The Warren Buffett investment in Goldman Sachs is getting rave reviews from all corners. Of course, agreeing with any Buffett investment decision is usually a wise move. Those who questioned his touch as he sat out the tech bubble have probably learned their lesson.
Don't get me wrong. I'm a Buffett fan. What bothers me about this deal, however, is how it is being pushed in the press as a sign of confidence in the U.S. and our financial markets. Maybe. But I don't think Buffett did this deal to make the rest of us feel better. If that's what he hoped to accomplish, he could have bought common shares at a discount.
When you look at the details of the deal, it's pretty clear that Buffett did this deal for Buffett (as he should). He's investing $5 billion in perpetual preferred stock at a 10% yield. He'll be pulling down $500 million each year, forever, from this. He's also getting warrants to buy $5 billion worth of common stock at $115 per share over the next 5 years. This is a free call option. He gets the $500 million every year, and if Goldman stock rises, he'll get a windfall from exercising the warrants.
With the stock at about $125 when the deal was announced, Buffett already started out with about a $430 million paper profit. Considering how stocks often react to news of a Buffett investment (they go up), he was well aware (as was Goldman) that Goldman common would rise following the announcement. As of now, he's made another $150 million in paper profits.
Let's also keep in mind that Buffett did this deal after Goldman essentially became a bank and was afforded all of the borrowing rights at the Fed that banks are permitted. He also did this with full knowledge that Goldman would be separately raising another $5 billion through the sale of common shares. When you're guaranteed 10% forever from a company, your primary concern is that the company endures. These moves help ensure that Goldman doesn't go out of business and will be able to cut Buffett his check for many years to come.
In sum, this looks like another terrific deal for Buffett which is hardly surprising. He's sitting on a pile of cash, and liquidity rules these days. It's a buyer's market, and he's one of the brightest buyers around. But let's not rush to call a bottom in the market. Let's also not rush to view this as an endorsement of the economy or the financial system. Things can get a lot worse for both, and Buffett will still be sitting on a terrific investment.
The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.
