Lehman Emerges from Bankruptcy

This morning, Doc # 26039 hit the Lehman docket stating:

"PLEASE TAKE NOTICE that all conditions precedent to the Effective Date of the Modified Third Amended Joint Chapter 11 Plan of Lehman Brothers Holdings Inc. and Its Affiliated Debtors, dated December 5, 2011 [ECF No. 22973], have been satisfied, and the Effective Date was declared for each of the Debtors on March 6, 2012 at 12:01 A.M."

And so Lehman has emerged with distribution to start flowing April 17th, which was slightly later than the market was assuming (bonds were down just slightly when the news hit the wire).  Here is a 2 year chart of the Lehman 6.875% bond which is part of the LBHI Class 3 Claims:

In its Third Amended Disclosure Statement, Lehman stated that Class 3 LBHI holders were to receive 21.1% recovery on their claims.  With the claims going out tonight at in the 28.5% context the market is suggesting the recovery will be substantially higher than contemplated in the plan.  This stems from the market believing that the non-cash assets held by Lehman will be worth more tomorrow than they are today.

In fact one of the reasons I think you saw a substantial rally in the past few months (outside of just general market strength) stemmed from market participants wanting to get ahead of any future distributions which would then just be reinvested in the Lehman complex (all else being equal).  Essentially the formula goes: Get distribution, buy more LBHI bonds, get further distributions, rinse and repeat until there is nothing left in the estate.  This happened in Enron for quite some time with the caveat that after distributions become sizable enough, liquidity drops precipitously across the structure.

My Lehman model has nearly 20 tabs.  What drives this is a complex web of value flowing subsidiary to the holding company less certain inter company claims among other things.  This is before considering all the various values of cash and other assets, as well as the size of the claims pool, all of which really need to be triangulated using data found in Lehman monthly operating reports (MORs).

For example, here is Exhibit A from DECLARATION OF STEVEN J. COHN IN SUPPORT OF MOTION OF LEHMAN BROTHERS HOLDINGS INC. FOR AUTHORITY TO USE NON-CASH ASSETS IN LIEU OF AVAILABLE CASH AS RESERVES FOR DISPUTED CLAIMS PURSUANT
TO SECTION 8.4 OF THE DEBTORS’ CONFIRMED JOINT CHAPTER 11 PLAN:

As you can see, the estimated claims for Lehman Brothers Holdings Inc is $270B with $221.8B allowed, $104.7B disputed (total claims of $326.5B).  Some of this range stems from mortgage reps and warranties that could be significantly larger which would add to the estimated claims pool hence lowering your recovery.

Net/Net, I calculate a value of somewhere, like most people, in the low to mid 30s.  Call it 32 to be fair and conservative (On a claims pool of ~$270B).

We know from the same document which references the claims pool that Class 3 holders are to receive 2.93% points in an initial distribution (as referenced above to occur on April 17th, 2012).  We also know, according to the Third Amended Plan, that distributions are to occur at the end of every September and March going forward until there is nothing left.

On the surface, if I told you you were going to receive ALL 32 points I've calculated in the next year, you'd be buying these bonds with every penny you had.  Unfortunately this is not the case with distributions expected over some future time period.  It could be two years, or it could be five years.  Frankly, its hard to guess when Lehman can sell off its real estate, private equity, or principal investments.

For simplicity (I don't actually believe this, but let's just try it), assume Lehman distributes the remaining 29.07 bond points equally over the next seven distributions (so eight total distributions).  With a purchase price today at 28.5 what is my IRR?  With my handy XIRR function, I calculate an IRR of ~6.5%.

But what if I assume, like I truly do, that the distributions will be front end loaded, with heavy distributions in both the March and September 2013 payments at the expense of the tail distributions.  Now my IRR is closer to 9.0% which is significantly more attractive, but still probably not cutting it.  What is so crazy about this investment is that just adding 1 point to the recovery from both the 3/30/2013 investment and 9/30/2013 investment (so a total recovery of 34 which is entirely plausible) my IRR gets closer to 14% which is highly attractive in this market.  Or better yet, keeping the recovery the same, but lowering my purchase price to 27.5 pushes the IRR closer to 12% which is respectable.

With the opportunity set so limited from both a distressed perspective and market in general perspective, as well as Lehman's low correlation with beta movements in the market, Lehman will still be a fixture in the distressed space for some time to come.  Like I said, my valuation of 32 is both fair and conservative and I could make an entirely reasonable argument that the number could be higher depending on how asset values and the ultimate claims pool shakes out.  Unless a torpedo in a massive mortgage put back or left field liability comes down the pipe I highly doubt an investor loses money in this structure purchasing in the 28 context.  That's not to say your IRR will be something to shake a stick at.  But given the opportunity set, I'd be surprised if funds do not continue to pounce on the structure if it drifts lower in any overall market sell off.