August 12, 2008 / 1:47 PM / 11 years ago

UPDATE 1-Lehman says Merrill cut risk by CDO sale, capital raise

(Recasts; adds details, share movement)

Aug 12 (Reuters) - Lehman Brothers said Merrill Lynch & Co Inc MER.N removed the largest overhang on its shares by selling $30.6 billion of collateralized debt obligations (CDOs) and $9.8 billion in common shares.

The brokerage, however, lowered its price target on the stock to $32 from $44, saying the transactions significantly diluted its book value per share.

“Merrill management capitulated to both internal and external demands and decided to put its CDO inventory issues behind it, even at a steep cost to shareholders,” analyst Roger Freeman wrote in a note to clients.

Merrill sold the CDOs to Lone Star Funds [LS.UL] for a pre-tax loss of $4.4 billion, or at a discount of 40 percent, from its carrying value of $11.1 billion in the second quarter, the brokerage said.

Analyst Freeman said he now expects Merrill to post a loss of $1.77 a share for the third quarter, compared with his prior view of a profit of $4.19 a share.

The analyst, who has an “equal weight” rating on the stock, said Merrill’s risk profile was still elevated compared with its peers as it still has sizeable subprime and commercial exposures.

Morgan Stanley (MS.N) was the most attractive name in the space with 26 percent potential upside, compared with 21 percent for Merrill and 12 percent for Goldman Sachs Group Inc (GS.N), he said.

Shares of Merrill were down 2 percent at $25.65 in morning trade on the New York Stock Exchange. (Reporting by Supantha Mukherjee in Bangalore; Editing by Deepak Kannan)

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