Archive Page 3 of 9
June 10, 2008 8:29AM
By Elizabeth MacDonald
Hunt Petroleum, the oil and gas producer owned by the Hunt oil family of Dallas, Texas, has sold itself to XTO Energy (XTO) for $4.2 bn in stock.
An historic sale, to be sure, as the deal combines one of the largest US oil and gas players, with properties in 12 states, with one of the country’s oldest oil dynasties founded by H.L. Hunt, a company that owns properties in the Gulf of Mexico, Texas, Louisiana and elsewhere.
But behind the scenes of the sale, an ugly battle has broken out that has ripped apart the Hunt family, a fight that could see a stepped-up war of words due to the sale, a fight that’s already taken a nasty turn.
Albert Hill III, 37, great-grandson of H.L. Hunt, hired lawyer William Brewer of the Dallas law firm Bickel & Brewer to slap a law suit last November against his father, his sisters, his aunts, as well as trustee Thomas Hunt who oversees two trust funds owning 100% of the privately held stock in the family’s primary asset, Hunt Petroleum.
Albert III’s law suit accuses his family members and the trustee of tax evasion, fraud and mismanagement of about $4b in assets in the two family trust funds. The suit, filed in state district court, also alleges that the trustee hid Hunt Petroleum’s true value from the trusts’ beneficiaries and conspired with the family to underpay estate taxes owed to the IRS.
Brewer says his client is scrutinizing the deal to see if family could have received a higher price. His spokesman says XTO’s chief executive Robert Simpson noted on a conference call that the deal could generate more than $1.2 bn in cash flow next year, making the deal price equivalent to about 3.5 times projected cash flow, which apparently is very low. Simpson evidently commented on the call that the company used to pay six to seven times projected cash flow for these types of companies.
“The sale doesn’t in any way impact our lawsuit, and nothing will stand between our client and the legal recourse he is seeking,” Brewer says, adding the sale “seems like an attempt by the Hunt family to distance itself from alleged past misdeeds associated with Hunt Petroleum and the trusts that own the company. The price of these assets go up every day, so why was there the sudden rush to sell for less than companies typically pay for them?”
Specifically, Al III alleges in the complaint that the defendants conspired to push him as well as his family out of the two trusts soon after he refused to agree to a plan to divvy up the trust money amongst themselves once they sold off their interests in Hunt Petroleum.
“The suit has absolutely no merit,” says Michael Lynn, lawyer for Al Jr., the father. “We don’t think he [Al III] has rights under the trust as a beneficiary, we deny he’s a beneficiary.” Lynn adds that besides, “none of the beneficiaries have any right under Texas state law governing operations of trusts to control or provide advice or otherwise direct the investment decisions of trusts. The rest of the family have happily lived with that [the law] for decades.”
The lawyer for Tom Hunt, George Bramblett, argues similarly that Al III doesn’t deserve to be a beneficiary. Al III became a beneficiary when his father signed his stake over to the son, which the father has since tried to rescind.
Hunt says Al III’s lawsuit is “severely ill-founded” and that Al III is “acting in complete disregard of the specific intent of HL Hunt and his wife, Lyda, who established these trusts.”
He adds: “They intended that assets in the trusts be managed by a trustee and an advisory board, not by beneficiaries and certainly not by persons who only claim to be beneficiaries. Both trusts further expressly forbid even acknowledged beneficiaries from suing the trusts.”
Bramblett says in an interview that: “Al III is the one who won’t respect the trust’s provisions,” adding the suit is filled with “highly inflammatory” rhetoric, and that Al III and his lawyer Brewer have yet to take any depositions and interrogatories. “They’re just looking for publicity,” Bramblett says.
Al III steadfastly believes he is taking “a difficult but principled stand” in his battle to protect the family’s trusts for H.L. Hunt’s ancestors.
This is a fight that’s shaping up to be a pitched battle between father and son. Al III’s close family members though believe he is a prodigal son who, with his former beauty queen wife, a one-time Miss Georgia who finished first runner up in the Miss USA pageant of 1993, blew millions of dollars on a lavish lifestyle and have spent their way into a hole they hope the trusts can pull them out of, reports indicate.
Al Jr.’s staff totted up personal debts of Al III and Erin and came up with a total of $2.275m, including a $1.56m mortgage and a $97,094 revolving credit balance at Neiman Marcus, reports indicate.
“The personal attacks against Al Hill III are a smoke screen, designed to help several family members avoid a discussion of the real issues involved in this case,” Brewer says in a statement. “The family began ostracizing Al III when he wouldn’t go along with the lying, cheating and stealing that have been the modus operandi for years.”
Brewer adds that: “Until Al III began demanding transparency, full disclosure and forthright treatment of tax obligations, no one ever suggested he wasn’t part of the gang.”
Al III, whose parents divorced when he was eight years old, has asked the court to stop his father and aunts from selling Hunt Petroleum and partitioning the trusts, citing H.L. Hunt’s provision that the trusts remain intact until 21 years after the deaths of the two trusts’ initial beneficiaries, Margaret and H.L. Hunt Jr.
The suit though is loaded with purple rhetoric, with insistently eyeball-grabbing sections entitled “Defendants’ Shameless Campaign of Non-Disclosure, Browbeating, Threats, and Dirty Tricks.”
It goes so far as to call the trustee, Thomas Hunt, a man beloved by the family for generations, the “spider in a web of conflicting interests” of the family. Brewer points out that Hunt is not only trustee of two family trusts, but is chairman of Hunt Petroleum and executor of H.L. Hunt’s estate.
Brewer supplied notes of an October 2005 family meeting that purportedly cites the need for “checks and balances” from independent directors of Hunt Petroleum. The documents state that family members were worried about Tom Hunt’s various “conflicts of interests,” with one saying: “He wears so many hats it’s hard to keep them all straight.”
It’s a fight that has laid bare the inner workings of one of America’s most colorful dynasties, the H.L. Hunt dynasty, with more than 200 members.
H.L. Hunt invested his poker winnings in a stake in the Arkansas oil rush of the 1920s. He later hit it big with a huge strike in east Texas, at the time one of the largest oil discoveries in the world.
By 1948, Life magazine reported that H.L. Hunt was one of the richest men in the country, up in the big leagues with J. Paul Getty, Howard Hughes and the Rockefellers.
Al III’s great uncles captured headlines in the late ‘70s through 1980 for trying to corner the world’s silver market, triggering a colossal price spike and an epic bust. The two were then banned from commodities trading. Bunker Hunt, who had helped develop Libya’s oil fields, then filed one of the largest personal bankruptcies in history.
H.L. Hunt’s son Ray Hunt, who took over Hunt Oil from his father, is the wealthiest Hunt family member, says Forbes Magazine (he no longer is affiliated with Hunt Petroleum). The Hunt clan includes airline entrepreneurs, actors, an ambassador to Austria, lawyers, accountants, racehorse breeders, artists, and a fighter jet pilot, D Magazine says.
H.L. Hunt’s family is so entrenched in Dallas’s social stratosphere, it helped shape the city’s skyline, says D Magazine, with Ray Hunt’s Reunion Tower, Hunt Oil Tower and various other properties dotting the landscape for decades, reports indicate.
Al Hill III’s father, Albert Hill Jr., is a former tennis ace who reportedly helped build the World Championship Tennis tour with his uncle Lamar Hunt, one of the founders of Major League Soccer and the American Football League and also the founder and owner of the National Football League’s Kansas City Chiefs.
Albert Hill Jr. divorced his son’s mother and reportedly dated a Bond movie girl and Audrey Landers, a star from the TV series Dallas.
Brewer notes the father had a short stint at Betty Ford and a five-year suspended sentence for assault of a paramour. Al Jr. reportedly later became partially paralyzed from the neck down after he fell off his first-floor porch, cracking a vertebra in his neck. Rehab brought some movement back, and throughout his son Al III helped him through the ordeal.
Like father, like son. Al III also had an admitted problem with alcohol growing up, having driven his girlfriend’s Toyota Supra through a white clapboard house at 65 mph, reports indicate. He got a DWI charge reduced to reckless driving, spent 30 days in rehab, returned to school and gave up drinking and never resumed.
Al III’s chain of service stations and convenience stores, which he had reportedly begun acquiring in 1997, also encumbered him with business debt and by 2002 one business, Food Fast Holdings, was in bankruptcy protection, reports say.
Later, Al Jr. hired his son for $10,000 a week to serve as his investment consultant and family representative. The father then signed over 90% of his interest in the trust to his son Al III, along with his other two children.
Al Jr. has since fired his son and has written a letter to the trustee Tom Hunt and his daughters, trying to revoke his letter signing over most of his interest. The matter is now in probate court, with the father arguing he was not competent at the time to sign his interests over due to his injuries, his lawyer Lynn says.
Brewer says his client, the son, Al III, “is a direct beneficiary of his grandmother’s trust, and therefore entitled to the information, rights and full recourse he is seeking. A jury will find any suggestion to the contrary laughable.”
Brewer says his client Al III merely wants to know why the sudden rush to sell the company, why not let the trusts continue to operate as originally designed, with the 21-year provision.
He says Al III is holding fast that the core issue is the family’s move to break the trusts in order to sell Hunt Petroleum and then seize the proceeds sooner than the family would have been able to do had the trusts’ 21-year provisos remained intact. The Tom Hunt side of the case is maintaining there is a serious issue over who the trust beneficiaries lawfully are.
Brewer also says his client wants a full accounting of the trusts assets, “the mountain of cash, billions of dollars of mineral rights, and substantial real estate holdings, which have often been used as the personal bank account of those in control of HPC [Hunt Petroleum].”
Brewer says at one meeting, Al III asked for information, but was told to remain silent. Brewer says Tom Hunt called him a “whipper-snapper,” but that the family could owe upwards of $500 mn in taxes. Al III then hired Brewer to file suit alleging mismanagement and a second lawsuit alleging the executor had lied to the IRS about the tax obligations of the estate.
Al III is asking particular questions about the tax positions taken by Tom Hunt, the man who oversees both trusts, serves as chairman of Hunt Petroleum, and is executor of the family estate. Al III alleges Tom is conflicted and has enacted a complex scheme to shelter assets, avoid taxes, and cheat today’s generation of the Hunts out of the fortune planned for them decades ago.
Al III says his family threatened to ostracize him. He says his father sued him and yanked his son’s beneficiary claim on the trust. Al III also says he was fired from the family business, disinherited altogether, and terminated from his consulting relationship with his father.
The suit could take years to settle.
June 10, 2008 7:42AM
By Elizabeth MacDonald
Solar bulls are on a tear, given oil’s remorseless march towards $150, along with global efforts to cut carbon dioxide emissions and reliance on oil.
But the solar bulls could get burned if they’re not smart about the sector. Many of these companies are swamped in red ink, with their stocks trading at stratospheric multiples, making them highly speculative and volatile. That’s why the number of shares sold short in the 20 top solar companies has risen 12-fold, to 96.4 mn, from a year ago, says John Tabacco, chief executive of Locatestock.com.
The solar sector lives and breathes on whether or not governments around the world, notably the biggest players Germany, the US and Japan, will preserve tax credits that keep the industry afloat.
At the same time, government subsidies are drawing a flood of new players, hurting existing ones. That means investors must focus on solar companies that have better operating cash flow than others. Keep an eye on cash from operations in particular to see how healthy these companies are.
Solar has a lot of upside, don’t get me wrong. For instance, its backers point out that solar energy is not as hampered as the nuclear industry with regards to waste disposal. Big companies with rich balance sheets such as Google (Goog), Chevron (CVX) and Wal-Mart (WMT) are plowing money into solar, with some aiming to produce their own electricity through solar power.
JPMorgan Chase (JPM) and Wells Fargo (WFC) invested last year in the biggest solar plant built in decades.
Watch too global companies long active in the solar space. They include Kyocera (KYO), BP (BP), Boeing’s Spectrolab (BA), and Applied Materials (AMAT), which produces thin-film solar module fabrication lines other companies purchase to make solar modules in their own plants.
“Costs for the [solar] technology will fall below coal as soon as 2020, the U.S. government estimates,” says Bloomberg.
China is big on solar too. For instance, Rizhao, a coastal city of nearly 3 mn people, is one of a number of cities there that have heavily invested in solar electricity.
The solar industry has grown at a 47% average annual rate in the past six years, with about $30 billion in sales in 2007, according to Photon International. Though solar power accounts for only 0.06% of world electricity generation, Photon thinks the sector has room to grow at double-digit rates for years to come. Sales from solar panels (known in the industry as photovoltaic) will triple to $71 bn by 2012 as a shortfall in silicon has caused prices to rise and margins to drop.
But silicon supply pressures and threats of cutbacks in government subsidies to the sector could whipsaw the stocks.
Germany, which has the biggest market for solar energy at about 55% of world demand (Japan is next at about 20%, the US is at 5%) now plans to cut back its subsidies to the sector by 7% next year, though it still has generous subsidies whereby solar energy can be sold to its grid for as much as 20 years at a fixed price that’s more than the standard price for electricity.
The US Congress has threatened to cut its subsidies, which have at times been perilously hanging by a thread.
The House Ways and Means committee voted to approve a six-year extension of the solar energy tax credit–but it is paying for it and other measures by ending the ability of hedge fund managers to defer US taxation from offshore earnings. Not a solid pipeline of support here.
Though the solar industry is still small versus the electricity sector, which relies on coal or gas to power its plants and utilities, its prognosis looks good with analysts saying solar costs will come down dramatically in coming years as technology improves. Solar electricity still accounts for less than one-thousandth of global energy consumption, largely because of costs.
Despite government subsidies, retail prices for solar power still are on average twice those for electricity from standard utilities. Solar systems sell electricity at about 30 cents per kilowatt hour, versus retail prices for electricity around the world of 15 cents to 18 cents.
A growing number of corporate executives think this price gap is fast closing. They include Jeffrey Immelt, chief executive of General Electric (GE). GE has bought two small US solar concerns in recent years. “I am convinced that in the next five years, the solar industry has the ability to take out half its [manufacturing] costs,” he has said.
Here’s what to watch out for.
JA Solar Holdings (JASO) just came out with solid earnings. LDK Solar (LDK), Canadian Solar (CSIQ), and Yingli Green Energy Holding (YGE) are all on the radar screen.
JA Solar Holdings’ (JASO) first-quarter net income almost tripled amid increased demand for solar products and a strong boost in income from operations. The Chinese manufacturer of high-performance solar cells posted net income of $22 mn, or 14 cents a share; a year earlier, income was $8.63 mn, or 7 cents a share. Revenue surged to $160 mn from $47.8 mn. JA Solar is Chinese and it is thought of by many as one of the cheapest cost producers with solid pipeline of silicon supplies.
Another hot solar stock is Trina Solar (TSL), which recently re-affirmed 2008 revenue guidance to between $770 mn and $808 mn, and operating margin guidance at 15% to 17%.
But JA Solar and other solar stocks fell recently when analysts said solar cell makers with heavy exposure to soaring silicon prices could be at risk.
Calyon Securities analyst George Kotzias said in a client note that so-called thin-film technology stands to gain on silicon because thin-film technology is less expensive than silicon. Thin-film had a 12% market share in 2007, which could grow to about 20% in 2008, he said.
That means you should watch out for companies that make solar cells with silicon such as SunPower Corp., JA Solar Holdings (JASO), LDK Solar (LDK), Trina Solar (TSL), Canadian Solar (CSIQ) and Yingli Green Energy Holding (YGE).
On April 1, LDK Solar, a China-based supplier of the silicon wafers, cut its profit outlook. LDK, which makes multicrystalline photovoltaic wafers, is vulnerable to polysilicon pricing-silicon shortages have led to price spikes–as well as increasing competition in the wafer segment on gross margin. LDK Solar is a middleman, it buys its pure silicon in China at low prices and kneads it into wafers that are sold around the globe.
Another company to watch, especially if it ever has an initial public offering, is Hemlock Semiconductor, a US company owned by Dow Corning, which is the world’s biggest producer of silicon for solar cells. All the silicon Hemlock produces until 2012 is already sold out, with production due to quadruple over the next five years.
Silicon costs comprise at least a third of the total manufactured cost of a typical solar module. Currently there are only seven big makers of silicon needed for solar cells, which ought to show you how technological complex the processes are when it comes to refining the material. (Silicon used for solar cells has to be 99.9999% pure.)
Besides Hemlock, other silicon makers include Tokuyama Mitsubishi Materials and Sumitomo Metal of Japan, as well as Wacker of Germany and US-based MEMC Electronic Materials (WFR).
But new players are entering the field, as many as 50 in just over a year, driven by a shortage of silicon that has pushed up prices for the material in the past five years.
Among the new entrants is Asia Silicon, a China-based company that has raised more than $150 mn from investors to build a silicon plant in northern China, which says it can sell silicon for just $40 per kilogram in just seven years time, versus the going price of about $70 now.
LDK and other silicon wafer suppliers may soon be threatened by a new technology which may replace silicon. Talk is of solar materials that can be “painted” on to surfaces in so-called “thin-film” applications.
Nanosolar, a US private company backed by $150m from investors, is leading the way here. FirstSolar (FSLR), a US company that sells thin-film cells made with cadmium telluride, has seen its market capitalize soar ten times from its initial public offering last year, now at $20 bn.
Despite all that, as companies and countries around the world move toward solar, costs may drop as supply chains proliferate. And solar could hit grid parity with standard electricity by around 2012 as the industry works to cut costs and prices conventional forms of electricity are expected to rise.
And watch what happens to the solar industry if governments around the world either enact or raise carbon taxes on oil and gas to combat climate change. That will make fossil fuels, and in turn electricity, look even more prohibitively expensive than they do now, and can only make solar look that much more attractive.
June 9, 2008 4:28PM
By Elizabeth MacDonald
Usually you’ll see disclosures in filings from retail chains or restaurant chains hurt by an economic down turn that consumers are staying away to save money due to high fuel costs or increasing inflation eating into their discretionary income.But for one restaurant chain, those problems are not the only reason behind its challenging times.
Brinker International (EAT), which runs “casual dining” chains, cited high gas prices and a downbeat outlook on consumer confidence as the reason why diners are not eating out at Brinker restaurants such as Chili’s, On the Border or Macaroni Grill chain (which it’s trying to sell).
But Brinker filed an announcement of a quarterly dividend that cited a whole range of other reasons absent the Black Plague–though it did cite “epidemics or pandemics”– that it said could hurt future profits. Check out its disclosure below, it included everything under the sun. Is Brinker more scared than usual?
Here’s what it wrote, see for yourself at
http://sec.gov/Archives/edgar/data/703351/000110465908038230/a08-16013_1ex99.htm
Future profits could be “affected by general business and economic conditions, the impact of competition, the impact of acquisitions and divestitures and other strategic transactions, the seasonality of the company’s business, adverse weather conditions, future commodity prices, fuel and utility costs and availability, terrorists acts, consumer perception of food safety, changes in consumer taste and behavior, health epidemics or pandemics, changes in demographic trends, availability of employees, unfavorable publicity, the company’s ability to meet its growth plan, acts of God, governmental regulations, and inflation.”
June 9, 2008 9:25AM
By Elizabeth MacDonald
As expected, Lehman Brothers pre-announced its results today, reporting a $2.8 bn loss, or a loss of $5.14 a share for the second quarter ended May 31, 2008.
The stock is trending down in trading, as Wall Street’s smallest investment firm has expressed its dismay at its mounting losses. We reported to you last week that the firm would not disclose its full results until the week of July 16th, which Lehman says it will now do.
So far, shares have dropped to a five-year low. Already Lehman has cut 6,400 jobs since last July, or 25% of its workforce, with headcount down by 1,900 in just this quarter alone.
At the same time, Lehman said it will raise an additional $6 bn in capital. Lehman’s chief financial officer Erin Callan said on a conference call with analysts this morning that the firm asked itself, “what level of equity do we need to bolster the balance sheet, and stop the questions about our balance sheets? This capital raising has been done to end the questions and chatter about Lehman Brothers.”
However, despite the assurances, the question still on the minds of traders on Wall Street is this: “Is the worst over?” From what Fox Business’s Ken Sweet reports based on Lehman’s conference call with analysts, the answer remains unclear. More detail is at bottom.
Lehman’s $2.8 bn loss compares poorly to its first quarter net income of $489 mn, or $0.81 per share, and $1.3 bn, or $2.21 a share, for the second quarter of fiscal 2007. Analysts who track Lehman had been predicting a second quarter loss of about $300 mn.
I am updating this blog throughout the morning with the help of Fox Business reporter Sweet, who listened in on Lehman’s conference call. Sweet reports that Lehman’s Callan said on the call that “very importantly,” the “preliminary” results are “still subject to refinement and change,” with the full quarterly report due on June 16. Sweet reports that Callan added that the firm saw “no loss of counterparties or clients during the quarter.”
Lehman’s biggest hit came from marking down its asset-backed securities, a writedown of $4.1 bn. The largest chunk of that came from its securities backed by residential mortgages, a hit that amounted to a net $2 bn writedown. Fox Business’s Sweet reports that Callan said that the writedown occurred largely because of the collapse of the $3 bn Peloton hedge fund, run by two former Goldman Sachs star traders, as well as the Bear Stearns collapse, “which caused significant capital deterioration” in Lehman’s residential book of business.
Lehman’s remaining $2.1 bn writedown came from its commercial real estate, acquisition finance and other asset-backed positions. It also got a $400 mn gain from marking up its debt liabilities, legit under accounting rules. As expected, Lehman booked losses on hedges this quarter, “as gains from some hedging activity were more than offset by other hedging losses.”
Chairman and chief executive officer Richard S. Fuld, Jr., who earlier this year had said that “the worst is behind us,” said in a statement: “I am very disappointed in this quarter’s results. Notwithstanding the solid underlying performance of our client franchise, we had our first-ever quarterly loss as a public company. However, with our strengthened balance sheet and the improvement in the financial markets since March, we are well-positioned to serve our clients and execute our strategy.”
Moody’s cut Lehman’s rating outlook to negative, coming fast on the heels of S&P’s downgrade last week on Lehman to A from A+. Lehman announced plans to raise $6 bn of fresh capital from an array of investors, which reportedly includes the New Jersey Division of Investment, a pension fund. The capital infusion comes as Lehman has already raised $6 bn, including a boost to its long-term capital through the issuance of $4 bn of convertible preferred stock in April, a stock-bond hybrid that doesn’t dilute the ownership of common shareholders. That brings its total capital raise to $12 bn so far.
Fox Business’s Sweet reports that Lehman’s Callan said the capital raise was “substantially oversubscribed” and now “fully allocated,” adding the firm is “not going to use this raise to decrease leverage,” as the firm is satisfied with its leverage ratios. Callan said: “We stand extremely well-capitalized.” Callan also said that “deleveraging is complete, we don’t plan on reducing the balance sheet further.”
This morning, the firm announced it has priced a $4 bn public offering of 143 mn shares of common at $28 per share, as well as a $2 bn offering of two million shares of convertible preferred at a sweet 8.75%. So far, no word yet of an idea raised last week, a stock rights offering for employees, where workers can buy Lehman shares at a discount.
I’ve previewed what to watch out for in Lehman’s earnings in prior blogs, (”Questions About Lehman Brothers Continue to Mount,”and “The Fire-engine Red Flags at Lehman Brothers”).
Overall, Lehman says it has bolstered its liquidity pool to an estimated $45 bn from $34 bn at the end of the prior quarter. Lehman had well more than double the cash Bear Stearns had before its sale to JPMorgan Chase and well more than three times as much as Bear’s capital (Lehman is about twice the size of Bear Stearns). Still the firm has just $25 bn in shareholders equity against a huge $786 bn in assets and another $761 bn in liabilities.
Fox Business’s Sweet reports that Lehman’s chief financial officer Callan said Lehman cut its gross assets by about $130 bn, to $780 bn, plus that the firm cut gross leverage to under 25.0x from 31.7x (the multiple by which its borrowings exceed equity) at the end of the first quarter. Callan said: “I want to be clear at this point that we do not intend to lower our leverage ratios from these levels.”
Watch out for Lehman’s calculation of gross leverage ratio–the ratio is a figure that divides net assets by tangible equity capital. As I warned in a prior blog, Lehman is making this metriclook better by including junior subordinated notes, which are debt instruments, in its tangible equity capital, as it considers them “long-term” and thus “equity-like” in nature.
Also, keep in mind that a lower leverage ratio doesn’t mean bad assets won’t remain, or that firms won’t still make lousy bets. Bear Stearns’ seemingly had solid capital levels due to what it thought were still decent asset bets right before it nearly collapsed.
Back to the $130 bn reduction in its gross assets. Lehman said it delevered its exposure to residential mortgages, commercial mortgages and real estate investments by an estimated 15% to 20% in each asset class, and cut its acquisition finance exposures by an estimated 35%. Check out this exchange on the conference call between Lehman’s Callan and an analyst:
Analyst: “Listen, just to make sure, interpreting the $130 bn in asset reduction was mainly in the residential and commerical finance category?”
Callan: “Leverage finance is a more meaningful and a bigger number,” adding that much of what was sold were whole loans, not securities, with a big chunk coming from subprime and non-performing assets.
Analyst: “The $130 bn must be the absolute easiest to sell.”
Callan: “Just to give some anecdotal evidence, the vast majority of what we sold was whole loans, not securities. The whole loans had more transparency. The commercial side was very similar. We were selling the risk component of those assets.”
With these moves, Lehman is dumping much of the assets that had let it report soaring profit growth, better on average than many of its rivals. The cut still leaves about $100 bn of difficult-to-sell assets, including leveraged loans, on the balance sheet.
Next up are the illiquid assets Lehman can’t get a mark on, much like the rest of the firms on Wall Street, because the markets for them are still largely in a black-out.
Lehman’s total stockholders’ equity was an estimated $26 bn, and total long-term capital was approximately $156 bn. Lehman has not reported the amount of frozen solid, illiquid securities, called ‘level 3′ assets, which stood at about $39 bn at last quarter end, or two and a half times its shareholder equity. Watch to see whether this number will increase next week when Lehman reports. Why? Check out this exchange that just now took place on the analysts’ conference call with Lehman’s Callan:
Analyst: “Comment on the level 3, and the liquidation you have done, level 3 will be down materially?”
Callan: “It’s not safe to assume, certainly a significant portion went out to the door, and we did have some asset reclassification. The UK residential market lost its transparency, so that might go into level 3. It may not go down.”
That response then led to the question on Wall Street’s mind, which was posed on the conference call by Michael Mayo, a top bank analyst at Deutsche Bank. “How do we know that you’ve taken enough writedowns?” he asked.
Callan didn’t offer a percentage, but instead replied that the “aggregate number is very large,” and that Lehman was the “most active seller of assets this quarter,” adding that “unquestionably the price discovery we got was tremendous. We sold risky mortgages, not just the [triple] AAA assets.”
Callan added later that the “deleveraging did not create a meaningful P&L [profit and loss] event. We weren’t just selling assets at significant losses.”
Lehman said on the call that it took a write-down on its exposure to Suncal Cos., a California property developer as well as to Archstone-Smith, an apartment building real estate investment trust. David Einhorn, who runs Greenlight Capital and is short Lehman’s shares, has already raised questions whether Lehman is not taking sufficient writedowns to these exposures.
For now, Lehman is saying it is not accessing the Federal Reserve window, a window historically only open to deposit takers like banks. Even if the Fed shuts that window in September as planned (though many still think it will keep it open if needed), Lehman says it won’t run out of short-term funds. FBN’s Sweet reports that Callan said on the conference call that the firm had “tested the primary dealer facility, April 16 was when it was used, on an overnight basis.”
Meanwhile, the Fed and the Securities and Exchange Commission are checking Lehman’s books more closely, as well as other top firms on Wall Street. The extra scrutiny comes as Sheila Bair, head of the Federal Deposit Insurance Corp., and Federal Reserve chairman Ben Bernanke are said to be leaning towards tighter oversight of capital and risk management. Congress is expected to debate legislation that would overhaul financial regulation next year.
Footnote: Fox Business’s sister publication, The Wall Street Journal, reports that the stunning $2.8 bn second-quarter loss Lehman Brothers Holdings announced Monday stemmed in part from two big real-estate investments made at high prices near the top of the market that are coming back to bite the investment bank. Lehman joined with Tishman Speyer Properties last year to pay $22 billion for real-estate investment trust Archstone-Smith in the largest apartment-building deal ever, the Journal says. And in a series of projects, it teamed up with Irvine, Calif.-based land developer SunCal Cos. to develop and sell thousands of house lots to builders across Southern California. Some $1.6 billion worth of assets from those deals remain on Lehman’s books, the paper reported.
June 9, 2008 7:27AM
By Elizabeth MacDonald
Americans in this century have been barraged with more economic data than the prior four centuries combined, according to one analysis.
That information overload is fast turning into a form of information pollution. Some economists and experts now say the government consciously and systematically manipulates important economic data.
One of those experts who thinks the US let its economic reality check bounce a long time ago is Kevin Phillips, a political and economic commentator for more than three decades and onetime Nixon strategist.
A generation ago Phillips wrote “The Emerging Republican Majority” which Newsweek magazine described as the “political bible of the Nixon administration,” and previously has dissected the fakery in the government deficit numbers-federal, budget, current account and trade deficits-where he says that essentially the country is living on “borrowed prosperity.”
Phillips, author of “Bad Money: Reckless Finance, Failed Politics and the Global Crisis of American Capitalism,” (Viking, April 2008), says that the government has manipulated economic numbers to create a “make-believe economy” over the last four decades. Phillips says that since the ‘60s, Washington bureaucrats from both sides of the political aisle have pulled the levers behind the scenes to overplay the vitality of the US economy.
Now do I personally expect all data to be perfect? No, it’s silly and simplistic to think that way. I also don’t think there is any grand conspiracy here. I personally get an allergic skin reaction to the hysterical, hand wringing Emily Litella business journalists whose self-righteous stubbornness and aversion to nuance often drains them of all common sense.
Phillips too is careful to say there is “no vast conspiracy here,” just what he calls “Pollyanna creep,” a phrase coined by John Williams, a California-based economic analyst and statistician.
“Pollyanna creep” arose from the subtle changes to calculations of economic data that you should be aware of. The methodologies use to arrive at economic data we take for granted as fact are less than exacting. They can produce jarringly wide differences in results-often what Mark Twain once called the difference between a firefly and lightening.
Take inflation. Phillips says the government’s manipulation has engendered a fake, low inflation world which fueled low interest rates which unwittingly ignited a debt boom, from colossal government borrowing that’s created what I call a Supersize-me government to the junk bond fiasco to the S&L crisis to today’s housing and credit bubble. He also says the true economic growth rate, GDP, has been overstated.
Specifically, Phillips targets three of the most closely watched and what he says are highly manipulated economic measures: The consumer price index, which tracks inflation; the gross domestic product, which tracks the economy’s overall growth; and the monthly unemployment figure.
Phillips says that, once you vacuum out the nonsense, inflation is really at 5% (instead of 2%), average annual GDP growth is in the 1% range (instead of the 3% to 4% range), and unemployment is really at 8% (instead of 5%).
Phillips clearly experiences particular acid reflux for the way the government calculates inflation, notably the fake “core” inflation rate which excludes food and energy costs.
Even the Federal Reserve Bank of Philadelphia and the Wharton School at the University of Pennsylvania, in a research piece within the past two weeks, blasted this fake inflation rate: “We find that food and energy prices are not the most volatile components of inflation and that depending on which inflation measure is used, core inflation is not necessarily the best predictor of total inflation.”
And in his surprise statements about the need for a strong dollar last week, Federal Reserve chairman Ben Bernanke gave an unusual argument-he focused on high headline inflation, not core inflation when he noted his concern that rising inflation could directly unsettle inflation expectations, a Fed worry for some time now.
Suspiciously low inflation can dupe investors into buying treasury bonds that in reality have lower real or after-inflation yields. The breakeven inflation rate, or the difference between yields on conventional and inflation-linked bonds, on five-year treasury issues is now 2.4%, the same range for the past four years. But if inflation is really higher, at say 5% annually, then bond investors are getting bamboozled into negative returns.
Phillips raises the specter of this boogeyman. That the federal government is purposely keeping the inflation rate falsely low in order to cut federal payments, from interest on the national debt to cost-of-living outlays for Social Security and disability payments, which are indexed to inflation. If inflation was calculated in the correct manner, Social Security checks would be 70% greater than they currently are, says Williams.
A low inflation rate also makes US GDP look a lot better, as quarterly increases in the dollar value of the country’s goods and services get attributed to greater output rather than higher prices.
The government also chucks into the GDP number its best guess of things like how much people can earn from a free checking account, or estimated values of employer-paid health-and life-insurance premiums, Phillips says.
Monkeying around with government data started in the early ‘60s, Phillips says, during the John F. Kennedy administration. It appointed a committee to weigh changes to unemployment data, at a time when unemployment was soaring.
Out-of-work Americans who had quit searching for jobs–even if this was because none could be found–were then labeled “discouraged workers” and excluded from the ranks of the unemployed, though they were previously classified as such, Phillips notes.
In fiscal year 1969, the Johnson administration, with Congress’s blessing, orchestrated a “unified budget” that chucked in taxpayers’ Social Security funds with the rest of the federal budget, a change that let the government get its mitts on taxpayer Social Security funds for the very first time to use for all sorts of spending programs, including pork barrel projects.
The move, though, masked emerging deficits in Social Security funds, as taxpayer funds that were drawn down were replaced with treasury bonds, essentially more government debt.
Next, President Richard Nixon asked his Federal Reserve chairman Arthur Burns, to concoct a new inflation number that would be split off from traditional headline CPI, dubbed “core” inflation, Phillips says.
This new-fangled “core inflation” would simply knock out, due to nettlesome “volatility,” nettlesome food and energy prices. The new number could be shouted from the hilltops and blasted through newspaper headlines whenever the true CPI number was terrifying. It’s a number the markets are still too obsessed with today, though some seem to be surfacing out of this delusion.
Let me digress here. Americans don’t buy gas and groceries with “core” dollars, as the Wall Street Journal editorial page rightfully notes. And the concoction that is core inflation is most fantabulous when you consider that it includes highly volatile items such as college tuition and health care costs, which are just as rocky, if not more so, than food or energy prices. Why not exclude these items too?
Moreover, the official core inflation stat ascribes nearly the same weight to food and energy as it does to expensive, volatile purchases such as cars and electronics, which consumers buy less frequently. Again, why not exclude all of these items too? Isn’t all of this further proof that this is a really fake number?
And doesn’t the obsessive focus on core inflation give a dangerously strong bias toward slashing interest rates to record lows, creating more toxic inflation?
When is the Federal Reserve going to be replaced by a computer, as economist Milton Friedman wanted in the ’70s?
I do go on. Let me continue with the cooked government data story.
In 1983, Phillips says the Reagan administration monkeyed around even more with inflation data, when the Bureau of Labor Statistics (BLS) decided that housing, too, was overstating CPI.
So, the BLS swapped in what it calls an “owner equivalent rent” measurement, what homeowners would pay to live in their homes if they were renters. But that number likely understated housing costs as it is based on overall rent, which stayed flat in most of the country during the housing bubble.
So, the government has cooked up its own housing inflation number that likely understates home prices, Phillips argues, and in turn has understated housing inflation during the recent housing boom by three to four percentage points.
Moreover, Phillips says in the 1990s, the CPI has been subjected to three other adjustments, all delivering a downward bias and all dubious:
*Product substitution: If flank steak gets too expensive, people are assumed to shift to hamburger, but nobody is assumed to move up to filet mignon, he says;
*Geometric weighting: Goods and services in which costs are rising most rapidly get a lower weighting for a presumed reduction in consumption
*And, most strangely, hedonic adjustment: An unusual bit of monkeyshines by which the government says that product improvements in things like computers, cell phones or television actually amount to a reduction in price, so a $2000 laptop with a built in camera is less expensive than a $1500 laptop without one.
Pollyanna creep in the inflation data continued under the Bush administration. In 2006 it stopped publishing the M-3 money supply numbers, which captured rising inflationary impetus from bank credit activity, Phillips says.
Under the Clintons, Phillips says, the nation’s employment figures were massaged and kneaded too.
In 1994, the Bureau of Labor Statistics redefined the work force to include only that small percentage of what it called “discouraged workers” who had been seeking work for less than a year, Phillips says. The longer-term “discouraged”-some 4m U.S. adults who simply are not working-fell out of the main monthly tally. Some now call them the “hidden unemployed.”
The Clinton administration also dropped the number of households sampled for the data, from 60,000 to 50,000, making the number more rickety.
But a disproportionate number of the dropped households were in the inner cities. So, along with a new adjustment formula that is believed to also have cut black unemployment estimates, poverty figures get to look a lot less worse, Phillips says.
As for the way gross domestic product is manipulated, just check out one method the government uses to arrive at this number, the adjustments made to calculate the launches of new businesses and the ending of old ones, Phillips notes.
Since the government can’t pay for bureaucrats to roam every market in the land, a calculation does it for them. Watch how this plays out in the data the government reported that said payrolls shrank by just 20,000 jobs in April, and that the unemployment rate dropped to 5% from 5.1%.
Check this out. Recent job losses would have approached 287,000 if not for the government’s use of the so-called ‘birth-death’ model, which adjusts jobs added or lost by estimating the number of businesses that either launched or were shuttered each month.
By this measure, the financial services sector added 8,000 jobs in April at a time when its estimated 36,000 have already been laid off, with an estimated 24,000 more layoffs coming. The government then suddenly said the economy lost 3,700 financial services jobs. It said too that in April the construction sector added, get this, 45,000 jobs. Then suddenly in May it said construction shed 34,000 jobs.
Take a dramamine.
June 6, 2008 5:14PM
By Elizabeth MacDonald
The embarrassing shareholder class action lawsuit filed by the pensions funds for Detroit policemen and firemen as well as its city workers against Yahoo! spells out not just what it calls a web of cushy interlocking relationships and rich pay for the board members, but what it says is the real reason why Yahoo!’s board rejected Microsoft’s $33 a share offer to buy the Internet giant.
Read on. It’s a good one.
The lawsuit created headlines this week as it contained allegations that the board and Yahoo! chief executive Jerry Yang had enacted a brand new employee compensation plan that acted as a deal spoiler, as it could have encouraged employees to walk out en masse for “any good reason,” including changes in job titles, with total payouts reaching as much as $2.4bn, including accelerated stock and stock option vesting for all employees, all sums an acquirer such as Microsoft would have to pay (the reason why Microsoft said it set aside an extra $1.5bn to do the deal).
Already, billionaire activist investor Carl Icahn, who has invested in Yahoo! in a bid to try to unseat its board, says Yahoo!’s new employee severance plan is an indication that Yahoo! is trying to “sabotage” a Microsoft deal.
For more of the nasty details of this fight, and the details are illuminating, see my blog “Why Icahn Now Wants to Boot Yahoo!’s Jerry Yang.”
Yahoo! responded to Icahn, stating in part: “We again note that (Icahn) has no credible plan to operate Yahoo!” and that eliminating Yahoo!’s severance plan would have a “destabilizing impact” on the company, adding that publicly putting a price tag on itself is “ill advised,” according to the response.
Amidst the squabbling, Icahn on Friday urged Yahoo! to sell itself to Microsoft for $34.38 a share. The board won’t like that deal price either, though.
The lawsuit says that the board directors who are not employees of Yahoo! have an incentive to reject Microsoft’s $33 a share offer or any bid in that vicinity.
That’s because it alleges that 80% of the value of the director’s compensation in fiscal 2006 and over 70% in fiscal 2007 came in the form of stock options that had strike prices either at or below the $33 a share bid, so the offer would hardly make them any money.
Specifically, the suit says each director got 50,000 Yahoo! stock options with an exercise price of $36.75 in May 2005, 15,000 options with an exercise price of $32.92 in May 2006, and 15,000 options with an exercise price of $27.05 in June 2007.
So the board members’ 2005 and 2006 options would be essentially worthless at a bid of $33 a share, and the 2007 options would be worth just $90,000 per director, the suit says.
However, the lawsuit goes on to say that the Yahoo! board “can be characterized by extravagant compensation and business relationships that have only benefited the top executives” and comprised of “friends” of Yang.
Yahoo! spokesman Brad Williams says: “We can’t comment on these excerpts specifically,” adding that “generally, many of the allegations in the complaint,” he says, “are based on rumors and speculation by parties outside Yahoo! Inc. We believe the case is without merit.”
Here’s a rundown of the Yahoo! board members and their inter-relationships, according to the lawsuit. I am assisted in this coverage by ace Fox Business reporter Cristine Ambrose:
Roy J. Bostock: Has served on Yahoo!’s board since 2003 and became non-executive chairman of the board on January 31, 2008. Bostock received compensation worth almost $650,000 for serving as a Yahoo! director in fiscal 2006 and compensation worth $499,264 in fiscal 2007. As non-executive chairman, he receives an additional annual cash fee of $275,000. Bostock is also chairman of the board of Northwest Airlines, having succeeded co-Yahoo! director Gary Wilson in 2007.
Gary L. Wilson: A Yahoo! board member since November 2001. Wilson received compensation of over $482,000 for the fiscal year 2007, and about $588,000 for 2006 for serving as a Yahoo! board member. Wilson has numerous ties to Bostock. They were roommates at Duke University, are both trustees of Duke and serve on the boards of the NCAA Foundation and Northwest Airlines. The two also serve on the advisory board of NeoSpire Corp., a managed hosting company co-founded by Wilson’s son, Derek Wilson, and with which Yahoo! does business.
Ronald W. Burkle: Has served as a member of the Yahoo! board since November 2001. He got paid $588,000 in fiscal 2006 and $482,046 in fiscal 2007 for serving as a Yahoo! board member. He also serves as well as board member of Occidental Petroleum Corp.
Eric Hippeau: Has served as a Yahoo! director since January 1996. Hippeau received compensation worth about $606,000 in fiscal 2006 and $496,674 in fiscal 2007 for serving as a Yahoo! board member. Between May 2000 and October 2007, Hippeau made almost $27 mn by exercising Yahoo! stock options and selling the related shares, according to data from Vickers. Hippeau has numerous business dealings with CEO Jerry Yang and Yahoo! Hippeau is managing partner of Softbank Capital (”Softbank”) which holds a large amount in Yahoo!’s lucrative Asian operations: Yahoo! Japan and the parent of Alibaba.com. Yang is also on the board of Alibaba.com and Yahoo! Japan. He is a co-founder of the company and Chief Executive Officer.
Jerry Yang: Co-founder and chief executive, replaced Terry Semel, whose 2006 compensation package of $71.7 mn enraged shareholders who alleged he was being unreasonably rewarded while the company lost itself in the fast-growing advertising market. Yang gets a $1 token annual payment he has accepted for years, but that’s because the Internet company which he co-founded already has made him a billionaire. Yang’s stake in Yahoo! by some estimates is currently worth $1.5 bn. And Yang isn’t the only Silicon Valley billionaire who work for a $1 salary each year. Apple CEO Steve Jobs and Google co-founders Larry Page and Sergey Brin all do, too.
Yang and Hippeau served together on a board of Ziff-Davis, of which Hippeau served as CEO and board of chairman from 1993 until at least 2000. In connection with Softbank’s investments, Hippeau also serves on the board of directors of several companies that have business relationships with Yahoo!, including PureVideo, a network of video websites; Goodmail Systems, creator of a service for trusted e-mail delivery; and Beliefnet, a website devoted to spiritual beliefs.
Vyomesh Joshi: Served as a Yahoo! director since July 2005. Joshi received compensation worth about $600,000 for serving as a Yahoo! board member in fiscal 2006 and $520,000 in fiscal 2007. Joshi is executive vice president of Hewlett Packard, a company with which Yahoo! has a long-standing business relationship.
Arthur H. Kern: Joined the Yahoo! board in January 1996, shortly before Yahoo! became a publicly traded company. Kern received compensation of almost $500,000 for the fiscal year of 2007 and over $600,000 for fiscal 2006 for serving as a Yahoo! board member and committee chairman. Outsiders believe that most of Kern’s wealth and success is linked to his affiliation with Yang. Kern has made some $113 mn by exercising Yahoo! stock options and then selling the related shares. In January 1996, Kern received an option to purchase 114,068 shares of Yahoo! stocks at an exercise price of $1 per share (not adjusted for subsequent stock splits). In addition, he received options to purchase 40,000 Yahoo! shares under the Company’s 1996 director’s stock option plan, once again not adjusted for splits
Robert A. Kotick: has been a director of Yahoo! since March 2003. Kotick received compensation $492,774 for the fiscal year of 2007 and over $629,000 for 2006 serving as a Yahoo! board member. Kotick is chairman and chief executive officer of Activision, a company in which Yahoo! does business. Activision makes video games.
Edward R, Kozel: has been a member of the Yahoo! board since October 2000. Kozel received compensation of $516,202 for the fiscal year 2007 an almost $620,000 for the fiscal year 2006 serving as a Yahoo! board member. Kozel is chief executive officer of Sky Ryder, a company with which Yahoo! does business. He is a non-employee director of two entities in which Yahoo! does business: Network Appliance and Reuters Group. Yang and Kozel have been involved in multiple business ventures together for several years, and have served together on the boards of Cisco, American Internet, Pipelinks and Combinet. Yang and Kozel also both served in an executive capacity for Growth Networks.
June 6, 2008 7:53AM
By Elizabeth MacDonald
The US housing data is all over the map. The disparate data comes as federal regulators grow increasingly concerned that banks with swelling portfolios of troubled loans tied to land and housing are struggling to unload some of their real-estate debt.
Exactly where house prices are is important information the markets need now. Goldman Sachs looked at 24 house price busts with declines of more than 15% since the ’70s across 15 countries. On average, real house prices tended to fall around 30% and only bottomed out after six years. That’s pretty much what the market is looking for.
Standard & Poor’s widely followed S&P/Case-Shiller index says that house prices are now down 16%, in nominal terms, from the peak hit in the second quarter of 2006. Housing prices rose 132% from 1997 to peak by the end of the first half of 2006, the biggest housing boom in US history, the index says.
But according to available data from the Office of Housing Enterprise and Oversight, U.S. home prices have declined by a seasonally adjusted 3.9% after the index hit its peak in April 2007. That’s right. Just 3.9%.
What gives? There are wide disparities in how each housing price index is calculated.
The S&P/Case-Shiller home price index is thought to be intrinsically gloomier than most housing indices because it only uses purchase prices from sales of homes. It doesn’t factor in new appraisals from refinancing deals or remodeling values.
The S&P/Case-Shiller indexes are value-weighted, meaning that price trends for more expensive homes have greater influence on estimated price changes than other homes. It’s notably pessimistic as it’s now heavy with distressed transactions of homes backed by jumbo loans along with those backed by subprime loans. Case-Shiller also lags the market by about four months, so we’re seeing prices for January.
Meanwhile, the government home-price data from OFHEO do not include jumbo and subprime mortgages as Case-Shiller does. And the geographic coverage of the indexes differs.
OFHEO’s U.S. index is calculated using data from all states. OFHEO offers data for over 400 different census, state and metropolitan statistical areas versus only 20 major metro areas for the CSI. However, critics say OFHEO data is thin in hard-hit markets like Florida and California.
The quirks in housing data don’t stop there. The Commerce Dept. recently reported that sales of newly constructed single family homes rose in April for the first time in half a year. Sounds great right? Wrong. Buried in the data is the fact that the prior six month’s data were revised downward, so it made the comparison look a lot better.
The housing data matter in particular for banks trying to set up the right loan loss reserves. Wachovia in mid-April cited the milder OFHEO data to forecast that the U.S. housing crisis would end in “mid-2009″ and that prices would fall an additional 6.8% before then, or 12.9% from their peak, the Wall Street Journal reports. Mid-April was when the Charlotte, N.C., bank reported a first-quarter loss and raised $8b.
Similarly, when Seattle-based Washington Mutual posted a $1.14b net loss for the first quarter, chief executive Kerry Killinger used Case-Shiller data to show investors the magnitude of declines in housing prices. But when WaMu assessed the current value of properties backing its mortgages, WaMu used OFHEO data, the presentation’s footnotes suggest, the Wall Street Journal reports.
That’s just a sample of some of the dubious data that’s been on my mind. Here’s more:
- A critically important market for derivatives, the credit swaps market, now approaches an estimated $65T. But nobody in this galaxy knows what the exact figure is, instead, computerized black boxes loaded with algorithms and ‘binomial trees’ conduct these trades away from the major exchanges, leaving market regulators in the dark;
- Oil supply and demand data tracking systems in emerging markets such as Russia, India and China are either as transparent as a vat of molasses or simply don’t exist, causing oil prices to whipsaw as speculators try to fill in the blanks (see prior blog “Why Suing OPEC Won’t Work “).
- Similarly, OPEC’s output data is unreliable, often because member countries don’t want to admit they’re producing above OPEC’s quotas. The markets must then rely on data from unofficial “tanker trackers” like Lloyds Maritime Information Services or Petro-Logistics SA, a teensy company that operates upstairs from a grocery store in Geneva, Switzerland.
- Watch China’s poor oil data. There are thousands of so-called teapot refineries all over China” that are left out of China’s official statistics, Business Week reports. China appears to be creating a strategic stockpile of oil, but has never acknowledged it, says Eduardo Lopez, senior demand analyst for the Paris-based International Energy Agency, an affiliate of the OECD. Lopez says Russia produces “awful data” and reliable demand statistics are scarce in countries like India and Indonesia.
- The scarcity of good global data is a key reason why it’s impossible to know for sure whether the next “super-spike” in oil in the coming three or four years will be up to $200 or more…or down to $80 or less.
- Over the past 25 years, actual federal tax revenues in any given year have averaged $150 billion (in today’s terms) above or below the revenue levels that the Congressional Budget Office predicted a year in advance, analysts note, due to static, not dynamic, estimates.
June 6, 2008 7:48AM
By Elizabeth MacDonald
Lehman Brothers is considering releasing its second-quarter earnings a week earlier, tying that announcement to news about a plan to raise capital, as the embattled investment bank looks to quiet doubts about its future.
Lehman (LEH) could announce a $5 bn capital raise early next week in advance of what may be its first quarterly loss since going public in 1994. Talk is that Lehman is approaching a US pension fund as well as investors in South Korea and China.
The $5 bn is higher than estimates earlier in the week of $3 bn to $4 bn in a possible capital raise. Michael Mayo, a top bank analyst at Deutsche Bank, says he expects a $4 bn capital raise to deal with second quarter losses after $2.9 bn in credit market writedowns. That could equate to a quarterly loss of about $200 mn.
The funds would help avoid another ratings downgrade, as Standard & Poor’s has recently downgraded the firm due to anticipated write-downs, problems with hedging and its leverage ratios.
Sources have dismissed one idea, that Lehman will do a stock rights offering, where employees receive a right to buy the shares at a discount. Instead Lehman is seeking out other sources, as the amount of capital raised in a rights offering may not be sufficient. Lehman has already raised $4 bn selling preferred stock in April.
The capital raise comes as two Federal Reserve Bank presidents, the Richmond Fed president Jeffrey Lacker and the Philadelphia Fed president Charles I. Plosser, warned on Thursday the Fed’s decision in March to lend to Wall Street securities firms could create future financial crises. The Federal Reserve is on schedule to shut the new Fed facility, put in place after the near-collapse of Bear Stearns, in September.
Lehman says it has more than $40 bn in liquid assets, up from $34 bn in the prior quarter. It also says that its holding company had unencumbered assets of $64 bn and its regulated units had $99 bn at the end of the last quarter. It had $7.6 bn in cash and equivalents on the balance sheet as of the last quarter.
The questions about Lehman’s prior quarterly results continue to mount. David Einhorn, who runs Greenlight Capital hedge fund and is short Lehman, as well as other analysts on Wall Street are poring through Lehman’s results and are finding a growing number of discrepancies (see bottom).
Besides the discrepancies, when Lehman reports second quarter results, keep tabs on its sagging balance sheet, watch whether its assets and liabilities have risen, watch too whether its leverage is dropping (it says its at 25:1) and also watch potentially quirky, though legit, accounting moves that made its important valuation measures look better (see blog, “The Fire-Engine Red Flags at Lehman Brothers).
With volume heavy recently at 133 million shares, more than four times the usual, in just the past three days, Lehman’s stock has fallen 18%, dropping to its lowest level since August 2003.
Lehman’s total assets of $786 bn at the end of its fiscal first quarter were up 14% from the fiscal fourth quarter of 2007 and a steep 40% a year earlier (it is now about twice the size of Bear’s assets at $399 bn). Of that sum, a big $695 bn was for its financial instruments and collateralized agreements. Sanford Bernstein estimates that one third of Lehman’s assets are “illiquid” or “less liquid.”
Lehman also had $761 bn in total liabilities (versus Bear’s $387 bn). Lehman, like other firms, now seeks to delever its balance sheet. As we reported to you early Wednesday morning, it has sold $100 bn in assets, cutting its leverage ratio to 25:1 from 31.7:1. But it faces a frozen market already struggling to digest the potentially $500 bn in assets Citigroup (C) is also seeking to dump.
Questions swirl around the size of a potential writedown at Lehman, specifically with regards to Lehman’s exposure to an estimated $6.5 bn worth of potentially collateralized debt obligations and its gauge of illiquid assets, called level 3 assets (the quarterly marked the first time Lehman disclosed its CDOs).
According to a footnote in Lehman’s last quarterly report, its CDO book has exposures “to franchise lending, small business finance lending, or consumer lending.” With that disclosure, there seem to be no residential mortgages, despite the fact there is no explanation of how Lehman defines ‘consumer lending.’
How much of that sum could be written down? The footnote says “approximately 25% of the positions held at February 29, 2008 and November 30, 2007 were rated BB+ or lower (or equivalent ratings) by recognized credit rating agencies.” That means $1.6 bn could be at risk as they are below investment grade.
Einhorn says he queried Lehman’s chief financial officer Erin Callan about this, and that Callan declined to explain the “modest” writedown, but “instead stated that based on current price action, Lehman ‘would expect to recognize further losses’ in the second quarter.”
The small $200 mn writedown comes as Lehman reported in its last quarter $40.2 bn worth of illiquid assets for which management could not get a price tag on, and instead relied on its own internal models to value, called level 3 assets. That sum is up from $38.88 bn in the fourth quarter of 2007.
According to Einhorn, Lehman provided different level 3 sums in its investor conference call about its last quarterly report versus what it posted in its filing.
For example, in its last quarterly report, Lehman said it had $228 mn of realized and unrealized gains. Einhorn though says that Callan said on the conference call that Lehman actually had an $875 mn loss instead. He says he “asked Lehman, “did you write-up the level 3 assets by over a billion dollars sometime between the press release and the filing of the 10-Q?” and that it replied “no, absolutely not.”
Einhorn says in a follow-up e-mail that Lehman said “that the movement between the conference call and the 10-Q is ‘typical’ and the change reflects ‘re-categorization of certain assets between level 2 and level 3.’” How such a “re-categorization” created a $1.1 bn swing is the question.
In addition, Lehman booked a $722 mn gain last quarter in its $8.4 bn portfolio of level 3 corporate equities, despite the fact that during the quarter the S&P fell 10%.
Einhorn says: “This is particularly odd since about one-quarter of this bucket is Archstone-Smith, a multi-family REIT that Lehman says it wrote down by a sizable, but undisclosed, amount.”
Einhorn says Lehman attributed the gain to a large profit on a pre-IPO financing round for KSK Energy Ventures Limited, a power development company in Asia that operates three small power plants. According to Lehman, it booked a $400 mn to $600 mn unrealized gain on the investment in the first quarter.
But Einhorn says Lehman eventually only bought the stake for $86.5 mn in January. How does an asset rise to nearly $600 mn from just $86.5 mn in less than six weeks?
It appears Lehman may be using a valuation for KSK that estimates what Lehman says it would want to sell the stake for if the company eventually does go public, which it has yet to do.
Einhorn says when he pointed out the discrepancy, Callan told him that “during the first quarter ‘a new party’ came in and completed a pre-IPO round in February at a much higher valuation than Lehman paid. She said Lehman valued the stake at a 30% discount to where the new party came in to reflect the restricted securities Lehman held.”
But Einhorn says that KSK Energy Ventures filed a “prospectus in India on February 12, 2008 that revealed a different set of facts” with smaller numbers.
He says the prospectus shows that instead, “Lehman had made an initial $112 mn investment in KSK Electricity Financing in November 2005. The company completed a restructuring on January 20, 2008, through which Lehman sold its original investment for a gain of about $65 mn.
It then “concurrently purchased about one-third of KSK Energy Ventures for $86.5 million. The only other significant shareholder, KSK Energy Limited, owns 65% of the remaining equity and did not contribute capital during this round.”
Einhorn says he “confronted them [Lehman] with the evidence that there was no subsequent round and that Lehman was the lead, if not the only, investor in the January restructuring. Suddenly, the story changed.”
He says that “management responded that it was ‘not sure’ if Lehman was the lead on the round. It took what it ‘thought was the most conservative approach at the time and the low end of what all those data points produced.’ Management followed-up in an e-mail stating that in February it had ‘revalued’ its January investment based on a variety of analyses,” including forward cash flow multiples, an analysis of comparable companies and a third-party research report. Einhorn says one of his partners noted: “This seems like one helluva power plug!”
Additionally, Lehman had $39 bn of exposure to commercial mortgages at the end of last year year. But during the last quarter Lehman marked down its level 3 mortgages by $750 mn, or only 3%, Einhorn says, despite Lehman saying that only about a fifth of the level 3 mortgage assets are in markets that performed well, such as in Asia, with the rest representing many low quality assets. Remember, management gets to price-tag illiquid assets when the markets for them freeze up.
Einhorn says that the index of AAA commercial mortgage backed securities declined about 10% in the quarter. Lower rated bonds fell even further. “Since Lehman’s portfolio is less than AAA, it would seem its write-down probably should have been more than 10 points,” versus “less than three points gross,” he says.
Einhorn adds that “part of the commercial mortgage exposure is a venture called SunCal, where Lehman is a lender and equity investor. SunCal is a large land developer, principally in California’s Inland Empire. This is one of the hardest hit housing markets in the country. A number of publicly-traded home builders have written land holdings in this area down to pennies on the dollar,” but that “Lehman has not disclosed a material charge on its SunCal investment.”
June 4, 2008 9:21AM
By Elizabeth MacDonald
Lehman’s second quarterly earnings, due the week of June 16, are expected to be vastly more negative than its prior quarter, in which Lehman beat earnings expectations and told Wall Street it has lots of liquidity to weather the credit storm.
The markets then heaved a sigh of relief, given the suicidal feeling on Wall Street at the time due to Bear Stearns’ near collapse.
Though Lehman is expected to report strong revenues and market-share gains in a variety of businesses, here’s what you should watch out for. I’ve bullet-pointed them below.
Ignored in Lehman’s first quarter results was its sagging balance sheet, the fact that Lehman’s assets and leverage had risen and also its quirky accounting moves that made its profits and important valuation measures look better. All perfectly legit under the accounting rules, I’ve warned you about the growing use of accounting gimmicks on Wall Street (see “Bankers Cry Uncle” and “Merrill’s Neat End-Run”).
Ignored in its first quarter figures were Lehman’s tiny writedowns on its most-watched securitized assets of just $200m, which has since drawn growing criticism that the firm is moving at a glacial pace to mark down the value of degraded inventory in the form of bad assets on its balance sheets, assets backed by sour residential and commercial mortgages and other credits.
Talk now is that Lehman’s balance sheet is so damaged from bad real estate loans and other credit–it has traded recently below book value–that Lehman may be forced either to issue more dilutive equity, or sell a part, or all, of itself to a larger firm.
Yesterday shares in Lehman traded down as much as 15% on rumors that it is doing possible emergency capital raising of as much as $4b in advance of potentially bigger writedowns when it reports within two weeks. Potential investors named include the Korea Development Bank and Woori Financial Group of South Korea, also CV Starr, the investment vehicle of Hank Greenberg, former chairman and chief executive officer of AIG, and China’s State Administration of Foreign Exchange, reports say.
Lehman told Fox Business’s Liz Claman yesterday that it doesn’t need to raise capital and that “it has no plans to do so.” It has already raised $8b, it says it has more than $40b in liquid assets, up from $34b in the prior quarter. It also says that its holding company had unencumbered assets of $64b and its regulated units had $99b at the end of the last quarter. It had $7.6b in cash and equivalents on the balance sheet as of the last quarter.
And while it now has access to funding from the Federal Reserve, Lehman has quelled rumors it’s on the brink by stressing it has not gone to the Fed for funds, having only done a test run at the window in mid-April.
However, the stock is now down about 60% from its peak and the potential capital raise, estimated at $4b, would be about a quarter of its $17b market cap. Its market valuation is down from $45b within the past year.
Yesterday’s trading alone vaporized $1.7b off of Lehman’s market cap, and the closing price was Lehman’s lowest since the summer of 2003, though losses would have been worse absent the stock buybacks the firm did yesterday.
Hold on to this cheat sheet when Lehman reports its quarterly earnings in coming weeks:
*Lehman’s teensy write downs. Lehman ended the prior quarter with $67.9b of real estate assets, including residential and commercial loans. It had $39b in illiquid assets that swamp its shareholders equity by about one and a half times, called level 3 assets (see blog “What to Watch Out for at Lehman,” and “The Answer to Who’s Next on Wall Street”). But it only took a $200m writedown in the first quarter, disclosing too that it had $6.5b in “other asset-backed securities,” which includes potentially $1b in toxic collateralized debt obligations. These numbers are important. Lehman also had $14.6b in prime and Alt-A (considered one step away from subprime) mortgage assets last quarter, up from $12.7b in the prior quarter. Watch to see if Lehman continued to increase that line item–sort of like Citigroup’s ousted chief executive, Chuck Prince, saying he’s continuing to “dance” in subprime last summer.
*Lehman’s sagging balance sheet. Lehman’s total assets of $786b at the end of its fiscal first quarter was up 14% from the fiscal fourth quarter of 2007 and a steep 40% a year earlier (that’s nearly twice the size of Bear’s assets at $399b). Of that sum, a big $695b was for its financial instruments and collateralized agreements. Sanford Bernstein estimates that one third of Lehman’s assets are illiquid or “less liquid.” It also had $761b in total liabilities (compared to Bear’s $387b). Lehman now seeks to unload damaged assets, with a reported $100b sold, but it faces a frozen market already struggling to digest the potentially $500b in assets Citigroup is also seeking to dump. Lehman and the rest of Wall Street need to do so because their balance sheets are highly leveraged.
*Lehman’s high leverage ratio. This is a key measure. Gross leverage compares how much a company has borrowed versus its assets. It is defined as total assets divided by total stockholders equity. The higher the ratio, the less assets need to fall in value before a company’s equity is erased. Lehman says its gross leverage ratio is now at 25:1 versus 32:1 at the end of the first quarter. That means for every buck of assets, Lehman now says it had borrowed $25, down from $32.
Lehman has chopped that ratio down through more than $100b in asset sales, given that the 32:1 ratio in its first quarter was the highest ratio at Lehman since 2000, Sanford Bernstein Research says. That ratio was also much higher than the 28:1 it had recorded in the first quarter of 2007.
And although much of Wall Street, including Lehman, would like you to use a figure called net leverage which looks a lot better, (for Lehman, it was 15:1 in its first quarter, essentially flat versus the prior four quarters), don’t be fooled by that figure as it does not include hedges. Lehman has made wrong way bets on its hedges lately, calling into question its risk management procedures.
*Lehman now includes debt in its calculation of book value. What caught my eye was not just Lehman’s tiny $200m asset writedown, but also the way it measured its net worth, in which it included debt instruments as part of equity in order to add extra sheen to that valuation measure.
This is a key measure for Wall Street firms. Lehman concocted a new definition of its hard assets, what is known as “tangible equity,” to now include all long-term junior subordinated borrowings. To persuade you, it calls this debt ”equity-like” due to their “long-term nature.”
Translation: This is merely a weird debt instrument with no maturity date, in other words, they act much like an open-ended line of credit. Did those items help its leverage ratio? Yes. Prior to the last quarter, Lehman capped at 25% of tangible equity the amount of these gizmos as well as preferred stock that it included in its shareholder equity. In the fourth quarter Lehman did not include $237m of them, and $375m in the third. Now, no longer.
*Lehman booked profits on its liabilities. Yes, you read that right–it’s a perfectly legit accounting move (under SFAS 157 and SFAS 159) that tosses out the window the concept “quality of earnings.” Accounting rules let investment banks count as gains in profits the amount they forgo in their liabilities. When debt falls in value, companies get to book in earnings the difference. Lehman recorded $600m in profits from this move, again, allowed under accounting rules. Meanwhile, it posted $489m in profits. When you see accounting moves like these–again perfectly legit–you should ask, how healthy are the profits from continuing operations?
*Wrong way bets on its hedges. Lehman is estimated to have lost $500m to $700m on hedges in the second quarter, potentially widening its anticipated losses in the second quarter, losses that would be the first since Lehman went public in 1994. Lehman apparently used the hedges to offset losses in real estate and other credit.
Specifically, the firm reportedly bet that “indexes tracking markets such as real-estate securities and leveraged loans would fall. If that happened, it would book profits that would make up some of its losses from holding these securities and loans,” the Wall Street Journal reports.
Yet some of the indexes actually rose, even though the assets they were supposed to hedge against continued to lose value or stayed relatively flat. Coupled with Lehman’s losses from write-downs on assets and ineffective hedges, you may see a profit hit topping $2b, the Journal says. The paper added you may see more layoffs as well.
Footnote: You should ask yourself, how can any firm think it can hedge illiquid assets? Doesn’t this sort of sound like the “chaos trade,’ basically bets on chaos in the markets, that Bear Stearns entered into to hedge its risk exposures before it nearly collapsed? Shouldn’t Lehman just devote its energies to selling those frozen solid assets instead?
*Lehman’s put option trading has exploded. Trading of Lehman put options–options to sell the stock and profit if it falls–rose to nearly 284,000 contracts, four times the 20-day average, with bearish bets on Lehman topping bullish ones by 1.6-to-1, analysts note. Check this out: The most-active contracts were June $30 puts, which gained 68% to $3.35, according to one analysis. The open interest in Lehman puts is through the roof. Many of these strikes only pay off if Lehman collapses like Bear Stearns, with the bankruptcy strikes below $15, many expiring this month, implying traders think the clock is ticking (Lehman’s shares have already breached other put levels at $35).
June 3, 2008 9:00AM
By Elizabeth MacDonald
Billionaire investor Carl Icahn says he will seek to remove Jerry Yang as chief executive of Yahoo! if he succeeds in a proxy battle against the company over its failure to reach a deal with Microsoft Corp., the Wall Street Journal reports. Icahn has proposed an alternate slate of directors for Yahoo’s board, but has yet to directly target Yang, the paper says.
“It’s no longer a mystery to me why Microsoft’s offer isn’t around,” the Journal quoted Icahn as saying. “How can Yahoo keep saying they’re willing to negotiate and sell the company on the one hand, while at the same time they’re completely sabotaging the process without telling anyone?”
Icahn’s frustration evidently stems from a nasty shareholder class action law suit that is buzzing through Silicon Valley. Yahoo! tried to keep this embarrassing law suit secret, but failed. It’s a suit that could give more cannon fodder to corporate raider Icahn’s attempt to unseat the company’s board, as it purports to unmask what really went on behind the scenes at Yahoo! as it fought back Microsoft’s unwanted advances.
A Delaware chancery court judge has unsealed details of this embarrassing lawsuit filed against Yahoo’s (YHOO) directors, including chief executive Jerry Yang. The suit alleges they erected obstacles to thwart a takeover bid from Microsoft (MSFT).
The suit should make you rethink the “100-day” plan Jerry Yang promised when he assumed the chief executive position in June 2007, when former CEO Terry Semel left in the wake of a shareholder revolt. In that plan, Yang vowed “no sacred cows.” Instead, the suit shows that Yang made all of his employees expensive “sacred cows” in a bid to thwart Microsoft.
The web site of the law firm Bernstein Litowitz Berger & Grossmann LLP, which represents the investors (the pension funds for the Detroit policemen and firemen as well as Detroit’s city employees) have posted a copy of the complaint on its website, as well as a copy of the judge’s letter explaining his decision to unseal the filing. See http://www.blbglaw.com/complaints/YahooFirstAmendedVerifiedComplaint-Unsealed-5.12.08.pdf
It’s a suit I had told you about in a prior blog that Yahoo! had fought to keep sealed, as it was concerned it could damage the board’s efforts to repel a challenge by activist investor Icahn, (”Why Yahoo! Can’t Go it Alone,” see also “Why Carl Icahn May Fail at Yahoo!”, “Why Microsoft Should NOT Up its Bid for Yahoo!”).
Microsoft initially offered $31 a share for Yahoo!, then later upped it to $33 per share, or $47.5b. It then withdrew its offer when Yang and his cohort held out for $37 per share. Legg Mason money manager Bill Miller, whose fund is one of Yahoo!’s largest shareholders, has publicly said he would have happily supported a Microsoft offer of $34 per share. Yahoo’s shares closed yesterday at $26.40.
The shareholder suit, which has evidently gotten hold of Yahoo!’s internal emails and records of phone conversations and internal meetings, alleges Yahoo!’s board of directors breached their fiduciary duties and ought to be financially liable for rejecting the Microsoft bid and for deliberately enacting “roadblocks” to make a Yahoo! “acquisition less attractive” to Microsoft.
The roadblocks came in the form of an alleged costly employee-severance plan for 13,800 Yahoo! workers that Microsoft would have to pay in the event it bought Yahoo! The suit also alleges Yang “engineered an ingenious defense creating huge incentives for a massive employee walkout in the aftermath of a change in control.”
The “rich” new compensation plan would purportedly have made it easier for Yahoo! employees to quit Microsoft en masse, and get Microsoft to pay them upwards of a total of $2.4b in severance benefits, depending on the deal’s price, the suit says.
The plans would have given Yahoo!’s 13,800 employees anywhere from four months to two years of pay, depending on their employment level. Usually top executives get full severance pay in a deal, not all employees, as incoming management seeks to seat its own top guns.
In addition, the Yahoo! change in compensation would let employees easily walk out the door for any “good reason,” by claiming “a substantial adverse alteration” in job duties or responsibilities. Moreover, employees could quit and get accelerated vesting of their stock and stock options after a change in control.
According to notes the plaintiffs’ lawyers say they received in discovery, one Yahoo! vice president wrote that it is “a bizarre outcome if people who stick around make off worse financially than people who [are] laid off.” The suit attaches an email from Yahoo!’s senior director of integration and corporate development, Jonathan Dillon, who wrote that the new plan “will make things increasingly expensive for msft [sic] though.”
Yahoo!’s newly hired chief technology officer, Ari Balogh, allegedly objected to Yang’s new plan, the suit says. The suit also alleges Yang “chose to keep from Yahoo!’s employees the details of Microsoft’s own retention plans” secret by keeping Yahoo!’s senior human resource executives and advisors in the dark about it, and instead conducting closed door, “closed session” meetings with board compensation committee members.
The extra compensation costs would have made it prohibitively expensive for Microsoft to buy Yahoo!, who would have to foot that bill. Every $1.4b in severance cost theoretically would translate into about $1 per share less that Microsoft would have available to offer Yahoo shareholders.
Yahoo!’s new plan is the reason why Microsoft suddenly said it would earmark an extra $1.5b in retention pay to keep Yahoo! employees in the door in order to get the deal done, in addition to its then $45b offer. In an April 5, 2008 letter, Microsoft’s Steve Ballmer criticized Yahoo!’s board for adopting the severance plan, which he said “made any change of control more costly.”
Compensia, the outside compensation consultant Yahoo! hired to review the change, apparently wasn’t having any of this, though. An email exchange dated February 5 that’s attached as records to the suit shows Compensia principal Michael Benkowitz wrote “their [Yahoo!] latest proposal is to provide 100% equity acceleration for everyone,” to which his colleague Tim Sparks emailed back, “That’s nuts.”
Yang insisted on a more expensive plan than his human resources executives originally wanted, the suit says, by also “providing full” 100% “acceleration of all equity-based compensation ever granted to all employees,” with the blessing of Yahoo! president Susan Decker, the suit alleges. That would include accelerating their stock options and restricted stock rights.
The suit says Yahoo! estimated that Microsoft would have to pay severance benefits to all employees at a cost ranging from $2.1b (at the offer price of $31 a share) to $2.4b (at $35 a share) if they quit en masse, according to the unsealed court documents.
The outside compensation consultant hired to review the change, Compensia, was allegedly worried “about the breadth of the program,” and wrote an email expressing “surprise,” about the acceleration of stock-based grants, the suit says.
Footnote: The plaintiffs assert that in January 2007 Microsoft offered to buy Yahoo! for $40 a share, but that the proposal was rejected in a letter from then-CEO Terry Semel, who instead proposed “a commercial partnership arrangement.”
