Lehman Brothers May Be Following Along Bear Stern's Path

Lehman Brothers is another investment institution that took heavy losses in the sub-prime drama that is still rocking the home ownership markets. After taking steps toward solid ground and stabilizing in the $30 per share range, Lehman raised $4 billion through a preferred stock option while its traders took actions to hedge any further loss for Lehman.

It turns out that those hedges were inadequate, actually causing the loss of another $2 billion, and Lehman is back to the position of holding serious talks about how to raise more capital. This time the option being considered is an offering of common stock to raise another $3-4 billion. The difference between a preferred stock offering and a common stock offering is that preferred stock does not dilute the existing market price being traded while an offering of common stock does dilute market price, thus lowering the value of the stock for those who already hold it: preferred and common stock trade separately and at independent prices.

The question is: Will investors in common stock believe in Lehman Brothers enough to generate $3 billion to $4 billion in new capital for Lehman? Generally, a good stock that is backed by a sound company that is trading far below its book value is a cheap and ready purchase, a good investment. The qualification to that comes if the company is trading so far below book value because it is threatened by bankruptcy.

One thing that stands in favor of Lehman's continuance is the fact that the Federal Reserve has re-instituted lending to investment banks. This policy has not been in effect since the 1930s and was reactivated a short time ago when JP Morgan stepped in to rescue Bear Sterns. The Fed feared a total financial industry collapse because the canker of the sub-prime catastrophe bore so deep and spread so far. Consequently, Lehman has almost unlimited access to the Fed lending window.

On the negative side, traders are heavily buying put options against Lehman that trigger at prices below $15 per share. In light of the fact that Lehman has been trading between 45 and 30, the put activity does not bode well for the market expectations of Lehman's overall health. Of course the puts, which are investor's bets that a stock price will fall within a set period of time (e.g., 2 months), could be speculation in anticipation of how deeply an offering of common stock will dilute Lehman's present price. If this is so, then the put activity at least indicates that traders expect Lehman to stay afloat, backed by the Fed lending window and new capital from a common stock offering.

It looks like it's a good thing that the Fed re-instituted a policy of lending to investment banks. Of course, one possibility for Lehman's future is that another entity will step in and buy them out, in which case they will follow along Bear Stearns path.

Resource: http://www.investorguide.com/stock-archives.cgi?date=060408