Tug of War Over Lehman's Stock

Some see a white flag, others a red cape. Late yesterday afternoon Lehman Brothers announced a stock offering to raise up to $4 billion. This is usually considered a sign of trouble for a seasoned company such as Lehman, which has repeatedly denied over the past several months the need for fresh capital. While yesterday's move was not telegraphed by management, it was anticipated by speculators.

Check out the chart above, which tracks Lehman's stock price over the past year. See that downward spike about two weeks ago? Option traders were frothing at the company's prospects, halving and then doubling the share price in a 48-hour period. Newbies tempted to swim with the sharks got a serious case of whiplash.

Strangely, Lehman reiterated its mantra of "no problem" even as it announced its offering. Chief Financial Officer Erin Callan insisted that the capital was not needed to offset the impacts of write-downs or losses. Rather, the deal was meant to end questions about the bank's balance sheet--to restore investor confidence, as it were. "We have not changed our view on our real need for capital, but we have changed our view from a perception perspective," Callan told Reuters. In effect, the firm is double-daring speculators to press their bets.

Lehman is issuing convertible preferred stock that will pay quarterly dividends at a rate of 7.25% per annum, a cost of capital more favorable than that obtained by either Citigroup (11%) or Merrill Lynch (9%) in earlier deals. Holders will have the option of swapping the preferred for common stock at an initial conversion price of just under $50 a share. Should Lehman's stock recover sufficiently to trigger conversions, shareholder equity will be diluted by as much as 20%. For that reason, the common stock should be selling lower today. However, LEH is opening up 10% as I post this, indicating that short-sellers may be covering.

Lehman may be safe for now, but see how times have changed. Six months ago Lehman was offering to buy back stock at $65 a share. Clearly management has revised its idea of what the company is really worth. For preferred shareholders, the risk is minimal. They get paid to wait and are first in line if the company is forced to liquidate. And the short-sellers will be back. Says one: "How can we have confidence in a firm that just diluted shareholders who have been just obliterated in the last year?"