as raising equity capital, can be painful for existing shareholders, whose investments would be diluted. Selling businesses such as its asset management unit, which includes prized fund manager Neuberger Berman as well as stakes in several hedge funds, could hurt Lehman's earnings prospects.
In the end, money managers said, Lehman may have to do a bit of each.
"There is no optimal solution here," said Walter Todd, principal at Greenwood Capital Associates. "Depending on how much capital they need to raise, utilizing several of these options would probably be the best avenue for them."
Lehman declined to comment.
Difficult Choices
Lehman has not detailed its plans, but according to sources, the bank is looking at various options, including seeking buyers for commercial mortgages and property on its balance sheet. It also may shed about 1,200 jobs, or roughly 5% of the work force, in its latest round of cost cutting.
At the same time, it is weighing the sale of part or all of its asset management business, including Neuberger Berman. It is in talks with state-controlled Korea Development Bank over a possible investment in the overall business.
One portfolio manager said a rights offering in which existing shareholders can buy additional shares would be the better way to go if the company has the time to do so.
Otherwise, a stake sale to a large investor like the Korean bank would be preferable to selling Neuberger Berman, which Lehman bought for about $3.1 billion in 2003.
"Another equity infusion will probably do well for them, which will allow them to more aggressively address some of the problems that are in the investment portfolio," said Peter Kovalski, portfolio manager at Alpine Woods Capital Investors, which owns Lehman shares. "You'd hate to see them sell a good asset."
But an equity infusion alone may not be enough. The company may have to sell at least part of the asset management business as well, an analyst said.
"It provides a real nice, consistent revenue stream for the company. So you are only going to sell that if you absolutely have to," said Bill Fitzpatrick, an equity analyst at Optique Capital Management. "But it appears as though at this point that is indeed necessary."
Lehman is likely to have less leverage in negotiating a good price, even for its good assets. "They are in a bad situation because people know they are in distress," said Greenwood's Todd, a former Lehman banker.
Roller-Coaster
Lehman has not been alone in feeling pain during the credit crunch.
A Wachovia analyst said in a research note on Tuesday that the third quarter will be a "quarter to forget" for Wall Street investment banks. Wachovia slashed its estimates for Goldman Sachs Group Inc, Morgan Stanley as well as Lehman.
"The overall industry has continued to surprise on the downside with problems," Alpine Woods' Kovalski said.
Lehman shares are down about 75% this year, requiring the company to repair relationships with key employees whose stock holdings have tumbled in value, Ladenburg Thalmann analyst Richard Bove wrote in a note last week.
The management needs to take decisive action, or it could become the target of a hostile takeover, Bove wrote.
"It's going to be a roller-coaster for Lehman," Fitzpatrick said. "But I do think they make it out of this."
