Thain Capitulates, Merrill Raises $8.5 billion in Equity

John Thain has made numerous denials that he would raise equity capital, but is caving in to the inevitable.

He is throwing in the kitchen sink, selling $11 billion worth of CDO's and trying to put an end to the decline in the stock once and for all. God help him if the stock does not hold:

* Plans to issue new common shares with gross proceeds of approximately $8.5 billion through a public offering launched today (excluding a fifteen percent, or approximately $1.3 billion, option granted to the underwriter to purchase additional shares of common stock to cover over-allotments)

* Agreement that Temasek Holdings will purchase $3.4 billion of common stock in the public offering, a portion of which is subject to receipt of regulatory approvals

* Exchange of all of the outstanding mandatory convertible preferred securities for common stock or new preferred securities, which eliminates the reset features in the original securities

* Purchase of approximately 750 thousand shares of common stock in the public offering by executive management Business Wire

Hedge funds and traders ran Erin Callan out of Lehman Brothers for lesser transgressions, but the alpha males have been more cautious in going after Thain. Taking on a Goldman alum sure ain't the same as picking on a woman, now is it?

Thain’s spin was as follows:

“The sale of the substantial majority of our CDO positions represents a significant milestone in our risk reduction efforts,” said John A. Thain, Chairman and CEO of Merrill Lynch. “Our consistent focus has been to opportunistically reduce risk, and in order to take advantage of this sizeable sale on an accelerated basis, we have decided to further enhance our capital position by issuing common stock. The actions we announced both today and on July 17 will materially enhance the company’s capital position and financial flexibility going forward.”

As a result of the transactions announced today, the company expects to record a pre-tax write-down in the third quarter of 2008 of approximately $5.7 billion. This write-down is comprised of a $4.4 billion loss associated with the sale of CDOs, a $0.5 billion net loss on the termination of hedges with XL Capital Assurance and an approximately $0.8 billion maximum loss related to the potential settlement of other CDO hedges with certain monoline counterparties. In the third quarter, Merrill Lynch also expects to record an expense of $2.5 billion related to its reset payment to Temasek and $2.4 billion of additional dividends as a result of the exchange of certain existing mandatory convertible preferred stock for common stock as described under “Common Stock Offerings and Early Conversion of Mandatory Convertible Preferred.”

Pro forma for the transactions announced today, the sale of our interest in Bloomberg L.P. and the expected FDS transaction, Merrill Lynch’s Tier 1 capital ratio, total capital ratio and adjusted “if-converted” book value per share as of June 27, 2008 would have been 10.5%, 16.6% and $22.21. These figures do not include the impact of any exercise of the approximately $1.3 billion over-allotment option.

Moody’s approves of the transaction, just in case anyone still cares…

“The CDO sales and hedge unwinds reduce uncertainty regarding some of MER’s riskiest positions, which benefits bondholders,” said Peter Nerby, a Senior Vice President at Moodys, in explaining the affirmation of the A2 rating and the stable outlook.

Moody’s said that the substantial amount of new equity capital raised by MER is a significant step in bolstering the firm’s capital adequacy, and thus reduces the riskiness of its credit profile.

This could be the final puke in Merrill’s stock, but all bets are off if it does not hold. The stock is holding together after hours, trading at $24.13 at 5:57PM.

Let’s go back to my playbook, courtesy of Mohamed El-Erian:

If you are a bond holder, you want to be ahead of a recapitalization. If you are an equity holder, you always want to come in after. When people have been pushing the financial sector, they haven’t made the distinction between what is is good for the bondholder and what is good for the equity holder.

The equity holder wanted to buy emerging markets after they recapitalized in the late 1990’s, U.S. corporates after after they recapitalized in 2002 and 2003 on the back of Enron, Worldcom, etc. The timing is critical. For the bondholder’s it’s the other way around because a recapitalization lowers risk and therefore brings in spreads. And the people who are diluted are equity holders.

Of course, it did not work in the case of Lehman Brothers, but if Merrill’s balance sheet is truly cleaned up investors can go back to the drawing board and value Merrill’s powerful retail distribution network and their stake in Blackrock (BLK-NYSE). It is time to put a position on long, with a stop, and take a shot.

But we continue to move along in the process of injecting capital into financials; perhaps a (pending) GSE raise will mark an important inflection point in the process and prices. But Thain has done the what Erin Callan was vilified for, with an assist from regulators who scattered the shorts over a week ago.

No doubt the deal would have been done at $15 a share without the assist. Although Dan Tully and David Komansky, along with the rest of Mother Merrill’s alumni are not happy about the dilution, something had to be done.

The soap opera is ending, but the struggle for credibility is ongoing, as the gang from Goldman work their magic all over Wall Street.
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Update 12:42PM: Tech Ticker kicks the deal around....

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Will it hold the print?

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Merrill Lynch Announces Substantial Sale of U.S. ABS CDOs, Exposure Reduction of $11.1 Billion
Business Wire
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The content contained in this blog represents the opinions of 1440 Wall Street. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author. No Position

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