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Current time:0:00Total duration:10:28

Video transcript

I tend to do a lot of videos with simplified examples and round numbers but let's take let's let's get a little bit of dose of reality and actually analyze a real transaction that happened just to show to you that some of these CEOs are selling for well below what the people paid for them or what they were listed as on the books and even that the price is actually probably even worth less than what the person actually paid so let's let's just analyze this and then I'll let you make your own conclusions so this was a press release this is part of the press release that Merrill Lynch sent out on July 28th and and just remember they had just finished reporting earnings right as of June 30th they that's when they do a snapshot of their book so keep that in the back of your mind right so it says on July 28th Merrill Lynch agreed to sell 30 point six billion gross notional amount of US super senior ABS CDOs to an affiliate of Lone Star funds so this is important so the thirty point six billion what is that that's the number that either Merrill Lynch originally paid for it or the what the amount that they originally valued those CDOs are so thirty point six billion gross notional notional I have a notion it's worth this notional amount of us super senior that sounds safe super senior ABS that's short for asset-backed securities CDOs we know a lot about CDOs now collateralized debt obligations to an affiliate of Lone Star funds so this is a Texas private equity firm I'll do I'll underline them in green because I I think they know what they're doing for a purchase price of six point seven billion dollars so just just off that first line just very superficial before we do any other real analysis notice that at one time there was an asset though that someone had a notion was worth thirty point six billion dollars and now they sell to this private equity firm for six point seven billion dollars so what's what's the recovery on that asset just superficially and we're gonna do some we're gonna dig in a little bit and realize that the cover e's even worse than that so they paid they were able to sell for six point seven something that they originally thought was worth 30.6 so that's 22 cents on the dollar so this at least what that first sentence implies that is 22 cents on the dollar 22 cents on the dollar at least relative to the original amount that though those assets were booked at at the end of the second quarter of 2008 notice the end of the second quarter of 2008 was four weeks ago relative to this press release that's June 30th four weeks ago right not a lot can happen in four weeks at the end of the second quarter of 2008 these CDOs were carried at 11 point 1 billion dollars so this is interesting so Merrill Lynch at one point probably last year had these assets on their balance sheet for 30 point six billion dollars at they to realize that they were stinky assets and they said well we have to you know just to be somewhat genuine we have to write down these assets a little bit but and notice they don't want to write around too much because they write them down too much no one else is going to want to invest in Merrill Lynch or maybe they'll say Merrill Lynch's problem might not even have anything left but at some point they said you know what what will will be pseudo honest with the market and these things that were worth thirty point six billion we're going to write them down to 11 point 1 billion so they must have taken and what if they did that in one period I don't know how many periods it took them to realize that this 30 point six billion dollar asset was really worth eleven point one but in those periods they would have had to take it what is that a twenty nine point five billion dollar write down right but as recent and you know they did that to look I guess pseudo honest that the asset is worth 11 billion but they evaluated 11 billion and then four weeks later they sell it for six point seven billion so whatever was on their books on as far as this asset is concerned whatever was on their books on July 1 or on June 30th what are they were getting recovery relative to that they're getting six point seven billion for something that just four weeks ago not a lot can happen in four weeks whoops eleven point one and then I can delete that so they got sixty cents on the dollar relative to what was on their books as of as of June 30th right so it's a 60 cent recovery relative to what they thought it was worth only only four weeks ago and then they say in in connection with the sale Merrill Lynch has two will record a write down essentially we you know now we sold this thing so now we have to essentially come to terms with reality and so they recorded a write down of 4.4 billion pre-tax and what's four point four that's the difference between what they thought it was worth between the 11 point 1 billion and what it ended up being worth or six point seven billion now this is this now what what's interesting here is that's not the end of the bad news you might think that's bad enough they were only able to get 22 cents on the dollar for something that they originally valued at thirty point six or what four weeks ago they only valued at three eleven point 1 billion right and and I don't think they got a lot more information I think they just put that 11 point 1 billion down and on June 30th just because it was probably a convenient number enough of a write down to make it look like you're writing things down but not so much of a write down to scare people too much but this is the interesting part I mean this paragraph talks a little bit about their exposure and we can get into that but if I talked about that I could talk for another 20 minutes but let's get to this last paragraph that was buried in the press release and this is really the crux of things and this I think will give you a clue of the shell games that the financial industry tries to play on people Merrill Lynch will provide financing to the purchaser for approximately seventy five percent of the purchase price so loans to our funds they're buying it for six point seven billion but seventy-five percent of that is a loan from Merrill Lynch so how much are they lending let's see six point seven times 0.75 they're lending them five roughly five billion dollars right so Merrill Lynch is lending five billion limits I don't like the color five billion so Lone Star says these things are so stinky we're only going to pay six point seven billion for them and in fact there's even there even stinkier than that in order for me to buy them I don't even want to buy them with my money you're going to have to lend me most of the money to buy that asset and even this wouldn't be so bad if you just lent it generally the Lone Star and if you know one day you know Lone Star if these assets were nothing you can still go after the Lone Star's other assets right if if you could just go after Lone Star generally maybe this loan isn't such a crazy thing because maybe Lone Star has a lot of assets I don't know but I suspect that there are fairly large private equity firm and this is I mean this is just insult to injury right here you gotta give credit to those Lone Star guys the recourse on this loan so that the recourse is essentially what you can go after if the person decides that they don't feel like paying that loan the recourse on this loan will be limited to the assets of the purchaser the purchaser will not own any assets other than those sold pursuant to this transaction so essentially what Lone Star did because Lone Star does own assets other than other than essentially this this this asset that is buying right now or I'm guessing it does and it's a real private equity firm but they probably did is they created a corporation that does not own anything else right so that if they default nothing's left so they created a corporation they capitalize that corporation with whatever 1.7 billion dollars they so essentially Lone Star puts one point seven billion dollars in that fund marrow into that you know the Lone Star funds or whatever an affiliate the affiliate is probably the corporation that they created so this affiliate is created by Lone Star Lone Star puts in 1.7 billion dollars into it Merrill Lynch lends this affiliate five billion dollars and then this affiliate buys or you know Merrill Lynch is able to offload this six point seven billion on to that affiliate and this is a special-purpose entity if I've ever heard of one because it's its purpose is very special essentially for Merrill Lynch to take something off of its books and not have to write it down all the way because think about what happens let's say that these assets are worth zero what let's just say that they're they're completely worthless and I should add in the previous video I showed you why that could be the case what's the loss to Lone Star well Lone Star they don't have to pay the five billion back we just said the purchaser will not own any assets other than those sold pursuant to this transaction and that the recourse is only those assets right so if they don't pay that loan back Merrill Lynch all they can do is take back those worthless assets and then what's going to happen well then Lonestar is just going to lose 1.7 billion dollars or even better what if those assets are only worth one point seven billion dollars right if let's say let's let's think about an example let's say those assets are worth one point seven billion dollars and Lonestar says you know what we don't feel like paying back this five billion dollar loan what's going to happen Merrill Lynch is going to just take back those 1.7 billion dollars of assets so what's the Lone Star's downside 1.7 billion so essentially what are they paying for it they're essentially paying 1.7 billion and they're kind of sharing the upside in between one point seven and five so really if you think that they're paying one point seven or even a little bit more really I'm what someone start putting at risk one point seven so one point seven billion divided by what was the original notional value of this asset so they're paying six cents on the original notional value and what are they paying relative to what Merrill Lynch told its shareholders this asset was worth four weeks before this press release they're paying fifteen cents on the dollar relative to that well anyway this is a real-world example this was not made up by me and frankly I don't think I could have made up something this outlandish but it hopefully gives you an idea of what is actually going on in the real world