Sunday, September 28, 2008

Why did Warren Buffet buy $5bn stake in Goldman Sachs - my take on it

Through Berkshire, Buffett is taking $5 billion worth of perpetual preferred stock in Goldman in a private offering. For that, he'll get a 10% dividend and warrants to buy $5 billion of common stock with a strike price of $115 a share. He'll be able to exercise the warrants at any time within five years. Until now, Mr. Buffett, who has navigated the stock market with legendary prowess, has largely refrained from investing in the stricken financial industry, saying repeatedly that things could get worse. But may be Mr. Warren Buffett is thinking about the worst being nearly over for the finance industry or at least for Goldman Sachs!

Goldman is one of the few big free-standing investment banks left on the Wall Street after collapse of Bear Stearns and Lehman Brothers recently. "Goldman Sachs is an exceptional institution," Buffett said in a statement. "It has an unrivaled global franchise, a proven and deep management team and the intellectual and financial capital to continue its track record of outperformance." On Sunday, Goldman won Federal Reserve approval to become a bank holding company, giving it easier access to financing and adding to speculation it might buy another bank.

Warren Buffet invests when he sees monopoly – Coke, P&G, Washington Post, Walmart, Nike and many more. As he says, “Be fearful when others are greedy and be greedy when others are fearful.” But only in next breath he may utter, “Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years. “ OR “Our favorite holding period is forever. “ So it is not necessary that this is the bottom for GS or the US stock markets, things may take time to improve– but the important thing is, smart money has come in somewhere! Future will only tell if Goldman also becomes a monopoly like other investments of Warren Buffet.

There won’t be a better time than this to take a bet on US financials stocks. Goldman is a pure Buffett play: - it is a blue-chip organization, it has a long and successful track-record, he is investing in a stock that has already plummeted from $248 to around $130 now. If the warrants do get exercised, it would give Warren Buffet nearly 9% stake in GS and most probably a seat on the board of directors to be involved in decision-making. He is still getting 10% on the preferred stock also, which is not at all bad as far as US interest rates are concerned. These shares are senior to both Goldman's other preferred stock and its common stock. That means no other shareholders will receive any dividends until Buffett has been paid his 10%, in full, each year.

But that was all about “FUNDAMENTALS”; it seems there is more to this deal than meets the eye. Mr. Buffett has a close relationship with Byron Trott, who heads Goldman’s Chicago office. It was Mr. Trott who brought Mr. Buffett into Mars Inc.'s $23 billion acquisition of Wm. Wrigley Jr. & Co. earlier this year. Mr. Buffett agreed to put about $6.5 billion into the deal. It wasn't immediately clear what role Mr. Trott may have played in Mr. Buffett's decision to invest in Goldman. Other thing is the US Government is in the process of finalizing the $700bn bailout for the finance industry. If the bailout goes through, GS will have the US Govt as a buyer of last resort for its bad mortgage debt. Goldman has dropped nearly 50% from its peak going towards which Warren Buffet can get all his investment back by exercising warrants. Warren Buffet has time and again said that the bailout is needed for USA.  To quote him, “We are looking over a precipice in terms of the economic condition of the country for the next few years. If Congress doesn't help us on this, heaven help us. Thank heavens that Paulson had the imagination to step up with something that is of the scope that can really do something about it." Why should Warren Buffett after striking a best deal be interested in Bailout package of U.S Govt where the Govt doesn’t take stake in any bailout company and they will buy only distress asset? Is that Paulson who holds ESOP in Goldman Sachs helping Buffett get the best possible deal, so that his asset valuation grows in times to come? And who can better oversee investment interest of Warren Buffet in Goldman Sachs than Henry Paulson, the ex-Chairman and ex-CEO of Goldman Sachs? Should I have to mention about “something cooking”!

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