Subprime Storm Brewing! Traders Run to Take Cover!

Word broke today that the "smart money" at Bear Stearns (ticker symbol: BSC) sent a letter to its clients [Wall Street Journal] advising them of the NAVs for their subprime-heavy hedge funds. 

Turns out that the Bear's High-Grade Structured Credit Strategies Enhanced Leverage Fund was virtually wiped out of its entire asset base while another Bear subprime fund is worth less than a 10th of its value from a few months ago. 

And, amazingly, this comes after Bear put up $1.6 billion in rescue finanacing.  Talk about throwing good money after bad!

For readers unfamiliar with "subprime" allow me to provide a quick primer:  "subprime" is a general term that refers to the practice of making loans to borrowers who do not qualify for market interest rates because of problems with their credit history.  While these "subprime" loans provide investors with an above-average yield it doesn't come cheap!  The risk premium attributed to these instruments is usually classified of the "highest risk" and, commonly referred to as junk.  And, unfortunately these instruments seem to be holding up on their moniker.  An alarming number of these loans are in default and the meltdown is showing no sign of slowing down.

What's next and what is the net result?  I would suppose that we see at least half a dozen hedge funds take huge hits while attempting to "unwind" trades and the net result as I see it:  the "smart money" gets burned chasing the hot dot!  Now that's a surprise!

>> Subprime Uncertainty Fans Out [Wall Street Journal] <<

Disclosure:  I do not hold any position in BSC nor does my firm have any exposure to BSC.

Starwood Hotels...a HOT takeover target? Bidding starts at $90 per share!

Today, shares of Hilton Hotel (ticker symbol: HLT) soared 26% after word broke that the company agreed to be bought by the Blackstone Group for $20.1 billion in cash.  The deal is valued at $26 billion including debt.  This proposed acquisition represents a 32% premium over Tuesday's closing price.  With this transaction setting a form of precedent, I am a believer that the next target in this space is Starwood Hotels (ticker symbol: HOT).  Starwood is the corporate holding firm for the St. Regis Hotels, the luxurious W Hotels, Westin and Sheraton Hotels.

Now lets review the numbers of today's announced deal and what an "implied" buyout price might be for HOT based on Blackstone's offer for HLT:

Blackstone Offer for Hilton

Given the Blackstone Offer Price for HLT of $47.50 per share the stock closed today at $45.50.  Based on today's closing price, the price-to-earnings multiple (2008 EPS) stands at 29.6x.

Keep in mind the following:  Starwood's capital structure is less reliant on debt as is Hilton.  Hilton sits on about $7 billion in debt (debt-to equity ratio of 1.9) whereas Starwood has approximately $2.61 billion in debt giving it debt-to-equity ratio of 0.83.  This would, potentially, make it a a very good target for LBO firms.  An LBO firm could step in and immediately refinance HOT's current debt (as is done in most cases) and issue senior debt based on HOT's assets.

With that said and based on my "behind the envelope" calculations, I would predict any offer for Starwood to look something like this...

Buyout Offer for Starwood

Based on the multiples listed above and a 2008 EPS of $3.01 the implied price of a 100% buyout of HOT's equity => $90.00 per share

This price would value the deal at approximately $21.6 billion including debt.  Effectively a 20% premium on today's share price to get a deal done....

Everyone in private equity is running for the exit doors! (KKR is going public)

KKR, one of the world's largest and most successful private equity firms, has decided to take itself public and "cash out".  This will ulitmately push the firm to compete against the world's top investment banks such as Goldman Sachs, CSFB, and Merrill Lynch.  KKR's planned IPO seeks $1.25 billion which would represent between 5% and 10% of the firm's value.  With those number, we would potentially extrapolate the value of the firm at roughly $25 billion. 

Since the Blackstone IPO, we are seeing a rush to the IPO market with recent filing by Och Ziff (hedge fund) and I also expect potential filing by the Carlyle Group and also Texas Pacific Group. 

What does this all mean?  The idea of selling their equity simply represents a "cashing out" of the "smart money" private equity executives.  When these guys are selling, it means something!  They see the top of the private equity market coming to a halt soon.  Eventually, the debt market (which is used to help finance these monster deals) will dry up with higher yields and and higher transaction costs.

[Wall Street Journal Article] http://online.wsj.com/article/SB118349434385057002.html?mod=home_whats_news_us

Edward Lampert's ESL Raising More Money

I am always fascinated by Edward Lampert's successes and he is back on the road raising more money for his funds.  Here is a short video that David Faber did on Lampert.