Gloves Come Off as Lehman, Equity Residential Fight Over Control of Archstone

After a federal judge on Tuesday cleared the way for Lehman Brothers Holdings Inc. to exit the largest bankruptcy in history, the battle is officially on for control of Archstone, Lehman’s largest real estate asset. The card includes Lehman in one corner, possibly teaming with investors that may or may not include Blackstone and Brookfield Asset Management, squaring off against industry heavyweight Equity Residential and Lehman's partners in Archstone, Barclays Capital and Bank of America Corp.

U.S. Bankruptcy Judge James Peck approved Lehman's plan to exit Chapter 11 reorganization by Jan. 31, more than three years after the world's fourth-largest investment bank collapsed, and plunged the global financial markets further into crisis.

Under the agreement, Lehman Brothers, which had $639 billion in assets at the time it filed for bankruptcy protection in September 2008, will pay out $65 billion to creditors over the next three years versus $450 billion in claims.

Included in Lehman's vastly scaled-down portfolio is a minority 47% stake in Englewood, CO-based Archstone. Barclays Capital and Bank of America Corp. own a combined 53% of the apartment company. Formerly Archstone Smith Trust, the firm was one of the nation's largest REITs at the time Lehman and Tishman Speyer Properties acquired it in a $22 billion leveraged buyout during the peak of the real estate market in 2007.

Chicago-based Equity Residential (NYSE: EQR), an apartment REIT headed by real estate tycoon Sam Zell, emerged as the top bidder to buy out the banks’ majority interest in Archstone. On Dec. 2, an EQR subsidiary entered into a purchase agreement with BofA and Barclays to acquire 50% of their interests in Archstone for a total consideration of $1.33 billion in cash, implying a total equity value of $5 billion.

The acquisition would give Equity Residential a 26.5% interest in Archstone, which has ownership interests in 77,000 apartment units in the U.S. and Germany. However, EQR's end game appears to be full ownership. Zell told the Wall Street Journal that EQR would "like to own the whole company."

Lehman Brother called the offer for Archstone "inadequate," noting in a securities filing that if Archstone were to be broken up and sold in pieces, its net value "would suggest at least an additional $1 billion of value" over the value implied in Equity Residential's offer.

"Lehman believes that the EQR purchase price does not take into consideration the value of Archstone’s platform, including its management, which Lehman believes is the best in the industry, nor does it take into account Archstone’s valuable strategic position within the apartment industry," Lehman stated in the filing.

Lehman said that Bank of America and Barclays failed to provide sufficient information to trigger a 10-day period under its agreements with the banks allowing Lehman to exercise its rights to make a counteroffer. Lehman further alleged it appears that the banks and EQR timed the delivery of the offer for just prior to Lehman’s hearing to confirm its Chapter 11 hearing this week, and the election of its new board of directors, "to optimize the chance that Lehman will not exercise its rights."

Meanwhile, Bloomberg reported this week that Lehman is in talks with investors seeking to raise $2.6 billion, including Brookfield Asset Management Inc. and Blackstone Group LP, to exercise its right to counter EQR's offer and buy a controlling stake in Archstone.

If EQR is successful, it expects to fund the acquisition through a combination of cash on-hand, available borrowings under its $1.25 billion revolving credit facility, which could increase to a total of $1.75 billion; proceeds from the disposition of non-core apartment assets, bank debt and secured and unsecured debt, and equity offerings. Equity Residential and its subsidiary also obtained a commitment from Morgan Stanley Senior Funding, Inc. to provide a $1 billion bridge loan facility.

The sitution has captured Wall Street's attention. Among the scenarios being discussed is Lehman exercising its right of first offer and teaming with a large investor to cut a deal with EQR for a portion of Archstone's assets, retaining the remainder of the portfolio for an potential IPO to raise additional proceeds from real estate sales.

In any case, Lehman "came out swinging" against the EQR cash offer, a move likely to buy it more time in order to raise capital or execute a plan to maximize Archstone's value, Citi REIT analyst Michael Bilerman said in a research note.

"This response by Lehman clearly shows that EQR will have to put up a fight to acquire any interest in Archstone, and while shareholders were expecting such a fight, it nonetheless highlights the potentially long and uncertain road ahead," Bilerman said.

Sandler O’Neill REIT analysts Alexander Goldfarb and James Milam believe that Archstone CEO Scot Sellers and Lehman want to keep the company as an independent entity, and thus "will do everything they can to source the capital necessary to match EQR's offer."




The attraction of Archstone for EQR is clear as it would boost the REIT's penetration in core markets with one of the highest quality portfolios in the multifamily industry, rivaling that of its former office counterpart. Archstone's U.S. portfolio is concentrated in high-value markets such as Washington, D.C., Manhattan, Northern and Southern California, and Seattle.

"We have no doubt in EQR's ability to fund the announced transaction or a potential deal for the whole company, as EQR has ample capital options between secured and unsecured debt, bridge financing, term loans, equity issuance and dispositions," the Sandler O’Neill analysts said.