Recently, The Motley Fool had five analysts identify Warren Buffett's best investment. I expected that one of the five would identify Buffett's 2011 deal with Bank of America (NYSE:BAC) -- a $5 billion infusion when the bank and market needed it. However, because two of my colleagues identified the deal as the best, I decided that I should take a deeper look at the deal that some people may have forgotten about, especially with all the daily noise that surrounds a stock like Bank of America.
A quick rundown of the deal
In case you are unaware or simply forgot, Buffett, using the bullet-proof balance sheet of Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B), provided Bank of America with $5 billion in August 2011. Buffett received some special preferred shares, as well as warrants to purchase B of A common shares. These warrants are redeemable at any time until 2021, allowing Berkshire to purchase 700 million shares of Bank of America at around $7.14 a share.
What I found interesting, and must have missed when the deal was announced almost two years ago, is that the preferred stock received by Berkshire is cumulative, meaning that if the dividend does not get paid for some reason, the amount continues to accrue until all past-due dividends are paid. By receiving these shares, Buffett ensured that Berkshire would be covered should Bank of America's performance suffer dramatically. Pretty shrewd move if you ask me.
A sweetheart deal
The deal that Buffett received is truly a deal ordinary investors will never see. Part of this is because of the capital required. I don't know about you, but I don't have ready access to $5 billion. However, it's not like Buffett is the only person out there with access to this kind of money, so the reason behind the deal extends beyond available capital.
Perhaps more important than the money is the stature afforded to Buffett because of his success at Berkshire Hathaway and his history of great capital allocation. Similar deals with Goldman Sachs and General Electric provided a template for Buffett to work with Bank of America and CEO Brian Moynihan. In its acquisition of Heinz, in addition to the equity stake in the company, Berkshire received preferred shares that will pay a 9% dividend each year, further illustrating Buffett's love of preferred shares.
What about B of A shareholders?
It's great that Buffett got this great deal, but what will it mean for B of A shareholders when Berkshire redeems its warrants? In the short term, earnings per share would decline because of 700 million new shares added to the shares outstanding, which would probably affect the share price. As Bank of America continues to rise above the strike price for the warrants, it may be time for Moynihan and company to try to get Berkshire to redeem sooner rather than later.
A template to open discussions could be Berkshire's recent deal with Goldman Sachs regarding similar warrants. Instead of executing the full value of the warrants and walking away with a 9% stake in the investment bank, both parties renegotiated the deal, and Berkshire will instead receive shares corresponding to the gain since the warrants were written.
With a current paper gain of $3.5 billion with its B of A warrants, a similar deal would net Berkshire almost 290 million sharesat today's price, a much more manageable chunk than the original 700 million. While I don't think Berkshire would necessarily renegotiate this deal with over eight years remaining, it might be in the best interest of B of A shareholders for Moynihan to at least approach Buffett and company with an offer.