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July 23, 2009 – Comments (0) | RELATED TICKERS: GS , BRK

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Berkshire Profit on Goldman Sachs Passes $2 Billion (Update2)

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By Erik Holm

July 23 (Bloomberg) -- Warren Buffett’s option to buy shares of Goldman Sachs Group Inc., part of an agreement reached at the depths of the credit crisis, has earned a profit on paper of about $2 billion, a return of more than 40 percent.

Goldman Sachs today passed $162 in New York trading for the first time since rival Lehman Brothers Holdings Inc. collapsed in September. Buffett’s Omaha, Nebraska-based Berkshire Hathaway Inc. has warrants to buy $5 billion of Goldman common stock for $115 a share any time in the next four years.

“It must feel good to be Warren Buffett,” said Gerald Martin, a finance professor at American University’s Kogod School of Business in Washington, who has studied the billionaire’s investing history. “That number just flies in the face of people who like to say he’s lost a step.”

The difference between the strike price and the share value translates into a $2.11 billion paper profit for Berkshire. The U.S. government got a 23 percent annualized return for its investment in the firm after an agreement yesterday by the bank to repay $1.1 billion to settle warrants.

Goldman Sachs turned to Buffett in September, agreeing to sell $5 billion in preferred shares paying 10 percent interest, after Lehman’s bankruptcy and the emergency takeover of Merrill Lynch & Co. by Bank of America Corp. Amid the crisis, Goldman earned an explicit endorsement from Buffett, the so-called Oracle of Omaha who is celebrated for his investing savvy.

Berkshire gained $790, or 0.9 percent, to $92,790 at 1:07 p.m. in New York Stock Exchange composite trading. The company has slipped about 3.9 percent this year as Berkshire posted a first-quarter loss on declines in the value of holdings in ConocoPhillips and derivatives tied to corporate bonds.

‘Economic Pearl Harbor’

The Goldman Sachs warrants, Buffett said, were tacked on to give him an incentive to sell some of Berkshire’s existing stock holdings to fund the deal at a time when he had an increasing number of investment opportunities as the economy froze and markets plummeted.

“I wouldn’t have done the deal without them throwing in the warrants,” Buffett said in a Bloomberg Television interview in March. “That was a time when I talked about an economic Pearl Harbor right at that point. So to part with the funds at that time, I not only wanted a good yield but I wanted a possible kicker.”

The 40 percent return is based on the gain if Buffett were to redeem the warrants and sell them at today’s price. Berkshire also gets $500 million in interest on the preferred shares annually.

Government Repaid

Goldman Sachs later took $10 billion from the U.S. as part of the government’s bailout of financial firms -- a deal that also required the bank to grant the Treasury warrants. The U.S. Troubled Asset Relief Program charged 5 percent annually, and placed restrictions on compensation for some employees. Goldman repaid the $10 billion in June, and this week agreed to the Treasury’s request for $1.1 billion to settle the warrants.

Buffett’s deal requires the firm to pay Berkshire a 10 percent fee if it repays the preferred shares before 2013.

“It makes sense, in a way,” said Martin of the Goldman Sachs decision to repay the U.S. funds first. “Who would you rather have breathing down your neck at a shareholder meeting, the government or Warren Buffett? An investment from Buffett reflects well on your company, and taking that government money was always a negative.”

Goldman Sachs stock dipped below Buffett’s $115 strike price in October, and fell to $52 on Nov. 20. The shares today gained $3.17, or 2 percent, to $163.63.

The bank said July 14 that second-quarter profit reached $3.44 billion as revenue from trading and stock underwriting set records.

‘Reasonable Chance’

Buffett made an investment in General Electric Co. in October, agreeing to buy $3 billion in preferred shares paying 10 percent and taking warrants to buy $3 billion of common stock at a strike price of $22.25. GE dipped below that level the day after the deal was announced and never recovered. The shares gained 36 cents to $11.99.

“There’s a reasonable chance both kickers will work out, or one kicker works out,” Buffett said in March, when the Goldman Sachs warrants were also under water. “But there’s also a reasonable chance neither one does.”

To contact the reporter on this story: Erik Holm in New York at eholm2@bloomberg.net.

Last Updated: July 23, 2009 13:22 EDT

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