Legg Mason To Raise Equity, Won't Solve Miller Problem

On the heels of its abysmal earnings report yesterday, where Legg Mason posted a $255.5 million loss, the company is opting to raise capital by issuing $1 billion in "special" equity. What makes this class of stock so special? The investor not only receives a share of stock for $50, it also gets 1/20 of a $1,000 bond that matures in 2021. What a clever way to raise capital to refinance that pesky $425 million in bonds maturing in July that Legg Mason can't repay otherwise because it spent the money keeping its money market funds afloat.
Recent equity issuances by financial firms beleaguered by enormous asset write-downs have incited sheer euphoria in the equity markets, but one has to wonder if this particular equity issuance will do the trick. Although the write-downs were related to the company bailing out its money market funds, which were invested in illiquid securities, Legg Mason appears to be suffering from a much bigger problem. Outflows from its flagship mutual fund point to a crisis of confidence in former star mutual fund manager Bill Miller.
For those who aren't familiar with Mr. Miller, he spent 15 years heralded as one of the finest mutual fund mangers due to a value investment approach that outperformed the S&P. Unfortunately, his streak ended with a thud in 2006. Performance in the flagship fund has suffered dramatically since then due to some very poor decisions in the past two years. In fact, it appears as if Mr. Miller has developed an uncanny ability to pick the worst performing stocks and sectors out of the bifurcated market we have experienced in recent years. Mr. Miller was a big buyer of the homebuilders in 2006. His investment thesis? The builders had very low P/E ratios thus causing them to be "value investments". His analysis, which appears to have involved looking at one number, failed to take into account the builders' bloated balance sheets and negative cash flow statements as well as a deteriorating housing market in a clearly cyclical industry. He was a big investor in Countrywide, the poster child of irresponsible lending which would have eventually gone bankrupt if not for a bailout by Bank of America. Mr. Miller held a stake in Bear Stearns at some very high prices, while failing to give any weight to the rumors of impending bankruptcy in early March which were even reported in a little-known financial commentary website called MockTheMarket in a story entitled Is Bear Stearns Going Bankrupt?. Furthermore, Mr. Miller holds a large stake in Yahoo, and seems to think that Microsoft will come back to Yahoo. The Bloomberg article quotes Mr. Miller as saying "I'm more puzzled by Microsoft not going up to $37 than Yahoo wanting to walk away." Really? Puzzled that Microsoft, who is known for its shrewd negotiations isn't going to pay $37 for a stock that was trading at $19 before it entered the ring? Mr. Miller goes on to claim that Microsoft will be back. That's funny because Microsoft's Gates says the company will pursue other alternatives after walking away from Yahoo. So, who are you going to side with?
Legg Mason's Value Trust Fund lost 19% in the first quarter. As of March 31, the fund held sizable stakes in some underperforming stocks such as UNH, Yahoo and GE. In his first-quarter investment commentary to shareholders Mr. Miller forecasts that the 'worst is behind us.' Hmmm, where have I heard that one before?