Lehman Brothers Bankrupt - Why and how it happened.

As a prospective MBA student and one really keen on investment banking - Lehman Brothers is a big name to me. It is the same with many prospective and current MBA students across top B-Schools all over the world - IIMs, ISB, Wharton, Harvard and what not? A glimpse at Wharton's MBA placement statistics for 2007 shows that Lehman recruited 18 grads. It could be around the same number of students placed across other top B-Schools here in USA. And the doomsday came on 15th September. Lehman filed for Chapter 11 Bankruptcy. This is what it posted on its website at midnight of the 14th.

"Lehman Brothers Holdings Inc. Announces It Intends to File Chapter 11 Bankruptcy Petition; No Other Lehman Brothers' U.S. Subsidiaries or Affiliates, Including Its Broker-Dealer and Investment Management Subsidiaries, Are Included in the Filing."

It is indeed a red letter day in USA's corporate history. A 158-year old company has filed for a bankruptcy and wrecked Wall Street and rattled the global finance system. Also rubbing salt to the finance industry's wound, is Merrill Lynch's demise (read as acquisition) by Bank of America. Two majors down on a day. But what actually happened at Lehman? This is my two cents on the issue.

"Know when to stop before you begin" goes the saying. Lehman got this messed up. Investment banking was always about high-stake bets and huge borrowings but it also demands high level of strategy. It is believed that Lehman borrowed too much money and invested it in 'very high' risk domains, namely real estate. Success in IB is proportional to the ability of that company to take risks. But there is thin line that separates risk from imprudence or over-confidence. More so when we speak of real-estate investments in this economy. Clearly Dick Fuld, Lehman's CEO got his priorities and numbers wrong. 

But as the credit crunch worsened, Lehman's leverage - borrowings relative to capital - continued to grow. This is in contrast to other major IBs. One instance of Lehman's miscalculated investment is its leveraged buyout of Archstone, a big apartment developer. Lehman paid $22.2 billion for this transaction (in partnership with Tishman Speyer) in Oct 2007. By then, real estate woes have already begun. But how prudent is that investment? Lehman's shares have lost 94% of their value since the beginning of this year due to its exposure to subprime debt crisis.

And on 15th of September came the bang. The filing shows that Lehman is closing its doors with more than $600 billion of debt. The bank has total debts of $613 billion against total assets of $639 billion. Its filing with the Bankruptcy Court of the Southern District of New York shows that Lehman had more than 100,000 creditors. The move into bankruptcy came after last-minute talks with Barclays PLC  and Bank of America faltered Sunday, leaving few options for the 158-year-old firm.

Many of us know that Lehman is actually a 14 year company with a 158-year name. That is because it was acquired by American Express in 1984 and spun-off in 1994 as a standalone company. Sadly, over the last week or so, Lehman was like a bug dying on your windscreen: you want to focus on the road but are compelled to watch the stricken insect’s last moments.

Good-bye Lehman.

Microsoft yahooing?

Last week ended (atleast for now) speculation about Microsoft acquiring Yahoo. But the intent and the way Microsoft carried on this process left a sour impression on techie community and consumers in general. Check out this letter that Steve Balmer, Microsoft CEO wrote to Jerry Yang, Yahoo CEO.

May 3, 2008

Mr Jerry Yang
CEO and Chief Yahoo
Yahoo! Inc.
701 First Avenue
Sunnyvale, CA 94089

Dear Jerry:
After over three months, we have reached the conclusion of the process regarding a possible combination of Microsoft and Yahoo!.

I first want to convey my personal thanks to you, your management team, and Yahoo!'s Board of Directors for your consideration of our proposal. I appreciate the time and attention all of you have given to this matter, and I especially appreciate the time that you have invested personally. I feel that our discussions this week have been particularly useful, providing me for the first time with real clarity on what is and is not possible.

I am disappointed that Yahoo! has not moved towards accepting our offer. I first called you with our offer on January 31 because I believed that a combination of our two companies would have created real value for our respective shareholders and would have provided consumers, publishers, and advertisers with greater innovation and choice in the marketplace.
Our decision to offer a 62 per cent premium at that time reflected the strength of these convictions. In our conversations this week, we conveyed our willingness to raise our offer to $33.00 per share, reflecting again our belief in this collective opportunity. This increase would have added approximately another $5 billion of value to your shareholders, compared to the current value of our initial offer. It also would have reflected a premium of over 70 per cent compared to the price at which your stock closed on January 31.
Yet it has proven insufficient, as your final position insisted on Microsoft paying yet another $5 billion or more, or at least another $4 per share above our $33.00 offer.

Also, after giving this week's conversations further thought, it is clear to me that it is not sensible for Microsoft to take our offer directly to your shareholders. This approach would necessarily involve a protracted proxy contest and eventually an exchange offer. Our discussions with you have led us to conclude that, in the interim, you would take steps that would make Yahoo! undesirable as an acquisition for Microsoft.

We regard with particular concern your apparent planning to respond to a "hostile" bid by pursuing a new arrangement that would involve or lead to the outsourcing to Google of key paid Internet search terms offered by Yahoo! today. In our view, such an arrangement with the dominant search provider would make an acquisition of Yahoo! undesirable to us for a number of reasons:

• First, it would fundamentally undermine Yahoo!'s own strategy and long-term viability by encouraging advertisers to use Google as opposed to your Panama paid search system. This would also fragment your search advertising and display advertising strategies and the ecosystem surrounding them. This would undermine the reliance on your display advertising business to fuel future growth.

• Given this, it would impair Yahoo's ability to retain the talented engineers working on advertising systems that are important to our interest in a combination of our companies.

• In addition, it would raise a host of regulatory and legal problems that no acquirer, including Microsoft, would want to inherit. Among other things, this would consolidate market share with the already-dominant paid search provider in a manner that would reduce competition and choice in the marketplace.

• This would also effectively enable Google to set the prices for key search terms on both their and your search platforms and, in the process, raise prices charged to advertisers on Yahoo. In addition to whatever resulting legal problems, this seems unwise from a business perspective unless in fact one simply wishes to use this as a vehicle to exit the paid search business in favor of Google.

• It could foreclose any chance of a combination with any other search provider that is not already relying on Google's search services.

Accordingly, your apparent plan to pursue such an arrangement in the event of a proxy contest or exchange offer leads me to the firm decision not to pursue such a path. Instead, I hereby formally withdraw Microsoft's proposal to acquire Yahoo!

We will move forward and will continue to innovate and grow our business at Microsoft with the talented team we have in place and potentially through strategic transactions with other business partners.

I still believe even today that our offer remains the only alternative put forward that provides your stockholders full and fair value for their shares. By failing to reach an agreement with us, you and your stockholders have left significant value on the table.

But clearly a deal is not to be.

Thank you again for the time we have spent together discussing this.

Sincerely yours,

Steven A Ballmer
Chief Executive Officer
Microsoft Corporation

It is a win-win situation for Microsoft. Irrespective of whether or not Yahoo accepts their offer, Microsoft is set to gain from this episode. Yahoo is now in dire straits. Their shares fell down by 18%. I feel Microsoft knew in the first place that Yahoo will decline their bid. After fending off months of threats by Microsoft Corp, Yahoo Inc's directors still will have to fight for their jobs as the company's own irate shareholders plot a mutiny. I feel it is a very clever strategy from Microsoft to de-stabilize Yahoo. Their motive must have been to severely weaken Yahoo (as a competitor) or to acquire it. Either one is good for Microsoft - the latter, a better option. Now, with these diversions, Yahoo will either retrace back to Microsoft or will take a long long time to recover.