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Buffet – Hero or Opportunist?

Warren Buffet last week announced that he bought (through his company Berkshire Hathaway) $5 Billion worth of Goldman Sachs preferred stock which will yield 10%. Goldman can buy it back at any time at a 10% premium to its current value. Along with this deal Goldman threw in $5B in warrants to buy more shares at $115 any time over the next 5 years.

Let’s look at the windfall this deal is to Mr. Buffett and his shareholders:
A warrant is similar to an option, but usually for a much longer term. An option gives one the right, but not the obligation to buy a stock at a predetermined price (the ‘strike price’). So an option has unlimitted upside but a fixed downside. In this case, those warrants are included for free. But let’s look at what the $115 is currently worth.

You can see that just going out two years and a few months, a $115 strike would be worth about $46. Going out the full five years, the option value would be closer to $65. To be clear, the value of the warrants alone is $2.8 Billion. If Mr. Buffett wished to sell just these warrants, this is the amount he’d recover. Next, the shares of preferred stock he purchased for the $5 Billion will return 10% or $500 million per year. The next 5 years of cash flow have a present value of $1.996 Billion using a cost of money of 8% (and in these times, money costs less that that.) As we look at the financial crisis we are in, it’s clear that those who have money are going to get richer while the rest of us watch. The deal I described here is not available to you or me, not in smaller units of $5000, or even $50,000. When you or I buy shares of Goldman Sachs, we get 1% dividends and no warrants at all.


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