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Commentary

Buffett gets in; Goldman Sachs is the bet

Warren Buffett is now officially in. The grand old man of value investing has just pumped in $5 billion into Goldman Sachs. Obviously this is viewed on the street as a sign of “confidence” in the system. Big Picture begs to differ.

Vote of confidence? Hardly. Doubtful. It is merely an opportunistic deal, and probably a damn good one, for Berkshire Hathaway (BRK). On the other hand, for Goldman Sachs, it is a very expensive deal. If you delve beneath the headlines, you see that Warren is not so much making a vote of confidence as he is extracting pound of flesh (and then some).

Read the whole thing. In effect, Berkshire gets $5 billion worth preferred shares – with a 10% payout on them, which is $500 million a year. He can ask for it back at 10% premium whenever he wants. Goldman can ditch Buffett at a 10% premium (changed, thanks Dheeraj), a perpetual 10% cost. Then he gets warrants (call options) for $5 billion worth GS stock at $115 per share. For no extra money down.

Obviously if Paulson doesn’t rescue the banks GS may not have that kind of upside, and this kind of liability might take it down further. Uhm, Buffett kinda expects it: (Via Calculated Risk)

“If I didn’t think the government was going to act I wouldn’t have done anything,” Bufett said Wednesday during a wide-ranging interview with CNBC Television.

Not quite the vote of confidence in Goldman Sachs, you’d think. But Buffett is going to need to put more capital in. He has big investments in housing (interiors etc.), financial services, rating agencies and insurance – the future of which aren’t looking very good. If he doesn’t participate now, there will be other repercussions – especially when some of these industries are going to face severe regulation.

But this is a smart cookie deal. He loses only if the U.S. economy tanks. What are the chances of that? Why don’t I hear a loud “NONE”?

  • Anonymous says:

    >Isn’t it supposed to be $5 Billion below the quoted para rather than $5 million? Sorry to correct it but i was quite confused reading that 🙂

  • Anonymous says:

    >”In effect, Berkshire gets $5 million worth preferred shares – with a 10% payout on them, which is $500 million a year”. Shouldn’t this be $5 Billion instead of million ?

    Regards,
    Samarth

  • Deepak Shenoy says:

    >Good catch guys, thanks – fixed.

  • Dheeraj says:

    >He can ask for it back at 10% premium whenever he wants.

    Sorry, you’ve misunderstood. It is Goldman which holds the right to call back (pay back Buffett) the shares. That’s why it’s at a 10% premium.

  • Deepak Shenoy says:

    >Good point – thanks Dheeraj – didn’t read that bit well. I have changed it. Reduces the pound of flesh extraction pain somewhat…

  • Anonymous says:

    >You know you have to wonder about Buffet. Here’s unarguably one of smartest guys on the planet speaking about the crisis and he says he backs paulson, and says the next president should keep him. This after just about anyone with any knowledge of this can see that the SEC and the Treasury have repeatedly failed to either diagnose this crisis correctly, or remedy it – see paulsons replies to congress in 2007 expressing confidence he has this under control. As Taleb put it so well, it’s like a bunch of doctors (referring to wall street) who’ve killed of all of the patients they’ve operated on, now asking for a fresh batch of patients to be sent to them (the bailout money) and pretending the results will be different. You expect the politicians, and their cronies in the government (paulson, bernake, wall street) to bluff their way out of this. But to have Buffet not call their bluff and to give them his vote of confidence in public really makes me wonder about buffet! If the good guys don’t tell it like it is, who will!

    It’s time Buffet took a stand. For what’s right! Deep down i wish he had done that.

  • Dheeraj says:

    >Deepak,

    Thanks for the mention.

    The call option is pretty standard. Any smart guy would include it. Without it GS would have been saddled with expensive borrowing for a long term.

    If, and when, rates go down to normal levels, GS can extinguish this expensive loan (that is what it is, a loan).

    Normally, when you have a call option, you also include a put option which protects the investor – if rates go up. Buffett has not insisted on it. Which means either the call option is expensive enough or Buffett is getting such a good deal that he doesn’t feel the need for it.

    Either way, Buffett wins.

    Anonymous,

    Buffett is only doing what we as humans do – “Act in self interest.” He’s one of the smartest and hard nosed businessman you can think of. The difference between him and some of the other persons with similar characteristics is that he can keep emotions at bay.

    He’s also a master at public relations (you can count a few Indian businessmen too who have the same skills).

  • Deepak Shenoy says:

    >Anon: Buffett has made a lot of money off the US Taxpayer, by way of reduced taxes, or tax writeoffs. Why would this deal be any different, when the person getting stiffed is the taxpayer?

  • Anonymous says:

    >Deepak

    I m a lil confused since u believe that the US economy is going down then by logic Buffet is going down so I dont see how Buffet is getting a great deal.

    Also Buffet is investing in preference capital which means clearly he stands below the debt holder in case of Goldman goes into liquidation. The US economy doesnt need to go down, just a few days of turmoil that we saw in the US markets can render Goldman bankrupt so thats the risk Buffet is taking. Clearly Buffet see’s value in Goldman fanchisee to put in money. And if u believe that the Goldman is not going to go down then shouldnt ppl be lending to Goldman and we wont have a problem in the first place.

    I dont buy the arguement of the tax payer getting shafted. The billions of dollars of bad debt exists in the system because it is the same tax payer who has overleveraged and is refusing to pay up today. So it is round tripping that happens with a few % been pocketed by the investment banks in between.

    The US is going down bcos it is today living beyond its means and adding external debt beyond the levels the world has ever seen and the average guy in the US hasnt woken up to realise that the party is over and time to pay up the bill.