Oh, to be Warren Buffett.
A few quarters ago, I determined that as RRSP strategies go, it made sense to invest in certain core names. Stocks that reflected the best firms in the various sectors of the economy that I wanted exposure to; and own them for a very long time. Goldman Sachs (GS:NYSE) was one of those names, and at 10x forward eps at the time (US$220 or so) it seemed like a fortuitously cheap price. With the rise in the Canadian dollar, and the crunch that came with the subprime mess, Goldman has been a loser. But so have 95% of stocks with a financial bent to them.
Mr. Buffett’s decision to invest US$5 billion in Goldman has the hallmarks of the deal that I’m all but certain Lehman’s Dick Fuld tried to pull off earlier this year (see prior post “From the desk of Dick Fuld, Lehman Brothers CEO” July 17-08). As one senior Wall Street banker said to me recently on hearing of the Fuld letter spoof: “that’s a safe assumption”. Have a quick look at an excerpt of the fake Fuld letter to Buffett:
My partners and I are prepared to consider a $5 billion convertible preferred investment, paying an 8% annual cash yield, with redemption and retraction rights in, say, 20 years. Our stock rallied yesterday on the back of the positive news out of Wells Fargo. But, with a sensible discount to yesterday’s closing price of $16.65, your firm would own approximately 33% of our Company, at closing. Naturally, we would very much want you to consider joining our Board of Directors at the earliest opportunity. Other names would be welcome as well.
As we both know, an announcement that Berkshire had agreed to invest capital in our firm would propel both LEH shares and the broader bank index. If yesterday’s rally is any indication, you could earn a 25% return in a single day merely on the news of your financial commitment to me and our franchise.
Change the name to Goldman, and the post came true last night. Buffett invested $5 billion in prefs, and rather than have it be convertible into equity, he gets warrants instead. Accomplishing the same outcome. The first day bump on his investment? About 20%, and the market hasn’t even opened yet.
The difference between being Mr. Buffett and us is clear, and speaks to the challenges that retail investors have when they try to invest in the public markets:
- Berkshire’s buying Goldman perpetual preferred shares with a 10% dividend; although I haven’t seen the exact terms, “perpetual” usually means they have no set “expiry”, and can’t be retracted by the investor. But Goldman can buy them back at a 10% premium to face value when the day comes that they can issue prefs in the public markets at a far cheaper yield; which has been most of their history as a company;
- as a preferred share owner, Berkshire has now jumped ahead of us common shareholders in the capital structure;
- a 10% yield on the prefs is about right, given where the Goldman subdebt was trading last week. Their 2031 6.75% bonds were trading at $76, which meant that 1) no one believes their “A” rating (since these bonds are trading below the credit rating of Brazil, for example, which is rated lower than this Goldman debt tranche), and 2) the implied yield is 8.9%, 110 bps below the yield on Berkshire’s prefs, which rank below the subdebt;
- Berkshire also gets a five year warrant to acquire common shares of Goldman at US$115, well below the US$125 close yesterday (US$115 is likely the price of the stock when they were negotiating the deal in private). With the warrant, Berkshire has the right but not the obligation to buy US$5 billion of Goldman common shares at any time over the next half decade. At the current pre-open quote, Mr. Buffet’s warrants are already US$956 million in the money…an immediate 20% notional return on his US$5 billion pref issue. If Goldman shares hold in here for 12 months, Berkshire will have made paper gains of about 30% on a preferred share issue;
- to bolster the capital base, Goldman is also issuing US$2.5 billion of common shares. On the heels of Mr. Buffett’s announcement, those shares will be much less dilutive than before. And this common share issue has the added virtue of improving the credit profile of Mr. Buffett’s prefs, given they rank junior to his offering.
36 months ago, Goldman issued perpetual prefs with a 6.2% interest rate, with no common share purchase warrant. But being Mr. Buffett, his near term return profile looks to be five times that level. How can a retail investor keep up with that?
I’d like to think that Mr. Buffett’s financial advisors used my July 2008 Fuld proposal as the template for their Goldman deal, but bloggers know better. One thing is for sure, it is better to be him than the rest of us when it comes to investing.
(disclosure – I own GS)