Goldman Sachs analyst William Tanona dished out some reluctant praise for Merrill Lynch (MER) after the company announced an emergency $8.5 billion equity issuance and the sale of its hideous ABS CDO portfolio for a $4.4 billion loss:
It was undoubtedly a bitter pill to swallow, but we believe management’s decision to finally sell the majority of its ABS CDO portfolio and write-off its monoline exposure was the right thing to do in order to move the firm forward. Nonetheless, these actions come at a very high cost to existing investors as outstanding shares increase by 38% under the “if converted” method (assuming no exercise of the over-allotment option [which will be exercised]). Although painful, we believe putting these issues largely behind it will better enable the firm to focus on existing business opportunities in the marketplace.
Tanona was particularly pleased that Merrill was able to reduce its net exposure to CDOs from $4.3 billion to $1.6 billion. Though he notes that, because Merrill is financing 75% of the purchase price, there are still risks involved if the buyer defaults on its obligation.
Finally, Tanona adjusts his estimates to reflect the new write-down outlook and the dilutive effects of MER’s new equity issuance:
We are lowering our 3Q2008 operating EPS estimate to ($4.40) from ($1.50). These
estimates exclude the gains from the Bloomberg and FDS sales. Including these gains, we
are lowering our GAAP estimate EPS estimate to ($1.00) versus our prior estimate of $2.72.
Despite a 38% increase in the sharecount, we are leaving our 2009 estimate unchanged at
$3.00. This reflects the acceleration of ABS CDO write-downs in 3Q2008, whereas we had
originally expected write-downs to continue into 2009. By 2010, however, we see less of an
impact from offsets to the sharecount dilution and our estimate is therefore being reduced
by 15% to $3.40.
Tanona maintains his Neutral rating.
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