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Thursday, 24 April 2014

Feel the loofa

Goldman and Buffett scratch each other's backs

Goldman Sachs and Warren Buffett have found a way to scratch each other’s backs - again. The mutual assistance started during the crisis when the Sage of Omaha stepped in with a $5 billion rescue investment in 2008 that provided him with a healthy 10 percent yield on Goldman preferred shares. Now, they’re amending terms of warrants granted to Buffett in the same deal that also works well both ways.

The new agreement simplifies one entitling Buffett’s Berkshire Hathaway to buy 43.5 million Goldman shares for $115 apiece. Based on the current share price of about $146, that would have left the conglomerate $1.4 billion in the money and as Goldman’s biggest shareholder with about a 9 percent stake.

The revised structure keeps Buffett in the black, assuming the stock doesn’t tank between now and October. Now, however, he isn’t obligated to shell out $5 billion to buy the stock. Instead, Berkshire will simply receive enough shares to cover the profit.

Without any outlay, Buffett can brag of an infinite return on the warrants. More practically, by not tying up the cash in Goldman, he can keep it in reserve for another Heinz-like elephantine acquisition target. Following the co-purchase of the ketchup maker, his reserves will dip by almost a third to about $30 billion.

Goldman, meanwhile, escapes some irritating side effects of the investment. It will no longer dilute shareholders as much. Instead of issuing 9 percent of new stock, based on Tuesday’s price it should only need to issue about 2 percent.

It also means Goldman will suffer a lesser hit to its rate of return. The 43.5 million shares Buffett was due would have increased the bank’s common equity by 9.3 percent. Applied to expected 2013 earnings, as tallied by Thomson Reuters, the bank’s return on equity would have been primed to drop from 9.4 percent to an even more disappointing 8.6 percent.

There’s one more benefit for the bank led by Lloyd Blankfein. It will now have 34 million fewer shares to worry about negotiating with the Federal Reserve for permission to buy back. For Goldman, Buffett’s aid keeps on giving.

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Goldman Sachs said on March 26 it has amended the terms of warrants granted to Berkshire Hathaway as part of the conglomerate’s $5 billion investment in the bank in 2008.

The original agreement gave Berkshire, controlled by Warren Buffett, the right to purchase 43,478,260 shares of Goldman Sachs for $115 each at any time until Oct. 1 this year.

The revised deal means Berkshire will receive the requisite number of shares equal in value to the difference between $115 and the stock’s average closing price over the 10 trading days before Oct. 1. Based on those terms at the price on March 26, Berkshire Hathaway would own about 9.5 million shares, or 2 percent, of Goldman Sachs, making it the bank’s ninth-largest shareholder, according to Thomson Reuters data.

Under the original terms of the deal, Berkshire would have been the largest holder with 43 million shares - more than a 9 percent stake.

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