Saturday, November 03, 2007
Iceberg theory,losses :Merrill Lynch going private?
Oh Dear.Another day another billion dollar writedown.When does it stop.I did warn you about Merrill's off balance sheet exposure in the last blog.Now this week it's been investigated by the SEC for off balance sheet loss manipulation.Bad Luck.Another 10$ billion could be written down.This should not come as a surprised to anyone except the Board of Directors at Merrill.Oh well you snooze,you lose.Their PR spokesperson denies this.Last year's financial statements are fiction,why anyone would believe the PR department l have no idea. So what next?
In the coming months,once the dubious quality of the accounting becomes apparent there will be further writedowns.So far the approximate numbers are 8$ billion+ another 10$ billion to come. I expect true exposure in reality is in the region of 50$ billion. So expect at least another 32$ billion in writedowns.
This is how I got to the 50$ billion as the 'real' writedown.Assume all management are at worst economical with the truth and at best have no idea what's going on;especially in investment banks and particularly if they think it will prop up the share price.Now use iceberg theory. The initial number is only 10% of the true figure, the other 9/10 ths are below the surface.Initial writedown estimates were approximately 5$ billion.Multiply by 10=50$ billion. Current Market Cap at Friday's close (59.71$) was 49$ billion. Take the 10 yet to be written down plus the other 32 , that should leave a market cap of around 7$ billion dollars if it survives as an on-going concern/independent entity.It's not rocket science is it?
So my made up target price of 15$ still stands.It's a better valuation than the rubbish the analysts are peddling. I'll be a net buyer at this price.The brand equity is roughly worth about 6$ a share ( 50 cents for each letter in the name, there are 12 letters),add $9 for on-going operations.
So what does the future hold for Merrill's various stakeholders?
Employees
If you're an employee wait for the mass severance package offer like the one in 2001/2. The party is just beginning,so if you're planning on staying in the firm,hold on real tight.The storm hasn't even arrived yet. If you are higher up at ML and have been comped in restricted stock,stock options and similar equity related incentives,you really should have got out at the end of last year and known better.Now don't you feel like a fool.Oh Well a fool and his money were lucky to get together in the first place.
Stockholders
Stockholders will probably start to litigate quite soon for misrepresentation etc quite soon,and breach of fiduciary duty by the Directors. So the firm should expect a host of class actions, coming to a Merrill Office near you very soon.
Auditors
If you're an audit partner at Deloitte LLP, New York.Expect litigation for a job done badly.Did you check your PI insurance like I told you to in the last blog?
The Firm
As the firm's creditworthiness begins to deteriorate, in fact it's already happening look at the credit default swap prices of it's bonds,financing will get a lot more expensive. The ratings agencies will start downgrading it's debt.Who knows in a peculiar twist of fate, they could become sub-investment grade.They themselves could become sub-prime.They could then buy their own debts, re-package them as CDOs and shove them off balance sheet into a SIV-lite. Maybe flog it to Citigroup.That's the financial engineering equivalent of eating your own vomit.How cool would that be.
There is one avenue which looks increasingly likely, it could be taken private. It will soon become a classic distressed asset play.So it goes private.De-leverages, gets rid of all non- core business.Keeps brokerage,M&A, underwriting.Reduces proprietary trading, reallocates capital. It's an easy way out.Sounds crazy.Well think about this.Of the current board of twelve.Three of them are ex-private equity boys and girls.Charles Rossotti ( advisor to The Carlyle Group), Ann N.Reese ( Clayton,Dubilier & Rice) and wait for it, the current acting Chairman, Alberto Cribiore ( Clayton, Dubilier & Rice and Brera Capital).If you're telling me that this hasn't crossed their minds, I'd be surprised.
Personally I'm still hoping it will still go under.That's my preferred outcome.This is called destructive capitalism.
RB
In the coming months,once the dubious quality of the accounting becomes apparent there will be further writedowns.So far the approximate numbers are 8$ billion+ another 10$ billion to come. I expect true exposure in reality is in the region of 50$ billion. So expect at least another 32$ billion in writedowns.
This is how I got to the 50$ billion as the 'real' writedown.Assume all management are at worst economical with the truth and at best have no idea what's going on;especially in investment banks and particularly if they think it will prop up the share price.Now use iceberg theory. The initial number is only 10% of the true figure, the other 9/10 ths are below the surface.Initial writedown estimates were approximately 5$ billion.Multiply by 10=50$ billion. Current Market Cap at Friday's close (59.71$) was 49$ billion. Take the 10 yet to be written down plus the other 32 , that should leave a market cap of around 7$ billion dollars if it survives as an on-going concern/independent entity.It's not rocket science is it?
So my made up target price of 15$ still stands.It's a better valuation than the rubbish the analysts are peddling. I'll be a net buyer at this price.The brand equity is roughly worth about 6$ a share ( 50 cents for each letter in the name, there are 12 letters),add $9 for on-going operations.
So what does the future hold for Merrill's various stakeholders?
Employees
If you're an employee wait for the mass severance package offer like the one in 2001/2. The party is just beginning,so if you're planning on staying in the firm,hold on real tight.The storm hasn't even arrived yet. If you are higher up at ML and have been comped in restricted stock,stock options and similar equity related incentives,you really should have got out at the end of last year and known better.Now don't you feel like a fool.Oh Well a fool and his money were lucky to get together in the first place.
Stockholders
Stockholders will probably start to litigate quite soon for misrepresentation etc quite soon,and breach of fiduciary duty by the Directors. So the firm should expect a host of class actions, coming to a Merrill Office near you very soon.
Auditors
If you're an audit partner at Deloitte LLP, New York.Expect litigation for a job done badly.Did you check your PI insurance like I told you to in the last blog?
The Firm
As the firm's creditworthiness begins to deteriorate, in fact it's already happening look at the credit default swap prices of it's bonds,financing will get a lot more expensive. The ratings agencies will start downgrading it's debt.Who knows in a peculiar twist of fate, they could become sub-investment grade.They themselves could become sub-prime.They could then buy their own debts, re-package them as CDOs and shove them off balance sheet into a SIV-lite. Maybe flog it to Citigroup.That's the financial engineering equivalent of eating your own vomit.How cool would that be.
There is one avenue which looks increasingly likely, it could be taken private. It will soon become a classic distressed asset play.So it goes private.De-leverages, gets rid of all non- core business.Keeps brokerage,M&A, underwriting.Reduces proprietary trading, reallocates capital. It's an easy way out.Sounds crazy.Well think about this.Of the current board of twelve.Three of them are ex-private equity boys and girls.Charles Rossotti ( advisor to The Carlyle Group), Ann N.Reese ( Clayton,Dubilier & Rice) and wait for it, the current acting Chairman, Alberto Cribiore ( Clayton, Dubilier & Rice and Brera Capital).If you're telling me that this hasn't crossed their minds, I'd be surprised.
Personally I'm still hoping it will still go under.That's my preferred outcome.This is called destructive capitalism.
RB
