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Tuesday, June 10, 2008

Lessons From Lehman

I’m still trying to make sense of Lehman’s disclosure yesterday that it will post a whopping $2.8 billion loss in the second quarter and raise $6 billion in equity by selling shares at a 20% discount to book value, but one lesson is already readily apparent: the best and brightest analysts aren’t working at the major Wall Street brokerage firms.

Lehman’s projected loss amounts to $5.14 a share, a mind-boggling deficit given that Wall Street analysts were expecting a loss of no more than $1.28 a share. Lehman’s planned fund raising will dilute the holdings of existing common shareholders by 30 percent.

As best I can tell, the loss gives some credence to warnings by hedge fund manager David Einhorn, who repeatedly has charged that Lehman hasn’t adequately marked down some of its assets. While it isn’t entirely clear to me that Lehman plans to write down some of the assets whose value Mr. Einhorn has questioned, the hedge fund manager was indeed correct in predicting a massive earnings train wreck. As Mr. Einhorn so elegantly puts it: “(Lehman) just raised $6 billion of capital that they said they didn’t need to replace losses they said they didn’t have.”

Individual Lehman shareholders should be concerned how Mr. Einhorn – who has a short position on Lehman’s stock – knew with such certainty that the company’s asset values would have to be aggressively written down. Admittedly, it’s quite possible that Mr. Einhorn is just way smarter than the Wall Street analysts who cover Lehman’s stock and is better versed on how to read a balance sheet. But Mr. Einhorn’s public statements indicate that he based his analysis on Lehman’s valuation methods, which possibly suggests we are dealing with basic accounting issues.

Lehman previously maintained that Mr. Einhorn’s criticisms had “no basis in fact.” The merits of that defense are increasingly hard to believe.

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