The Bottom is in Financials - Version 23,472

Finally Merrill Lynch (MER) did the dirty deed; selling off assets at 22 cents on the dollar. You can almost hear the shuddering across the other banks as this now marks "fair value" on this junk. Folks, some of these guys still have assets market at the full dollar because they are guaranteed by Ambak (ABK) and MBIA (MBI) and their "triple A rating" which are essentially neutered. It's all a big joke.

Already CNBC has on their home page for the upteempth time "Is the Bottom in Sight?" It has now been a YEAR since the first calls for the "kitchen sink quarter" and "the bottom is in sight". Keep saying it folks and one day you will nail it! While I think this is actually a good transaction because (a) it rids MER of risk and (b) it was not a government bailout and (c) Lone Star Funds is going to make a lot of money because even if the assets are only worth 44 cents on the dollar they will make 100% (plus Merrill is guaranteeing some kickbacks).... this points to the hypocrisy on the Street. John Thain has promised us over and over and over that the firm did not need to raise more capital. Even 2 weeks ago during earnings report when they sold off Bloomberg instead of Blackrock. [Jul 17: Blackrock Earnings Excellent as Usual; Merrill Lynch Won't Be Selling] What did I say at the time, having zero access to Merrill's balance sheet and not being the CEO? Just a few days later in our weekly summary I opined

I cut (to raise cash) a lot of the remaining Blackrock (BLK) after a stellar earnings and even more importantly the news that Merrill Lynch (MER) won't be selling its stake at this time. I still have some doubt that they won't be forced to sell some of their position to stay afloat as we get into 2009. Let's see how it works out.

So the CEO was assuring us everything was fine, most analysts are clapping about the "bottom in financials", and some random blogger (namely me) who has zero financial industry experience was doubting the veracity of one iota of this hot air. Who ended up being correct? Again - simply a lot of nonsense out there in pundit/analyst world and anyone who actually manages money listening to these people will simply have destroyed their invetor base's capital.

Anyhow this came at a cost of 40% dilution for current Merrill Lynch shareholders which is a beef I've had with the 'buy financials' crowd - even WHEN everything bottoms - the earnings PER share power is going to be decimated. In one fell swoop last night the share count grew by a massive amount. So just to have flat earnings per share with 48 hours ago, earnings would have to increase by the amount of the share count increase - just to be flat. And this is why the earnings power for these companies will simply be decimated for a long time. But... better to sell off coal and fertilizer and buy these stocks because they are "great value". So while "great news" for Merrill and their shareholders, the reality is these are the type of steps many other firms need to do. Effectively castrating themselves to stay alive. Those are exactly the type of stocks I want to be in. Not.

• Merrill Lynch & Co., in a broad move to clean up its troubled balance sheet, said Monday it will sell a big slice of its toxic asset-backed securities and issue new stock to raise $8.5 billion of fresh capital.
• The world's largest brokerage, struggling to right itself as the credit crisis continues, said it will issue more than 200 million new common shares as part of the deal. Merrill said it will write-down $5.7 billion because of additional losses on the sale of mortgage securities and hedging contracts. (kitchen sink quarter fellas! Get those buy orders in!)
• The latest move comes just over a week after Merrill reported a $4.6 billion second-quarter loss, where he raised $8 billion of much needed capital from asset sales instead of diluting the stock by issuing more shares.
• Perhaps the biggest benefactor in the deal is Temasek Holdings, the Singapore sovereign wealth fund that is already one of Merrill's biggest investors. The firm agreed to buy $3.4 billion worth of shares at a yet-to-be determined price, a potentially large percentage considering shares of the brokerage are down 54 percent this year.
• In a sign of how toxic Merrill's debt holdings have become, it has agreed to sell $30.6 billion of collateralized debt obligations (CDOs), a kind of repackaged debt, to an affiliate of private equity fund Lone Star Funds, for just $6.7 billion, or about 22 cents on the dollar.
• William Smith, president of Smith Asset Management Inc in New York, said Merrill fetched a "horrendous" price for the CDOs in the sale announced on Monday.
• "What is happening to Merrill and others is death by a thousand cuts. It's painful to see it happen over and over again," said Daniel Alpert, managing director at investment bank Westwood Capital.
• On a July 17 conference call, Thain said: "Right now we believe we are in a very comfortable spot in terms of our capital." He has made a series of similar comments over the past seven months.
• The brokerage said it is also paying Temasek $2.5 billion to reset some provisions on a previous stake sale. The most recent round of capital raising was particularly bruising because of provisions Merrill agreed to when it raised money in December and January. Essentially, the investment bank said it would give the investors in those raisings extra compensation if it later issued equity at a lower price.

That's how poor the situation has become. Temasek bought a stake in Merrill about 8 kitchen sinks ago [Dec 31: Merrill Lynch Tapped Singapore - Next China and Middle East] and there was a guarantee that if they issued more shares they'd have to make up the difference to Temasek. So now they have to pay up. Remember, we were told all fall "smart money" (Oil money, sovereign wealth funds) was buying stakes in these financials, so therefore YOU SHOULD too. Right! That was about 18 kitchen sinks ago. Except you don't have a guarantee that if your investment loses another 50% of its value Merrill Lynch (or Citigroup or Bear Stearns or this, or that) will pay you back for your losses. All you have is the punditry pounding the table on how great of a value these stocks are. As they are today. Eventually the squirrel will find the nut.

Last question - where would the United States of Suprime Financial system be without the printing press of the Federal Reserve and the largess of foreign investors? [Jun 10: Where Will U.S. Banks Beg Next?] Answer: Destroyed.

Conclusion: The 23,472nd kitchen sink quarter is here. Buy financials. They're a great value. Again.

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