Street Capitalist: Event Driven Value Investments

via After Frantic Day, Wall St. Banks Falter (NYTimes)

Lehman Brothers Holdings Inc., once the fourth-largest U.S. investment bank, said it intends to file for bankruptcy after Barclays Plc and Bank of America Corp. abandoned talks to buy the crippled firm.

Lehman, one the biggest underwriter of mortgage-backed securities, plans to file a Chapter 11 petition in the U.S. Bankruptcy Court for the Southern District of New York, the firm in a statement today. The filing will be by the holding company and won’t include any of its subsidiaries, Lehman said.

Lehman Brothers to File for Bankruptcy After Suitors Drop Out (Bloomberg)

via Lehman Brothers Bankruptcy Press Release (PDF)

One thought that I expressed earlier was that any good assets or lines of business held by AIG (NYSE:AIG) would attract private equity firms and buyers who may be more likely to bid more than someone like Warren Buffett. So far, some interest has materialized but AIG rejected the suitors:

During a weekend scramble to shore up its finances, AIG turned down a capital infusion from a group of private-equity firms led by J.C. Flowers & Co. because an option tied to the offer would have effectively given them control of the company, an 89-year-old giant that does business in nearly every corner of the world.

The proposed option would have allowed the firms to acquire AIG for $8 billion under certain conditions. That price is just one-fourth of AIG’s current market value…

When AIG’s board rejected the capital infusion, the company’s recently appointed chairman and chief executive, Robert Willumstad, took the extraordinary step of reaching out to the Federal Reserve for help. Mr. Willumstad asked New York Federal Reserve President Timothy Geithner if the Fed could backstop some asset sales.

Two other private-equity firms — Kohlberg Kravis Roberts & Co. and TPG — offered to inject capital into AIG if the Fed agreed to provide the insurer with a bridge loan until its restructuring plan was completed.

AIG Scrambles to Raise Cash, Talks to Fed (WSJ)

I’m thinking that the most favorable outcome for someone like Buffett or another cash rich bidder would be no federal backstopping. This would not only expedite the sale of assets, but it would shake out the private equity firms who may be trying to compete. Right now the WSJ says that AIG plans to sell its domestic automotive business and its annuities units, but is also looking at selling its aircraft-leasing arm, International Lease Finance Corp. (ILFC).

Take a moment to look at ILFC’s financials, which can be found here. Looking at a recent 10-Q, you’ll see that the company’s book value is around $7.4 billion which would make it a behemoth to acquire today by any traditional private equity firm who depends on raising debt. If it is sold, it’s highly probable that the buyer will be someone with a cash horde (like Buffett) or a strategic buyer (major corporation) who hopes to add/expand their line of business in this area.

None of the articles I’ve read have mentioned anything about Buffett or Berkshire Hathaway so far, but I’m sure we will, unless AIG is playing incredibly hard with their negotiations. If that’s the case, they may end up filing for bankruptcy like Lehman Brothers (NYSE:LEH), another firm that played hardball in their negotiations for asset sales and capital infusions.

Most value investors have been watching American International Group (NYSE:AIG) closely. A year ago, the company was trading at nearly $70 per share, now it’s hovering around $12 and trading at around 50% book value. AIG’s current troubles are linked to what’s been happening over the course of the weekend. Like Lehman, AIG is one of the top credit default swap counter parties and its financial products group is directly tied to the well-being of the credit markets (a place not very well right now).

via Wake-Up Call: Lehman’s Mortgage Marks (WSJ)

The company is barely holding on to its EDIT:AA-minus rating and has now announced that they’ll commence a wide scale restructuring program to shore up capital.

AIG’s management team was scrambling on Sunday afternoon to cobble together the plan and present it to the insurer’s board for approval, the people said. The insurer, which has already raised $20 billion in fresh capital so far this year, was also in discussions with several private equity firms about a capital injection and hoped to raise more than $10 billion, the people said.

AIG considered selling or spinning off the aircraft-leasing arm — International Lease Finance Corp. — earlier this year but decided in June to keep it. Since then, AIG’s position has deteriorated, however, making a disposal more likely.

AIG Plans Major Restructuring, Sale of Aircraft-Leasing Business (WSJ)

The aircraft-leasing business, International Lease Financial Corp (ILFC) would be an awesome catch for Warren Buffett’s Berkshire Hathaway (NYSE:BRK.A). Back in May, Steven Udvar-Hazy (ILFC’s founder) pushed for a split from AIG in fear of the effects of such a ratings downgrade. ILFC is a great business that has a large moat in its industry. Here is some background on ILFC:

He noted that the world airline industry had ordered more than 7,000 airplanes in the past three years, many of which could ultimately be financed through leasing. “With more than $250 billion worth of aircraft in the backlog, it’s important to be in a position to play a part in financing,” he said…

Mr. Udvar-Hazy’s status as a force in the aviation industry is owed largely to the fact that he pretty much invented ILFC’s leasing niche when he founded the company 35 years ago. Early on, he showed a willingness to take big risks. In an industry known for colossal failures and collapses, the Hungarian immigrant parlayed a $50,000 investment in 1973 into a personal fortune worth an estimated $3 billion. He did it in large part by driving hard bargains with airline customers and jet makers alike, say those who have dealt with him over the years.

Today, ILFC has a fleet of more than 900 airplanes, valued at about $50 billion. In 2007, ILFC brought in $4.73 billion in revenue and earned a profit of $604 million with a staff of 170. According to people familiar with the situation, one of Mr. Udvar-Hazy’s concerns is that his employees have been generating record profits, but their incentive awards are typically in AIG stock, which has fallen steeply.

ILFC Founder Weighs Split From AIG (WSJ)

Just reading about Steven Udvar-Hazy, you get the vibe that he is the kind of manager who meshes will with a culture like Berkshire’s. You really get that Rose Blumkin vibe about him. Just look at a couple of these quotes:

Mr. Udvar-Hazy likes to describe his job “as a hobby that I’ve found a way to get paid for. Some people play golf, I come to work.”

“Steve knows the industry better than anybody I know, and I know virtually everybody in the industry,” said Airbus’s Mr. Leahy, who over the years has become one of Mr. Udvar-Hazy’s closest friends.

Mr. Leahy said he was riding in a water taxi with Mr. Udvar-Hazy over the weekend in Venice at a conference when the two spotted a bright-red Airbus A320 jetliner flying overhead. “I said, ‘I wonder which carrier that is,’” Mr. Leahy said.

Mr. Udvar-Hazy didn’t hesitate, according to Mr. Leahy. “Unlike you, John, I know every one of my customers. That’s Myair, and that’s their No. 2 airplane.”

ILFC Founder Weighs Split From AIG (WSJ)

The likelihood of Berkshire being able to acquire this business from AIG is probably mixed. Buffett certainly has the cash available to do a deal like this, but I’m betting that he would face stiff competition from other firms when bidding for it. The other insurance businesses may be attractive to Berkshire as well, so AIG’s dismantling should create a number of opportunities for financial firms hoping to enter the insurance business and opportunities for those hoping to grow their businesses.

I was expecting another one of Henry Paulson’s Sunday brunch emergency deals, but it looks like the deal with Lehman Brothers (NYSE:LEH) has hit a snag:

The fate of Lehman Brothers Holdings Inc.’s darkened early Sunday afternoon with Barclays PLC, the sole remaining bidder for the 158-year-old Wall Street firm, telling federal regulators that it is walking away from a transaction, people familiar with the matter say.

The situation was rapidly evolving, and it’s possible Barclays or another bidder would emerge to save Lehman before markets opened Monday. But with the government balking at putting any taxpayer money at risk for Lehman, the likelihood of a transaction was dimming. That would leave an orderly liquidation as the most likely scenario, a dramatic outcome for a once-powerful firm…

The main stumbling block for any Barclays deal is a reluctance by U.S. regulators to financially back an acquisition or the creation of a so-called “bad bank” to wind down Lehman’s assets.

Barclays Walks from Lehman Deal; Likelihood for Transaction Narrows (WSJ)

As of this weekend, there were only two serious bidders for Lehman Brothers. Barclays (NYSE:BCS) and Bank of America (NYSE:BOA). Bank of America also chose to walk because there would be no federal financing involved.

The lack of a deal makes the risks high for everyone on Wall Street. Earlier this week on Charlie Rose, Robert Rubin (of Citigroup and Goldman Sachs fame) described the situation best:

RUBIN: Well, three things I don’t know. One of them is what the circumstances are and whether they really are in that serious a situation. Number two, whether they are so interconnected — you say too big to fail, I think the standard now has become too interconnected, or the issue has become too interconnected to fail. That`s after all the problem in Bear Stearns. My instinct is if that Bear Stearns was too interconnected to fail, the probability is that Lehman is.

If that’s the case, then the policy makers have to make this very complicated judgment of whether to intervene or not intervene, and the argument against intervening always is that in a market-based economy, failures should be rewarded with failure and success with reward. But on the other hand, the systemic risks of allowing these interconnected institutions to fail are such that I think as you weigh and balance all this, there are times when government is going to have to intervene. Then the practicalities of how do you do it can become very complicated.

Lehman Brothers does indeed pose a systemic risk for the rest of Wall Street.

A disorderly unwind of Lehman’s derivatives trades is only one worry. Another worry is that if Lehman collapses, its distressed assets — such as commercial real estate — could suddenly hit Wall Street for sale, forcing prices even lower and potentially forcing other dealers to mark down once again the value of their own holdings.

The possible merger between Bank of America and Merrill Lynch (NYSE:MER) seems to stem from the fact that anyone who held similar assets will be in a world of pain tomorrow as banks may have to further mark down toxic assets if Lehman liquidates. It’s a fact that Merrill holds more of these types of assets than even Lehman, so they may be forced into a shotgun marriage because capital raising will be difficult. EDIT: WSJ is reporting a deal at $26 per share for BoA-Merrill Lynch

In order to dampen any kind of blow that a liquidation might have with derivatives, the International Swaps and Derivatives Association announced that they’ll arrange to net any transactions involving Lehman Brothers. In a statement released today they say:

ISDA confirms a netting trading session will take place between 2 pm and 4 pm New York time for OTC derivatives. Product classes involved are credit, equity, rates, FX and commodity derivatives. The purpose of this session is to reduce risk associated with a potential Lehman Brothers Holding Inc. bankruptcy filing. Trades are contingent on a bankruptcy filing at or before 11:59 pm New York time, Sunday, September 14, 2008. If there is no filing, the trades cease to exist. These trades are subject to a protocol which is being distributed by ISDA (International Swaps and Derivatives Association). Traders should execute the protocol and return to ISDA

ISDA Statement on Lehman Brothers Bankruptcy Trades: Full Text (Bloomberg)

Netting would be the right course of action to take. Doing so would not only lower systemic risk on Wall Street, but also the capital requirements needed by banks to service such contracts. To give you an idea of how it works, look at the image posted below.

Netting would help reduce some of the risk stemming from Lehman liquidation. The amount of capital needed would be based upon the economic position that results from the outcome of each contract, rather than the amounts stated in the actual contracts. This means less capital will be needed on both ends of the deal, which should be helpful if Lehman goes bankrupt. The ISDA’s actions will probably help, but not enough to create a good day for stocks tomorrow. It might be a good time to monitor your watch lists for any high quality companies that you’ve been hoping will be on sale.

The WSJ seems to be a fan of repetition when describing the pain at Lehman Brothers (NYSE:LEH)

A group of three men, wearing Lehman badges and walking back into headquarters, discussed the fallout for other firms on Wall Street. “At some point, where does it stop?” one said.

The Lehman Stock Slide Hits Home: Employees Face $10 Billion in Losses (WSJ)

At a fast-food vendor across the street, people waiting to order food discussed the dive in Lehman’s share price this week, and the latest headlines from CNBC. Outside, a group of three men, wearing Lehman badges and walking back into headquarters, discussed the fallout for other firms on Wall Street. “At some point, where does it stop?” one said, as he headed back to the office.

Lehman Races to Find a Buyer (WSJ)