Wednesday, September 24, 2008

Buffett Buys A Piece of Goldman

It's a good time to be teaching Corporate Finance. Buffett's latest move (making a substantial investment in Goldman Sachs) is bound to make it into a lot of class discussions. The Wall Street Journal's take (at least, as expressed by Georgetown finance professor James Angel) is
Berkshire's plan "is a sign of confidence from one of the nation's most respected investors," said James Angel, a finance professor at Georgetown University, who added that "sharp investors" now are "sniffing around the wreckage of the credit crunch to pick up good assets on the cheap."
I think the second part of the statement is closer to the truth than the first. Here's what the Sage of Omaha gets for his money
The deal is structured in two parts, giving Berkshire a stream of cash and potential ownership of roughly 10% of Goldman. Berkshire will spend $5 billion on "perpetual" preferred shares of Goldman. These are not convertible into equity but pay a fat 10% dividend.

Berkshire also will get warrants granting it the right to buy $5 billion of Goldman common stock at $115 a share, which is 8% below the 4 p.m. closing share price Tuesday of $125.05. At Goldman's roughly $50 billion market value, based on that closing price, exercising those warrants would give Berkshire about a 10% stake in Goldman.
So, while the preferred isn't convertible, he gets what is essentially "synthetic convertible preferred". In essence, he gets his preferred payouts if the stock price doesn't rise, and the option to buy stock at a discount if the price is above $115. So, in effect he has a combination of preferred stock and an in-the-money call option. Barry Ritholtz prices the warrants at approximately $1.5 Billion, giving Buffett an effective yield of 14%, and cites another source who estimates their worth at $3.5B, and a yield of 17%.

Once again, Buffett has been able to make an investment at a very attractive price. In times where there's a lot of turmoil, having cash on hand makes it easy to buy companies (or parts of them) at a bargain, and according to Berkshire's first quarter, they had $31 Billion on hand. So, Buffett had cash at a time when Goldman desperately needed it. As a result, he got a great deal.

Just Damn. That guy is smart.