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Lehman's White Knight

A Korean bank reportedly offers to buy a 25% stake in the troubled U.S. broker amid signs of a possible bidding war.

By Roddy Boyd, writer
Last Updated: September 3, 2008: 11:40 AM EDT

NEW YORK (Fortune) -- One of the most compelling dramas in New York's theater district this summer hinges on Lehman Brothers' courtship of a Korean bank.

Just over a week after early enthusiasm over the reported talks dissipated, South Korea's largest newspaper reported Wednesday that a group led by Korea Development Bank is offering to buy a 25% stake in Lehman for up to $5.3 billion (more on that head-scratching price later).

The report came a day after the bank's head, Min Euoo Sung, confirmed that the state-owned institution was holding talks about investing in the troubled investment bank. Meanwhile, Tokyo Mitsubishi Bank may offer to buy a substantial investment in Lehman, according to the U.K.'s The Times on Wednesday.

The deal chatter offers a bit of good news for Lehman (LEH, Fortune 500), because management has been scouring the world for a partner that can help bolster the firm's equity base, which is straining under the weight of almost $65 billion of commercial and residential real estate securities and loans.

The market values for most of Lehman's mortgage-related assets, especially the commercial real estate paper, have been dropping steadily. In turn, this has fueled speculation of yet another quarter of writedowns for the firm, with estimates putting a likely charge anywhere from $2.8 billion to $4 billion. Over the past year, Lehman has taken some $6 billion in writedowns.

At varying points in recent weeks, Lehman's management has sought to sell a stake in the profitable Neuberger Berman money management unit. Alternatively, management has sought a direct equity investment and, according to the Wall Street Journal, is contemplating a spinoff to shareholders of its real estate portfolio, though it's not clear how such a deal would be financed.

Shareholder relief

Lehman shareholders, who have seen their investment drop 75% this year, were granted a temporary reprieve on news of the talks with the Korean bank. Shares were flat at $16.75 Wednesday, after a modest gain Tuesday. At one point early last week the stock dropped below $14 as rumors about impending writedowns gained strength.

According to news reports Wednesday, KDB has approached Lehman with an offer to buy, as part of a consortium of South Korean banks, a 25% stake. The additional bank partners were not identified. KDB and Lehman declined comment on the reports, according to the Associated Press.

One question about the reports centers on the quoted price. Were the Korea Development group to pay $5.3 billion for a quarter of Lehman, it would be paying an 88% premium based on Lehman's $11.3 market capitalization. Perhaps this is why on Tuesday, KDB chief Sung - himself former head of Lehman's South Korean operations - told Bloomberg that negotiations were held up over "differences over price."

Even so, the prospect of a deal at any price must have Lehman pinching itself, given the likelihood of near-term pain in its future combined with management's proclivity for risky deployment of its balance sheet (examples: the $13.5 billion 2007 buyout of real estate investment trust Archstone-Smith, a large owner of apartments, and a disastrous foray into Southern California real estate development with Sun-Cal.).

Price aside, there appear to be hurdles in Korea that must be surmounted for an investment of this scope to take place. According to a report in the New York Times, Jun Kwang-woo, head of the country's Financial Services Commission, expressed doubts last month that public-sector funds should assume a lead role in such a venture. Another report did note, however, that the FSC would keep a neutral stance on the matter until they saw the terms of any transaction.

A Lehman spokesman declined comment. But the firm's perceived eagerness to do a deal before mid-September, when it's due to unveil its latest round of dour earnings news, could mean that a deal with KDB will give Fuld another chance to resuscitate Lehman - if at the cost of another hit to current shareholders. To top of page

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