Lehman: Independent for How Long?
Lehman Brothers (LEH) appears to have averted a Bear Stearns-like financial crisis with plans to raise $6 billion. But the storied investment bank, now the smallest of the major Wall Street firms, may ultimately face the same fate: the end of its independence.
Takeover rumors have dogged Lehman ever since the bank went public in 1994. A few months after the IPO, Lehman's stock tanked, prompting speculation that insurance company Travelers (TRV) would swoop in at the sale price. Investors were betting on much the same for Lehman in 1998 after the collapse of hedge fund Long Term Capital sparked a bankruptcy scare. Yet Lehman always emerged intact. "Somehow these guys never die," says Roy Smith, a professor at New York University's Stern School of Business.
This time around the outcome could be different. Over the past decade, Lehman CEO Richard Fuld pushed aggressively to remake the onetime bond shop into a diversified financial institution. By some measures, it worked. In 2007, fixed income accounted for 31% of revenues, compared with 66% in 1998.
But the business model of Lehman—which now dabbles in everything from bond trading to equity underwriting to M&A, and dominates none—simply doesn't work in an environment that requires either strength or size. Lehman doesn't have a distinct specialty like boutique advisory firm Lazard (LAZ). Nor does it have the heft and scale of big, commercial banks like JPMorgan Chase (JPM) and Bank of America (BAC) that are market leaders in a number of areas. "It's hard to see where Lehman fits in," says CreditSights analyst David Hendler. "Lehman needs a bigger-balance-sheet bank that can use its skill set."
The question remains, though, which financial company would step up as a potential suitor for Lehman, whose stock price is currently trading at a five-year low (BusinessWeek.com, 6/4/08). JPMorgan Chase and Bank of America have the financial muscle (BusinessWeek, 6/4/08), but the two are still busy digesting recent acquisitions. And another subprime survivor, Wells Fargo (WFC), doesn't want to get into the investment banking game. That leaves a foreign player such as Britain's HSBC (HBC) or Barclays (BCS). Although both have their own set of headaches (BusinessWeek.com, 5/13/08) from the credit crunch, the two are looking to expand in the U.S.
Still, absorbing Lehman would be a yeoman's task. Unlike Bear Stearns, which has a couple of strong assets in its clearinghouse and prime brokerage business, Lehman has few standouts. The once-proud, fixed income business, which has had three heads in the past three years, remains in shambles after moving aggressively into risky subprime securities. Adding to its woes, top bond executive Rick Rieder left in May to start a hedge fund.
Meanwhile, Lehman pales next to Morgan Stanley (MS) and Goldman Sachs (GS) in mergers and acquisitions, where it ranks in the middle of the pack. "They don't have a long-standing history in investment banking to thrive in this environment," says Hendler.
Then, of course, the bank has a history of rocky marriages. When American Express (AXP) purchased Lehman back in 1984, it was a poor fit almost immediately. The freewheeling style of Lehman's legendary bond traders didn't mix well with the staid atmosphere of its corporate parent. Executives clashed on everything from pay packages to critical decisions like asset sales. The two finally divorced a decade later.
Despite the difficulties inherent in an acquisition, Lehman's days as an independent firm may be numbered. Says analyst Chris Whalen of Institutional Risk Analytics: "Lehman is next. When you have a pack of dinosaurs, the slowest gets picked off."