J.P. Morgan Falls as Venture Capital Arm Returns to Red

J.P. Morgan Chase (JPM) once boasted that it was the New Economy bank. The title stuck, but Morgan isn't boasting now.

The bank warned Wednesday that it expects a second-quarter loss in its venture capital unit, marking the third time in four quarters that investment writedowns and accounting losses have more than offset gains in its private equity arm, J.P. Morgan Partners.

The news isn't shocking, given the continuing shakeout in dot-com and telecom companies that have been favored by the former Chase Capital Partners. But considering the revival in the stock market and the unit's swing to the black last quarter, investors were hoping J.P. Morgan Partners would show robust second-quarter results. Now the bank's stake in once-hot technology investments is again looking like an albatross, causing analysts to cut earnings estimates and and the stock to drop 4%.

Surprise

"It's surprising," says James Mitchell, analyst at Putnam Lovell, referring to the venture arm's losses in the face of a 20% gain in the Nasdaq Composite Index this quarter. "Despite the fact that the markets have turned in their favor, they still have more writedowns." (He rates J.P. Morgan buy, saying the stock is cheap compared to peers. His firm hasn't underwritten for the bank.)

Mitchell says he thought the cash gains and writedowns of last quarter were a sign J.P. Morgan "was setting themselves up" for a strong second period by taking poor-performing investments off the balance sheet. But despite unrealized gains of about $150 million so far this quarter, "the company is going to take further writedowns in its private investment portfolio, particularly with respect to its telecom investments," said Mitchell in a report Wednesday.

J.P. Morgan declined to comment beyond the information it disclosed in a regulatory filing. In the filing, J.P. Morgan noted that a weak IPO and merger-and-acquisition environment limited its ability to use various "exit" strategies for its investments.

J.P. Morgan has said in the past that it remains committed to the private equity business, where it is the largest lender. The bank is in the process of raising a $13 billion private equity fund, of which it is committing $8 billion of its own cash.

The venture capital operation was once the toast of Wall Street, generating huge gains as tech stocks rose to record highs in the spring of 2000. And even after recent setbacks, the unit has shown a lush 44% liquidated internal rate of return, on an annualized basis, since its inception in 1984. But for now the bank is still ironing out the wrinkles of the technology bust in its portfolio. Wednesday afternoon, the stock slid $1.87 to $46.63.

Negativity

Among its weaker telecom holdings at the end of the first quarter were Via Net Networks (VNWI), Lucent (LU), QS Communications (QSCG) and Telefonica (TEF), all of which are down significantly for the second quarter.

"Going forward, we're just taking a much more negative view" of the private equity arm, says Mitchell. The new investments are probably not in start-up Internet companies, he says, but "they still have old investments" that need to be sold or written down, he says.

Mitchell cut his second-quarter estimate on J.P. Morgan Chase to 66 cents from 70, and slashed his 2001 view to $3.10 from $3.75. UBS Warburg analyst Diane Glossman cut her second-quarter estimate to 72 cents from 81 cents and reduced her 2001 view to $3.15 from $3.45, while trimming J.P. Morgan's price target to $55 from $60.

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