Smoke Screen: Lehman Preferred Offering

March 31, 2008

After hours, shares of Lehman (LEH) took a nosedive, down another 7% to $34.80 before recovering toward $36.60 by the end of trading.

Why? At exactly 4:39pm, Lehman announced a share offering to help them with a much needed capital infusion. Moreover, it is very troubling that on a daily basis, new information is uncovered that is verifying what is on the top of most investor’s minds: The problems are much worse than we are being led to believe.

Coming off a rather limp reception for “Paulson’s Package,” the market is in no mood to hold on to gains today, another sign that investors are not committed and institutions are doing some spring cleaning of their own. I thought that a quick translation of the press release would be a good idea as it seemed rather cryptic.

According to PRNewswire:

Lehman Brothers to Offer 3.0 Million Shares of Convertible Preferred Stock — Lehman Brothers Holdings Inc. (NYSE: LEH) today announced that, in response to investor interest, it intends to offer 3,000,000 shares of Non-Cumulative Perpetual Convertible Preferred Stock. Lehman Brothers also expects to grant the underwriter for the offering an option to purchase up to 450,000 additional shares of the Preferred Stock to the extent the underwriter sells more than 3,000,000 shares of the Preferred Stock in the offering. The proceeds from this offering will be used to bolster the Firm’s capital and increase financial flexibility.

Translation: We need cash. We need it now and we are doing it in a way that will be perceived as beneficial.

“Given the challenging environment and our previously stated view that it will likely continue the balance of the year, issuing convertible preferred is appropriate as it optimizes our funding and accelerates our plan to reduce leverage, and at the same time minimizes dilution to our shareholders,” said Erin Callan, managing director and chief financial officer of Lehman Brothers and a member of the Firm’s executive committee. “We also felt this was the right time as there was a window of opportunity in the market, as we have received significant interest from several key institutional investors, who have been strong supporters of the Firm over time.”

Translation: OH CRAP! We are in deep. Even though we have access to funds through the Fed’s Discount Window, that will look as if we really NEED the money. Maybe we should come up with a plan that seems less desperate. A great way will be to offer bonds, but who would buy those? Hey..what about a preferred stock issue as it will offer upside if we pull through and a yield. We will not be required to pay dividends as we are with bonds, so if the need arises, a cut is possible. The best part: No worries about ratings! No one really pays close attention to the ratings on a preferred, especially a convertible preferred.

The Non-Cumulative Perpetual Convertible Preferred Stock, Series P, carries a par value of $1.00 per share and a liquidation preference of $1,000 per share (the “Preferred Stock”). Upon conversion, the Preferred Stock will be convertible into shares of Lehman Brothers’ common stock, plus cash in lieu of fractional shares.

The non-cumulative dividend rate, conversion rate and other terms are yet to be determined. An application will be made to list the Preferred Stock on the New York Stock Exchange. The offering of the Preferred Stock is being conducted as a public offering registered under the Securities Act of 1933.

Translation: Get it out there…Don’t worry about the details. Look strong, business as usual.

Lehman Brothers Inc. is serving as sole book-running manager of this offering. The offering will be made under Lehman Brothers Holdings’ existing shelf registration statement filed with the Securities and Exchange Commission.

Translation: Who can we get to help with the offering? What other firm in good-faith would present this to their clients? Maybe we should do it ourselves.

Even though this is not dilutive and may actually be beneficial to LEH, it is hard to imagine how investors will react to this offering, especially after they have seen the slide that FNM and FRE took after a similar preferred offering was consumed.

Note: There are rumors that call for the issue to have a 7% yield and a 30-35% premium conversion.

Disclosure: Horowitz & Company clients do not hold positions in stocks mentioned but they do own put options on LEH.

Preferred Stocks for A Volatile Market

January 8, 2008

Several readers and podcast listeners have recently emailed in questions concerning preferred stocks. It seems that these inquiries were prompted because of the levels of low-yielding cash positions they are amassing within their portfolios. So, here are a few pointers.

Preferred stocks have long been thought of as a safe haven from many of the nasty downturns that occur from time to time within the equity markets. Now seems to be one of those times. During the first few trading days of 2008 the unusually high volatility is adding to an already tense situation on Wall Street. The dreaded “R” word has been appearing in conversations as we see additional data points that are moving us steadily towards a slowing economy.

The alternatives for investors are contracting, particularly when we see many positions hit hard without much logic or notice. A glance at the recent 52-week high/low list for January shows a disproportionate number of names making lows. Unless we see a significant change in the current mindset of investors OR some magic from the housing and credit markets, we should plan on seeing more of the same market conditions for the next few months.

So, what is an investor to do? Cash is definitely king right now and even though it seems a sacrilege to keep money out of what is usually considered productive investments, the daily whipsaw has the potential to make even the most seasoned investor take notice. Even with the ongoing credit concerns and financial stocks in sorry shape, there may be an opportunity in high-grade preferred stocks.

Investopedia has a good working definition for Preferred stocks:

A class of ownership in a corporation that has a higher claim on the assets and earnings than common stock. Preferred stock generally has a dividend that must be paid out before dividends to common stockholders and the shares usually do not have voting rights.

The precise details as to the structure of preferred stock is specific to each corporation. However, the best way to think of preferred stock is as a financial instrument that has characteristics of both debt (fixed dividends) and equity (potential appreciation). Also known as “preferred shares”.

The one catch is that many of these stocks seem to come from the financial sector which has not been seeing any hope of moving past their current dilemma in any time soon. Even so, the names on the following list have good ratings and are showing a yields substantially above market. Now may be a time to continue buying some of these as an alternative to the money that will otherwise be temporarily sidelined.

Realize that the current yield will help top protect some downside movement thereby giving a slight cushion if there is a downward movement in share price. Also note that on average, preferred stocks have also seen greater than usual swings recently. Usually, we have seen a maximum of a 5% variation in share price, even in poor market conditions. Recently though, some of these have seen their price range increase to 10%.

Still, there is probably a place for these in longer-term portfolios that need diversification that includes fixed income.

Note: The criteria used in this filter: Current yield above 6.50%, an A+ or better rating and qualification for the 15% dividend tax rate.

Preferred Stocks
Preferred Yields
(ABN.F) (AED) (AEV) (ARH.B) (BAC.B) (BCS.) (CCX.C) (DUA)
(NW.C) (PUK.) (RBS.F) (RBS.H)

Disclosure: Horowitz & Company clients may hold positions in some or all of the stocks mentioned.