When Warren Buffett tried to make a $3 billion investment in Uber Technologies, the ridesharing company said no thanks. Bloomberg reported that Berkshire Hathaway (BRK.A 3.75%)(BRK.B 4.02%) proposed making a convertible loan to Uber in an amount "well above $3 billion."
Buffett likes these kinds of deals. If the borrower (Uber) succeeds, and its stock appreciates, the lender (Berkshire) can take part in the upside by converting the debt into equity. You can think of it as a loan that has the potential to generate a stock-like return, while offering many of the protections of being a creditor rather than an owner.
Berkshire Hathaway ultimately made billions of dollars for shareholders by inking similar deals with Goldman Sachs and Bank of America during the financial crisis of 2008 and European debt crisis of 2010. In each deal, Berkshire received a high return on preferred stock, and received warrants that would allow Berkshire to profit if shares of the banks recovered. (They did.)
Omaha meets Silicon Valley
I've written a lot about the Buffett premium, or the billionaire investor's ability to extract an especially good deal because of his reputation. The deals he made with Bank of America and Goldman Sachs are prime examples. Buffett injected capital and credibility into the banks when they needed it the most, collecting a huge return for the service.
But Silicon Valley unicorns are a different animal than banks on the brink. Private tech companies advertise their valuations almost as much as their products, so attracting an investment from Buffett, a man known for driving a hard bargain, may not have all the sparkle that it may have elsewhere.
Fast-growing tech companies love using tricks to obscure, and even inflate, their reported value. Last year, Uber agreed to a gimmicky deal with SoftBank that allowed existing owners to cash out at a discounted valuation while allowing the ridesharing company to claim that its value hadn't budged at all.
SoftBank and its affiliates spent about $8 billion acquiring Uber shares from existing owners at a deep discount to its last-reported valuation. Then, to keep up appearances, the investors purchased a smaller stake directly from Uber at a valuation of approximately $70 billion, in line with the valuation of its most recent fundraising round.
The two investments, when blended together, valued Uber at about $54 billion, according to Bloomberg. But the structure of the deal allowed Uber to claim its most recent round was in line with previous fundraisings because SoftBank purchased a small slug of stock at a $70 billion valuation. If you buy a lot of stock at a low price, and a little stock at a high price, the real valuation is likely closer to the lowest price -- except in Silicon Valley.
Silicon Valley special situations
Berkshire Hathaway has recently gotten more comfortable with companies in the tech industry, evidenced by its $43 billion stake in Apple. But to my knowledge, it hasn't been particularly active in sourcing or negotiating deals to invest in private companies with short operating histories.
There are a few things that stick out to me about Buffett getting into talks with Uber:
- Buffett isn't that bullish on the ridesharing service: Admittedly, convertible securities are more common with private tech companies, but I suspect Buffett liked the extra downside protection afforded by being a lender rather than a pure equity investor. We don't have all the details, but since Uber ultimately struck an equity deal with SoftBank, it appears Uber favored selling equity to borrowing money. Buffett wanted to be a lender.
- Circles of competence are relative: You can know a lot less about an investment if you're in a better position for getting your money back. Buffett has shown he will stretch a little further outside his comfort zone as a bondholder than as a shareholder. Before Apple and IBM, another noteworthy tech bet was arguably a small investment Berkshire made in Amazon in 2002, when it bought bonds and convertible bonds issued by the online retailer.
- Berkshire has too much money: If it wasn't clear from the $109 billion of cash sitting on its balance sheet, or Buffett's complaints in his recent shareholder letter about business valuations, the fact that Buffett & Co. have tossed around the idea of being venture debt investors suggests they're really low on ideas.
Any way you slice it, a $3 billion investment wouldn't be needle-moving for a company with stock, bonds, and cash worth more than $300 billion. But that a 87-year-old man who still uses a flip phone considered betting $3 billion on a company built around a smartphone app strikes me as one of the more interesting financial stories in recent memory.