What Buffett Didn't Say About Goldman

The ceiling is holding fast. The market pared its losses from earlier in the day, with the S&P 500 (SNPINDEX: ^GSPC  ) and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) finishing down 0.1% and 0.2%, respectively. For the S&P 500, this is the 12th time this month the index has closed within 1% of its October 2007 high, and that number appears to defy chance.

Consistent with stocks' decline, option traders pushed the VIX (VOLATILITYINDICES: ^VIX  ) , Wall Street's "fear index," up 3% to close above 13. (The VIX is calculated from S&P 500 option prices and reflects investor expectations for stock market volatility over the coming 30 days.)

The bottom line on Buffett's new deal terms
In this morning's column, I mentioned that Berkshire Hathaway CEO Warren Buffett had renegotiated the terms of his warrants on shares of investment bank Goldman Sachs (NYSE: GS  ) and highlighted the 50-year relationship between Buffett and Goldman. Here, I'd like to focus on the new terms and why current or prospective Goldman shareholders should be paying attention.

The warrants Goldman initially granted to Berkshire gave Buffett the right to purchase 43.5 million shares of its shares at a strike price of $115, which would require a $5 billion cash payment and hand Berkshire roughly a 9% stake. Instead, Buffett will receive a share award roughly equivalent in value to the immediate capital gains on 43.5 million shares bought at $115 (strictly speaking, it will equal the difference in value between the average closing price on the 10 days before Oct. 1 and $115, multiplied by 43.5 million.)

Crucially, the new terms require no cash disbursement by Buffett -- it's pure manna from Goldman. Conversely, Berkshire will be left with a much smaller stake in the bank -- around 2%, based on Monday's closing price. In announcing the new terms, Buffett said:

"We intend to hold a significant investment in Goldman Sachs, a firm that I did my first transaction with more than 50 years ago. I have been privileged to have known and admired Goldman's executive leadership team since my first meeting with Sidney Weinberg in 1940."

That sounds like high praise, but it's actually a bit of folksy misdirection. Buffett has twice in his annual letters referred to Mae West's quote that "Too much of a good thing can be wonderful." Assuming he expects Goldman shares to produce a good return, if a 2% stake is a good thing, surely 9% would be wonderful.

If Buffett prefers not to put up $5 billion to buy Goldman shares at $115 per share, he is implicitly signaling that he believes he will find better uses for that capital. If one considers that the $115 cost basis he is passing up represents better than a 20% discount to today's closing price, current investors may want to revisit their return assumptions.

To help figure out whether Goldman Sachs is a buy today, I invite you to read our premium research report on the company today. Click here now for instant access!


Read/Post Comments (17) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 28, 2013, at 11:55 AM, DividendsBoom wrote:

    Sorry, but you are wrong when you say that buffet is passing up acquiring goldman shares at a $115 cost basis. He is merely grouping the roughly 20% discount he could receive on 100% of 43.5 million shares into a 100% discount on 20% of 43.5 million shares. Since this option is available, if he were to acquire the 43.5 million shares, the last 80% he would be acquiring at market value.

    Your article is grossly misleading and factually incorrect when you state, "If Buffett prefers not to put up $5 billion to buy Goldman shares at $115 per share, he is implicitly signalling that believes he will find better uses for that capital. If one considers that the $115 cost basis he is passing up represents better than a 20% discount to today's closing price, current investors may want to revisit their return assumptions."

    A retraction would be nice.

  • Report this Comment On March 28, 2013, at 12:09 PM, TMFAleph1 wrote:

    "Since this option is available, if he were to acquire the 43.5 million shares, the last 80% he would be acquiring at market value."

    Yes, and he is declining to commit to acquiring that remaining 80%. The option to receive shares at expiration equivalent to the warrants' intrinsic value was *not* available previously -- otherwise Goldman Sachs would not have had to alter the terms of the warrant agreement.

    The article is neither misleading, nor incorrect.

  • Report this Comment On March 28, 2013, at 1:15 PM, DividendsBoom wrote:

    So you agree that he is choosing not to acquire the last 80% at market value, yet hold that this statement isnt misleading:

    "If Buffett prefers not to put up $5 billion to buy Goldman shares at $115 per share, he is implicitly signaling that he believes he will find better uses for that capital. If one considers that the $115 cost basis he is passing up represents better than a 20% discount to today's closing price, current investors may want to revisit their return assumptions."

    The fact that it was not available previously does not dismiss that it is available now, and since it is, you have to look at both options and what they mean.

  • Report this Comment On March 28, 2013, at 1:28 PM, TMFAleph1 wrote:

    I'm afraid I don't see anything misleading or inconsistent in that statement. You're going to have to be more specific.

  • Report this Comment On March 28, 2013, at 1:49 PM, DividendsBoom wrote:

    he is passing up receiving additional shares at market value, you state he is passing up purchasing shares at $115. He isnt passing up that opportunity. he is merely condensing his

    discount.

    An analogy would be if you through a business deal received as a bonus a 20% off coupon to buy 5 items of merchandise that cost $1 each, but the store owner and you come to terms to get 1 $1 item free, in place of buying five. This doesnt mean that you dont feel like each item isnt worth .80. It means that you dont wish to buy 4 more items at $1 each, on top of the item you receive at no cost.

    I would also like to apologize for the tone of my first two comments, I must be grumpy. No excuse for that.

  • Report this Comment On March 28, 2013, at 2:22 PM, TMFAleph1 wrote:

    Here's the bottom line:

    The modification of the warrant agreement implies that Warren Buffett isn't interested in investing $5 billion of Berkshire's capital in Goldman Sachs shares at a cost basis of $115. That, in turn, implies that he thinks he can put that capital to better use elsewhere. That is relevant information for current and prospective Goldman shareholders.

  • Report this Comment On March 28, 2013, at 2:27 PM, TMFAleph1 wrote:

    "he is passing up receiving additional shares at market value, you state he is passing up purchasing shares at $115."

    I don't state that he is passing up purchasing the incremental amount of shares at $115, I state that he is passing up purchasing the 43.5 million shares at $115.

  • Report this Comment On March 28, 2013, at 2:30 PM, TheDumbMoney wrote:

    Aleph, you are absolutely right. The coverage of this deal was ridiculous, a lot moment in financial journalism that is filled with a lot of low moments. There were actually headlines like, "Buffett Acquiring More Shares of Goldman." I'm not kidding, it was pathetic. This was a way for him to reduce what otherwise would have been his exposure to Goldman, with his options expiring this fall, and for them not to have to dilute as much.

    TDUM

  • Report this Comment On March 28, 2013, at 2:38 PM, DividendsBoom wrote:

    "If one considers that the $115 cost basis he is passing up represents better than a 20% discount to today's closing price" he isnt passing it up, he is condensing/restructuring.

    "The modification of the warrant agreement implies that Warren Buffett isn't interested in investing $5 billion of Berkshire's capital in Goldman Sachs shares at a cost basis of $115"

    It implies he isnt interested in investing $5 billion dollars at market price, since that would be the incremental investment above what he is currently receiving.

  • Report this Comment On March 28, 2013, at 2:51 PM, DividendsBoom wrote:

    Maybe I misunderstood the point of your article. To me it reads: Buffet doesnt want to buy Goldman shares at a 20% discount, your conclusion paragraph.

    "If Buffett prefers not to put up $5 billion to buy Goldman shares at $115 per share, he is implicitly signaling that he believes he will find better uses for that capital. If one considers that the $115 cost basis he is passing up represents better than a 20% discount to today's closing price, current investors may want to revisit their return assumptions."

    but then you agree with me here in the comments:

    -----------"Since this option is available, if he were to acquire the 43.5 million shares, the last 80% he would be acquiring at market value."

    Yes, and he is declining to commit to acquiring that remaining 80%. -------

    So maybe your point is that Buffet doesnt want to buy 43.5 million shares at market value? Is that what the article is about, because your concluding paragraph makes me think it is the first one.

  • Report this Comment On March 28, 2013, at 2:57 PM, TMFAleph1 wrote:

    "It implies he isnt interested in investing $5 billion dollars at market price, since that would be the incremental investment above what he is currently receiving."

    You're thinking about this the wrong way. The right way to think about it is to focus on the terms of the original arrangement which would have required a $5 billion cash outlay to own 43.5 million shares at a cost basis of $115. That's what Buffett is passing up.

    I'm afraid that, although this discussion has been interesting, I won't be able to add anything further.

    All best!

  • Report this Comment On March 28, 2013, at 3:26 PM, DividendsBoom wrote:

    why is that the wrong way to think about it? clearly there were two options available. enforce the deal as it was previously written, or take the deal that he has now took.

    the correct way to think about it is to look at the options available. receive $1.4 billion in goldman shares, or receive $1.4 billion in goldman shares plus purchase an additional $5 billion in goldman shares at market cost

  • Report this Comment On March 28, 2013, at 3:46 PM, TMFAleph1 wrote:

    "or receive $1.4 billion in goldman shares plus purchase an additional $5 billion in goldman shares at market cost."

    You're saying this is an option, but it's irrelevant. The point is that he isn't interested in owning $5 billion at a cost basis of $115 -- that's the reason he negotiated the change in the warrant agreement.

    There are only two options that are worth comparing are:

    (1.) The original warrant agreement.

    (2.) The new warrant agreement.

    Some hypothetical third option in which Buffett goes into the market to top up his share award under the new agreement is nonsensical and irrelevant.

  • Report this Comment On March 28, 2013, at 5:44 PM, TMFAleph1 wrote:

    @TheDumbMoney

    Thanks for your comment.

    Yes, the financial media did not cover itself in glory covering this story. My quick search didn't reveal a single journalist or commentator who understood the implications of the re-negotiated terms -- even Reuters BreakingViews, who are supposed to be pretty savvy.

  • Report this Comment On March 28, 2013, at 10:14 PM, DividendsBoom wrote:

    except that in lieu of the fact that the second option exists, the first option becomes the equivalent of the third "hypothetical third option"

    i guess i didnt realize that you cant see that

  • Report this Comment On March 28, 2013, at 11:33 PM, TMFAleph1 wrote:

    Of course I understand that those two are theoretically equivalent (strictly speaking, they are only roughly equivalent because the new terms call are based on an average price over a ten-day period rather than the market price at expiration.)

    However, it is completely absurd to even consider this third option when Buffett has rejected the first. For one thing, in real life, the third option is far inferior to the original warrant terms because of the potential price impact of purchasing billions of dollars worth of shares in the open market.

    Concocting this third option is an exercise in pure theory that has absolutely no relevance to a real-world discussion of Buffett's decision.

  • Report this Comment On March 31, 2013, at 1:56 PM, TMFRoyal wrote:

    Nice point, Alex.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2335513, ~/Articles/ArticleHandler.aspx, 9/20/2014 8:13:01 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement