Hedge That Blog

Lehman Brothers this morning planned to raise more capital by  issuing 4 billion in common stock priced at $28 and 2 billion of preferred stocks that convert to common stock in 3 years.  The convertible preferred have a dividend of 8.75%.

A lot of people have been asking themselves, is it safe to go out and buy some stock?

In this uncertain environment its very hard to tell what the bank has or doesn’t have on their books.  Lehman Brothers is or “WAS” one of the biggest banks concentrated in and best known for its fixed income.  With the subprime crisis continuing to unravel as well as general economic malaise, this does not bode well for the bulge bracket bank who had such a big portion of its book in fixed income securities.

At the beginning of the financial crisis back in 2007, there were many private and foreign investment entities willing to buy a portion of a large respectable investment bank.

1. In late Nov of 2007, Abu Dubai’s government investment arm purchasing a 7.5 billion stake in Citigroup’s convertible bonds that would convert at 31-32/share yielded 11% and was respectively 4.9% of the company.    Please note at the time Citigroup was trading 30-31 dollars a share when the news was announced.

2.  In late Dec of 2007,  Merrill Lynch agreed to sell 5 billion worth of securities to an investor from Singapore (Temasek).

3. Morgan Stanley agrees to sell a 5 billion stake to China Investment Authority in mid Dec of 2007.

4.  The government of Singapore Investment Corporation agreed to invest 9.7 billion UBS.

There are a many number of instances of large government/private entities putting down billions of dollars to swoop up these bulge bracket financial firms.  The question remains is this the bottom?

Its very hard to tell whether this is the bottom or not.  Regular investors in my humble opinion should not be willing to commit large portions of their retirement fund accounts into such dangerous environments.  Although it is true that one can earn 20-30 even 50%+ short term returns in these stocks if they are able to correctly guess the bottom.

Remember Bear Stearns had a big drop in March of 2008 despite all the big names and investment authorities who were in the stock.  The potential gains are lucrative but the downside I believe is too great for an average investor to be willing to stomach the gains.

Think of it as a flush draw/open ended straight with very bad pot odds.  In the poker, you only want to draw for a flush if there is enough money in the pot to make it worth your while.  Although hitting pots will be lucrative, the chances of you hitting the flush draw or open ended straight is at best 3 to 1.  Therefore you should be compensated at least to a minimum of 3 to 1 in order for you to enter the pot.

Is Lehman the next bear stearns?  I don’t know for sure but is this financial turmoil going to continue for another few quarters?  You can bet your aces on it.

Next post will be on short selling as the CEO of Lehman Brothers Mr. Richard S. Fuld Jr. who claims the short sellers are behind the stock drop.