When it comes to Warren Buffett, I am of two minds. First and foremost, I respect how successful and consistent the world's best known value investor has been over the last 50 years. However, over the last few years, he has seemed more interested at times to provide his opinion on political manners instead of value investing. He has garnered enough attention to have some political initiatives named after him (i.e., The Buffett Tax). In addition, I think a good portion of his performance in last half decade has to do with his unique arrangements in structuring investments rather that straight equity deals one usually associates with value investing. One such example is his recent deal in teaming up with 3G Capital to buy out Heinz (HNZ). As part of the deal, Berkshire Hathaway (BRK.B, BRK.A) will provide some of the financing through preferred shares that provide a very high yield. Buffett also has not been shy by renting out his name and reputation as a great investor to firms finding themselves in turmoil. The warrants and high interest rates he was able to garner by lending money to General Electric (GE), Bank of America (BAC) and Goldman Sachs (GS) in the depths of the financial crisis are great examples of this investing strategy.
That being said, I have to give it up to the Oracle of Omaha on his deal today with Goldman Sachs. Buffett had acquired 43.5mm warrants as part of a financing deal that Goldman used to secure an investment from Berkshire Hathaway at the depths of the financial crisis. The exercise price of the warrants was $115 a share and they were set to expire at the end of the year. If exercised, this would have amounted to almost 9% of the investment bank. Instead, Buffett and Goldman Sachs agreed that Berkshire would be given 2% of the outstanding stock in Goldman in lieu of the warrants. This move has several significant advantages:
- It requires no capital outlay, which saves Berkshire from laying out approximately $5B to exercise its warrants.
- It keeps its stake down to 2% instead of 9% it would have had if it fully exercised its warrants. It reduces some filing requirements and more importantly, it reduces Berkshire's reputational risk. It is much less damaging to own 2% than 9% of this Vampire Squid next if it runs afoul of regulators or becomes the focus of reporters or politicians.
- This transaction also avoids any taxes for the moment, as no sale transaction takes place (Buffett loves to talk about the rich needing to pay more taxes, but is very adept at avoiding taxes in almost all circumstances).
As importantly, this transaction gives Berkshire a 2% stake in one of the few remaining investment banks left standing after the financial crisis. It is a holding that should do well in the coming years.
3 reasons GS is undervalued at $146 a share:
- Given the low interest rate environment and one of the best starts to M&A activity in years, Goldman is ideally positioned to grow its fee base as long as this M&A wave continues.
- The company has crushed earnings estimates over the last five quarters, and consensus earnings estimates have risen significantly for FY2013 and FY2014 over the past three months.
- Goldman Sachs is selling right at book value and also yields 1.4%.