Allan Sloan FORTUNE
The Deal by Allan Sloan Full coverage
January 24 2008: 5:16 AM EST
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Buy high, sell low

How Wall Street banks frittered away billions.

(Fortune Magazine) -- The one thing Wall Street knows how to do is raise money. The proof: Even with financial markets threatening to melt down worldwide, four of the Street's biggest firms have attracted a total of $50 billion of investor cash to help cover losses on subprime-mortgage-related carnage past and on carnage yet to come.

That's the good news - but there's bad news wrapped around it. When you take out your calculator, you see that these firms - Citigroup (C, Fortune 500), Merrill Lynch (MER, Fortune 500), Morgan Stanley (MS, Fortune 500) and UBS (UBS) - have frittered away billions of dollars by selling their stock for much less than they paid for it.

Hello? Didn't we learn in Investing 101 that the idea is to buy low and sell high? Yet the Wall Street Four, filled with financial geniuses who scarf up seven- and eight-digit pay packages, have done the opposite. The firms bought stock dear when they felt flush and are now selling it cheap because they need the money.

One Merrill deal is the simplest example. In December the Thundering Herd sold $5.6 billion of common stock at $48 a share to raise capital. Earlier in the year, however, it paid 75% more - $84.48 - for the shares it bought in the market. Its sale of $6.6 billion of convertible preferred stock in January fetched an implied price in the low 50s, still way below $84.48. (For more details on these deals, see below.)

The biggest losers in the buy-high, sell-low game are shareholders of Citi, which had raised a total of $20 billion in two deals when Fortune went to press and was looking to raise more. Both deals involve securities convertible into common stock at varying prices. Rather than get caught up in complex math to value this stuff, let's just assume that sophisticated buyers such as the sovereign wealth funds of Abu Dhabi and Singapore know what they're doing. They bought these converts rather than Citi common because they considered them a better economic deal. So even though the conversion prices are as high as $37.24, it's reasonable to assume that the value these deals place on Citi's common is about what it fetched when the deals were being negotiated - the high 20s and low 30s.

What do you think Citi paid last year when it repurchased its own shares? Would you believe an average of $53.24?

Now let's look at it another way. Citi has recently raised $20 billion, as we've seen. From 2005 through 2007, Citi spent a bit more than $20 billion buying back its shares in the open market, acquiring 434 million of them. The $20 billion of securities that Citi has just sold will convert into 575 million to 600 million shares, by my estimate. Those added shares dilute the stake of Citi's other holders.

In addition, Citi will have to pay fat rates until the securities convert: 11% (before taxes) on Abu Dhabi's $7.5 billion December deal and 7% (after taxes) on January's $12.5 billion of convertible preferred. That's some serious vig.

I'll spare you the arithmetic on Morgan Stanley (which has raised $5.6 billion) and UBS ($11.9 billion). But you get the point.

Why am I writing this, other than to rag on these firms? Two reasons. First, that capital is precious when you need it - and you're never sure when you're going to need it, so you'd best keep plenty around.

Second, that stock buybacks aren't necessarily good for shareholders, current conventional Street wisdom notwithstanding. The theory, promoted by "activist" shareholders and practiced by my employer, Time Warner, among others, is that buying back lots of stock enhances shareholder value. But as these cases show, buybacks can also erode shareholder value.

Look, I think it's great that the Street has raised all this money. I just hope that when things get better, Wall Street remembers its past buyback follies. Maybe next time the Street will sell shares when they're being bid up rather than find itself forced to sell at times like these. Repeat after me: Buy low, sell high. Not the other way around.  To top of page

Four big Wall Street firms that have sold stock to raise money are getting less for shares theyíre selling than they paid for those theyíve bought back. Even though weíre listing the conversion prices of the five sales of securities converted into common, the effective sale price was much lower, given that sophisticated buyers chose to purchase the converts rather than buy common. The conversion price of Citigroupís 2008 issue is an estimateóCiti released the formula itís using, but not the price.
    Citigroup Merrill Lynch Morgan Stanley UBS
(in Swiss Francs)
(convertibles, ranges shown)
2008 $34* $52.40-$61.31    
  2007 $31.83-$37.24 $48** $48.07-$57.68 $51.48-$62.92
purchases 2007 $53.24 $84.88 $76.23 $71.41
  2006 $48.83 $77.25 $65.43 $73.14
  2005 $46.16 $58.67 $54.31 $108.53
Sources: SEC filings, 2007 purchases through end of third quarter
**actual share price