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  • June 11, 2008 10:57 AM EDT by Elizabeth MacDonald

    Ignore the Bullish "Kitchen-Sink" Talk

    Ignore the bullish kitchen sink writedown talk, that future earnings per share results on Wall Street will look better when compared to EPS figures coming out now, as they have been socked hard by colossal writedowns.

    That's because shareholder dilution in the form of new stock issuance at Wall Street firms could keep earnings per share results down in future quarters.

    To plug the holes in their damaged balance sheets, Wall Street has turned to the equity markets to raise capital.

    Four of Wall Street's largest have raised at least $50 bn since last fall through such offerings. Citigroup(C), Merrill Lynch (MER), have issued a flood of new securities. Morgan Stanley (MS) and UBS (UBS) have, too. Lehman Brothers Holdings (LEH) plans to raise $6 billion more in capital, on top of the $6 bn it already announced, after disclosing a nearly $3 bn loss for its second quarter.

    This is shareholder dilution on a massive scale.

    Please do all you can to ignore the bullish "kitchen-sink" talk in the business media, that future earnings per share will look dramatically better when you compare them to earlier quarterly results that were hit hard by outsized writedowns.

    This is off the mark. Because along with the common stock issued, once the preferred shares convert, that means more dilution. And that means future earnings per share figures may not look so hot when compared to earlier EPS results socked by write downs.

    To arrive at earnings per share, you divide the number of shares outstanding into earnings. Since more stock is being issued, and more preferred shares will convert into common shares, that means the earnings number must be spread out over a much larger denominator of shares.

    Future earnings per share comparisons may at best look flat, if not lower.

    Also hanging up the financials' stock prices is this often ignored fear down on Wall Street. Whenever hedge funds hear about a common stock or preferred stock capital raise, they immediately plow into the market to short these stocks, knowing they can cover on the resulting equity offering.

    So where are the potholes on Wall Street? Check out this table from Portales Partners, which sells independent research to institutional investors:

    chart.JPG

    Want more?

    Meredith Whitney, a top analyst at Oppenheimer, has parsed through the dilutive effects of any further equity capital raises by Merrill Lynch.

    Specifically, Whitney looked at Merrill's $6.2 bn stock issuance last December to Singapore's Temasek investment authority and the investment company Davis Selected Advisors as well as the separate $6.6 bn convertible preferred stock issuance to the Korea Investment Corp., the Kuwait Investment Authority and Mizuho Corporate Bank last January.

    Whitney says that just a $1 bn equity capital raise below $38 per share (Merrill's stock is trading at around $38) would be 80% additionally dilutive than a straight common offering due to the fact that Merrill would have to issue additional shares to Temasek "if it were to issue stock below its original investment price at $48."

    A $3 bn equity capital raise at $38 per share would be 13.5% dilutive. A $5 bn equity capital raise at $38 per share would be 17.3% dilutive, she says.

    Similarly, Citigroup raised a total of $20 bn in two deals earlier this year. The deals involve securities that are convertible into common stock at different prices. Those shares convert into 575 mn to 600 mn of common shares.

    And check out the high rates Citi has to pay on its preferreds. For example, before they convert, Citi has to pay 11% before taxes on the $7.5 bn it sold to Abu Dhabi last December.

    So where are the potholes on Wall Street? Check out this table:

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maurizio mirolli

The devaluation of the dollar is the cause of all the common problems of our financial institutions and our economy. It has lead to massive speculations, one after the other. Land, housing, and then commodities of every sort. This is the message that must be sent to Washington, loud and clear. The past can not be changed but at least we can avoid the same mistake in the future.

June 13, 2008 at 12:58 pm

DrDetroit

re-reading post above, I meant 'you are of the same breed' YOU=WHARTON people - heh - NOT software engineers ! lol

June 12, 2008 at 3:05 pm

DrDetroit

As to Mark's comment above I agree Frank Zappa would have been a friend of yours Macdonald I bet. You seem to be someone to say what they see - AND at the same time have something they see to have something to say about. You're not looking, you're seeing ! Now, USUALLY that's looking, or aggression one wants but I sense you're starting to get a better canopy view of what's going on resultant from lower level observations. If Fox isn't paying you what they should be, they should be ! People I "DO" work with in my job all come from Wharton - you know, that shabby institution ? I'm a loathsome - mere software engineer, heh, but - really, they're all very classy - no nonsense - in fact, heh, perhaps TOO nonsense at times, it gets dry - alas outreaches like THESE posts for my own entertainment ! But you are of the same breed I detect, I don't even see too much personal intervention in your eco-journalism - GRANTED, you're clearly orchestrating your ideas and insights- but you do it without interfering with the content my view. So, eh ? that you're with Fox- oh well- I can live with that, hope they pay well - I don't detect the hardcore jeebus vibe in ya that I do with other foxers, or that moralistic 'right' position you'll see in so much fox programming - hope you do get your own dedicated show - only because I suspect too much politics exist at Fox, hopefully you get your own show - hmm - HBO but - that's not daily mainstream for people, I kind of find MSNBC, etc all 'owned' - Bloomberg ? but how exciting could THAT be ? Darn ! Oh, I know, just suffer with the office politics at Fox, enjoy yourself, do a book for fun ! (and income), benefit from your own investments, and go enjoy the rest of your life - doing whatever you want ! I intuit you'd make a good univ. prof. Hey when you're age 55, you'd be lookin' 30, all those 20 year old guys goin' "Yeah, I'm takin MacDonny again this year " jk - heh just kidding on that - but MORE like - 25 year old graduates entering decent graduate schools going "Wow, Prof MacDonald really prepared me to understand this global economy well" - to where you THEN - write a real book. Then you could retire old and grey - instead of looking back saying you wasted any time on Fox Network, you could say - wow - I really influenced 500,000 young minds - who learned to care to be careful in matters of the intellect !

June 12, 2008 at 3:04 pm

john holland

I have never read anyone better than Liz...I was a Broker for Mother-Merrill many years ago & read the $$$ Page first then & now. To make a small forture in Las Vegas, you need to start with a large one....StockMarket=Getoutwhileyoucan....Love, ELVIS

June 11, 2008 at 11:28 pm

Mark

Thanks Elizabeth, The false market is indeedthere. I in all seriously would love to see you and Peter Schiff have a show. And despite his loss in the primaries, I hope Ron Paul gets some major influence we will need him if we can sort this big mess out. Just wait til WAMU and Lehman go down, possibly Wachovia thanks to their buyout a couple years ago of GoldenWest, a subprime guru.

June 11, 2008 at 8:25 pm

DrDetroit

wow Looks like over 30 to 1 ratio there. Why does It's a Wonderful Life or thoughts on John Law come to mind wondering what happens if these institutions were ever required to cough up even 1/15th of total assets to cover losses. You could redo that chart and include Bear Stearns - would be neat to see similarities. I questioned Citi when I saw them in LATVIA seeking to raise capital through deposit accounts. Wow, they must be desperate, all respect to Latvia too. Gotta hand it to ya Ms. MacDonald- I bet you'd excel in any field you set foot in, you'd make a great detective as well I wager. You show a real passion for your work, and I think anyone leaves an experience with your insights better off than not at the end of the day. Thanks for reminding us all of just how good humanity can get !

June 11, 2008 at 3:17 pm

Justin

Anyone stupid enough to go looking for a pot of gold in financials deserves to be disappointed with big losses. The guaranteed money is this market is shorting all of them. Short the dollar, short the domestic autos, short the home builders, short big ticket retailers, short the transports, shorting anything that relies heavily on imports, and get out of the dollar. Commodities will be king the next 10 years. Buy them while fiat currency is still accepted around the world.

June 11, 2008 at 2:24 pm

about this blog

  • Elizabeth MacDonald is the stocks editor for Fox Business Network. She is recognized as one of the top prize-winning business journalists in the country, and has received 14 awards, including the top prize in business journalism, the Gerald Loeb Award for Distinguished Business Journalism, and the Newswomen's Club of New York Front Page Award for Excellence in Investigative Journalism.

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