The Sage of Omaha is famous for his nose for a bargain, and has experience in the securities industry thanks to his rescue of Salomon Brothers in the wake of its early 1990s Treasury bond scandal. While Goldman has a storied name, great relationships, and has fared better than any other securities firm in the credit crunch, it has become more hedge fund with some customer businesses attached than a traditional investment bank or securities trading firm. And now that Goldman could in theory raise deposits to fund that activity, it would have an insurmountable cost advantage. Buffett is acutely aware of the value of cheap funding; it’s one of the reasons he entered the insurance business.
From the Wall Street Journal:
Warren Buffett’s Berkshire Hathaway announced plans to invest $5 billion in Goldman Sachs Group Inc., which recently changed its structure to a bank-holding company from an investment bank.
In addition to the $5 billion from Berkshire Hathaway, which comes in the form of perpetual preferred shares, Goldman will raise at least $2.5 billion in common equity in a public offering.
Berkshire Hathaway will have warrants to buy another $5 billion in common stock with a strike price of $115 a share, which are exercisable at any time for a five-year term. The perpetual preferred stock will have a dividend of 10%.
Bloomberg comes up with a bigger number, per its headline, “Goldman to Raise $7.5 Billion From Berkshire, Public,” because a public stock offering is also in the works:
Goldman Sachs Group Inc. will raise at least $7.5 billion from Warren Buffett’s Berkshire Hathaway Inc. and public investors in a bid to quell concerns that pushed up the Wall Street firm’s borrowing costs and hurt its stock.
Berkshire is buying $5 billion of perpetual preferred shares, New York-based Goldman said today in a statement. Goldman, which this week transformed itself from the biggest U.S. securities firm to the fourth-largest bank by assets, also plans to raise at least $2.5 billion by selling common stock in a public offering.
Goldman Chief Executive Officer Lloyd Blankfein is turning to Buffett, the billionaire investor and second-wealthiest American, to boost market confidence even though Goldman hasn’t reported a quarterly loss since it went public in 1999. The bankruptcy of Lehman Brothers Holdings Inc. and emergency sale of Merrill Lynch & Co. to Bank of America Corp. on Sept. 15 have fueled fears about firms that rely on bond markets for funding.
“At this point you’re better safe than sorry, I think that’s the moral of Lehman,” said David Hendler, an analyst at CreditSights Inc. in New York. “Everything’s different because of the extraordinarily weak market conditions, as vividly described by our Treasury Secretary and Fed Chairman” in congressional testimony today, Hendler said.
Update 8:15 PM Reader Scott Frew went through the economics of this fundraising in comments, and this is pretty pricey capital. What has me puzzled is that Goldman should be required as a bank to delever. That will make this equity even more costly (lower leverage means lower ROE). One would also think that being supervised as a bank would constrain their risk-taking (I’m assuming, perhaps too optimistically, that regulators will become a tad more aggressive).
Thus a Goldman that would be permitted to raise deposits would presumably be a very different Goldman…..or if not, we are back to a variant of what lead to the S&L crisis, where deposits were used to fund risky investments.
24 comments
Comments are closed.
Buffett buying into the “best moat” out there. He is certainly astute.
It makes me wonder Yves, if we have been hard on the whole thing and maybe a silver lining?
Looking at the terms of the investment, is Berkshire an admirer of SWFs? sounds remarkably similar to deals done on citi, ubs.
Yves, you might like to take a look at Pritchard’s latest blog post on the telegraph – one of the few not to be pessimistic on the dollar?
I just watched Senator Bernie Sanders rip Kudlow a new one. Someone please put this on youtube.
Also check out Sanders site where he has an open pretest to the bailout.
http://sanders.senate.gov/
Word verification? Are you serious?
Yves–
$5 billion of 10% preferred–Goldie’s been of late on a $7-8 billion annual net income run rate, so this dividend, which is paid in after-tax dollars, is a significant hit. The warrants are $10 in the money at the moment of the deal, $25 a share in the money not much later as the market reacted. This is not cheap capital for Goldman, to put it mildly. The cynic in me wonders what this says about the propensity of Treasury to ever consider a repeat of its crushing of the preferred at Fannie and Freddie. I’m guessing Buffett thinks that’s not a high probability event here.
Great deal for Buffett? Yes, absolutely, almost independent of his view of Goldman’s future, beyond a view that they’ve got the income to pay the dividend. 10%, with in the money warrants on top, ain’t bad these days.
Great deal for Goldman? Cost of capital is not exactly cheap, but I’m thinking they didn’t have a lot of options.
Do those common stock warrants count as exceptional? 11% of the firm seems to me huge — especially given the number of institutional investors, who would be likely to listen closely to any advice Buffett chose to give.
Does anybody who understands stocks better than me view this as an option to take control of Goldman?
695B in private capital to go.
Scott,
Tha for going through the economics. I put the post up in haste and neglected to do so.
AnoninCA,
Berkshire tends not to want to own businesses Buffett likes, He’s happy to have a big minority stake with a board seat and maybe some special vetos.
Goldman had Sumitomo Bank as a special limited partner in 1986 and they got 12.5% of earnings. Goldman later took in another special limited partner (I am blanking on the exact name, but it was a charity, a school in Hawaii), so they’ve been wiling in the past to pay out a big chunk for capital. But they were more in the driver’s seat then than now.
Whoops, sorry re the typo above.
Also, see the musings in the update above. Any comments appreciated.
yves,
per your update–didn’t goldman just make the determination to morph into a commercial bank rather than merge with one, as broker dealer model was dead, even for them?
they will have to delever, as there is no way a lessening of gearing governance is remotely possible in the current environment.
Matthew Dubuque
This also shows how dire the meltdown is.
Recall how brilliantly GS bet that the financial system would collapse by placing heavy bets that more than half of the world’s top 50 banks would lose HALF their value from 12/07 to 12/09.
John Dizard first exposed this scandal in December of last year and I describe it from 5:25 onward in my April 2008 video entitled “What Did Goldman Sachs Know and When Did They Know it?” at:
http://tinyurl.com/63zo3w
In this article, Dizard described how Large Bank Basket Stability Notes sold by Goldman put that firm in the position of betting HEAVILY that half of the world’s largest 50 banks would lose half of their value by December 2009.
So if GOLDMAN needs this money in a hurry, you can draw your own conclusions about how the AUDITED financial status of others far less prescient will be revealed in January of next year!
John, if you are reading this I STILL need those PowerPoints you refer to.
thanks,
Matthew Dubuque
mdubuque@yahoo.com
Why should taxpayers money be used to buy paper for three decker houses in the Dorchester or capes at $1,000,000.00 a pop?
The Hawaii school mentioned above is Kamehameha.
Yves–
A couple of additional quick thoughts. It looks like an even better deal for Buffett than I’d thought at first. Really back of the envelope look at those warrants, with GS trading up around $135 a share, makes them worth roughly $1.5 billion right now, based on quick comparisons with Jan 2010 calls. So Buffett’s investment looks more like $3.5 billion, and the 10% interest more like 14 or so.
And Goldie bought back 1.5 million shares in Q3, ended 8/31, at an average price of $180 a share. Nice use of capital. I’m thinking that buyback program gets put on hold here.
Cheers.
looks like insider trading to me based on what the stock did in the last 10 mins of trading….
Goldman Sachs must be very desperate to take such a deal. Or maybe they did it for the headline.
As the stock spikes on the announcement Buffet will make all his money back, and still have a huge stake. He is going to make out like a bandit.
Warren Buffet brings some smarts into the mix and some people start climbing the walls. I guess old habits are hard to break.
Dean and Lewis,
Per Scott above, Goldman did this deal on terms that are incredibly rich for Berkshire. The only way I can see that this goes bad for Berkshire is if Goldman has to avail itself of some as yet devised government facility and Buffett’s paper gets retraded. Not impossible, but not immediate and not high odds of that either.
could one of you check whether
(a) its absolutely clear that this is indeed equity for federal income tax purpsoes
(b) whether “buffett” bought it through BH or some other C corporation
see, then the 14% return implicit on this would be subject to the dividend exclusion so after tax its an even better deal than it seems; its the equivalent of a bond paying 25% more or less.
To Matt Dubuque,
All investment banks were marketing these kind of structure (deep OTM puts or barriers on banks or baskets of banks) in 2007, not just Goldman. No one really knows if they were keeping the position naked or just offloaded the opposite solution to another counteparty.
Buffy Ol Boy has been surviving for years on a synthetic diet as close to fraud as you will find anywhere and his dance around derivative time bombs is the biggest con artist game in DC — is it any wonder he is so tightly connected to Paulson and exposing himself as the scum he really is!
With well over $33 billion in goodwill fun money, this guy will be right in line to swap Level 3 crap in exchange for taxpayer cash!
it’s the crash of ’87, and berkshire, in the immediate aftermath, is trading at $2700. It is the great regret of my investing life that i (then early 30s, reasonable but not excessive income, and new to the markets) did not take every one of the relatively few pennies i had and put them into berkshire.
i finally wised up in ’91 (berkshire by then at $7000), and so as a shareholder for 17 years and a wannabe shareholder for 21, my immediate reaction to the move was: this is great for us.
as for goldman, i guess my attitude is, these guys have proven themselves the smartest of the investment banks, and i don’t doubt that they will be the smartest of the bank holding companies.
i suspect most of buffet’s money will be used to buy up commercial banking assets, and regardless of how expensive it may look as capital, it was available and brought a very, very smart guy into the decision-making mix, and therefore was seen by goldman as very reasonably priced in comparison to the alternatives.
You guys need to come off the Buffet “high”.
He’s making 10% fricking percent with a free 5 year call option in the money.
As we head into a depression, which will last more than 5 years, I would bet all banks, including Goldman trade much lower than their current share prices.
Look at a 10 year chart of most banks, they have gone nowhnere. JP Morgan, one the better managed national banks, failed to exceed it all-time high reached in 1999. This includes its share price performance prior to the onset of current credit crisis.
Goldman gets diluted and faces a global depression. I don’t see how this helps the equity.
Granted, Buffett will get his 10% barring a bankruptcy. So for 10 frickin percent annual return we are calling it the deal of the century.
Count me on the short list that are less favorable on the deal.
“… this is pretty pricey capital. What has me puzzled is that Goldman should be required as a bank to delever.”
Uhhh, this sale of perpetual preferred to Berkshire IS delevering, isn’t it? You can delever by selling assets, or by raising capital. Looks like Goldman has chosen the latter appraoch (or more likely, BOTH).
What kills me is the cost. This looks like ENORMOUSLY pricey capital — the sort of terms that venture capitalists might impose on a bunch of techies working in their garage.
If last-man-standing GS has to pay this much for a capital infusion, it screams EMERGENCY, loud and clear.
How the hell are the weaker players going to raise capital at ANY price? Oh wait, I forgot: government to the rescue! Me so bearish …
Goldman needs to raise capital as it becomes a bank (and leaves its dealer-broker past behind). It will also become less leveraged and less volatile. All that makes prefered shares, who rank senior to common shares, more eattractive (they are exposed to the downside, but their upside is more limited). The good thing for Goldman is also that 1) they avoid getting the Chinese or Saudis into tehir capital and 2) Buffet is a good name and increases confidence.
The capital doesn’t come cheap, but remember, the era of cheap capital is over. Especially now, there is a lack of it.
And I wouldn’t discount Buffet’s actions as a mistake. He’s buying a top-class bank “on the cheap” and probably is not expecting the end of the world in the next year or two. A slow-down/recession yes, but not a disaster. I would agree that chances are good that the worst will be avoided!
uh, the Treasury Secretary is former head of Goldman, he’s asking for 700 billion dollars to bail out who?
Warren Buffet, capitalist titan, just another pig at the government trough.