Firm notes they are increasingly concerned about the company's $3.9 billion of non-bank SIV exposure, as the expiration of support agreements begins as early as this month and asset values remain under pressure. This is especially concerning with regard to their operating estimates, which suggest that the company is on track to trip certain debt covenants, adding additional liquidity risk. While the firm believes there are several scenarios under which the company can avoid a complete liquidity crisis, they view LM shares as overvalued relative to peers, given its leveraged balance sheet and falling EBITDA, which create additional risks to shareholders' equity.
Compounding the liquidity problems caused by the SIVs are Legg Mason's debt covenants, which restrict Legg's ability to access additional borrowings and stipulate a required debt/EBITDA ratio below 2.5x. Given the falling assets under management, FBR believes the company is on a run-rate to exceed the 2.5x leverage ratio (based on a trailing 12-month basis), which would require the repayment of a $500 million revolver and $550 million term loan.
Adjusting for the impact of recent market performance an expectation of accelerating investor outflows from equity and bond funds, FBR is lowering their FY09 and FY10 earnings estimates, which do not reflect any additional SIV charges, by $0.05 and $0.19 to $0.04 and $2.46, respectively. More importantly, they estimate that, by the end of the December quarter, trailing 12-month EBITDA will be approximately $976 million, which, depending on the expected value of contingent payments to Permal, could potentially result in noncompliance with the 2.5x leverage covenant.
Notablecalls: This one reads badly for Legg Mason (NYSE:LM). It seems the co has very little in terms of positives on the horizon. Au contraire, there seems to be lots of bad news in store for them:
- Performance is going to deteriorate. Pressure on EPS.
- I suspect we're going to see Bill Miller leave (outsted) the co. The news could come as soon as this year.
- Covenant issues - the killer.
I feel this one will be a sub-$10 stock in the very near future.
Going to call this one an ACTIONABLE SHORT.