Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) has just about closed up the last of the loose ends on its initial $5 billion investment in Goldman Sachs (GS). As reported, Berkshire is trading the warrants it owns on Goldman (to buy 43.5 million shares at $115 per share) for shares worth the equivalent to the immediate capital gain Berkshire would receive from exercising those warrants. Some contend that by choosing to own less of Goldman than what was previously committed to, Buffett is making an implicit statement about the value of Goldman Sachs. I will show why this isn't the case.
But First, A Little History
In September 2008, Berkshire Hathaway made a $5 billion investment in preferred shares from Goldman Sachs that paid 10% annually. The shares could be bought back at any time, but Goldman would have to pay a 10% premium when they did buy them back. Additionally Berkshire Hathaway received warrants (a warrant is a call option that is issued by the company rather than an investor) to buy 43.5 million shares of Goldman Sachs at $115 per share ($5 billion worth) that would expire in October of 2013. The preferred shares were then bought back in early 2011, but the warrants remained outstanding.
Recently, Berkshire and Goldman restructured the deal. Now, rather than Berkshire investing $5 billion in Goldman Sachs and netting an immediate capital gain across 43.5 million shares, Berkshire will receive 100% of this would-be capital gain in shares that Berkshire doesn't have to make any additional cash-outlay for. The number of shares and value received will be calculated using the average closing price of the 10 trading days before October 1. Basically:
(Average Closing Price / share - $115 / share) * 43.5 million shares = $Value of Shares Received
$Value of Shares Received / (Average Closing Price / share) = # of Shares Received
Let's Look at the Numbers
We will assume that the closing price on the 10 days leading up to Oct. 1 will be very similar to the closing price on Oct. 1. Looking at 4 different scenarios for the closing stock price of Goldman reveals just what Berkshire is giving up. Nothing. This table says it all:
Initial Deal | |||||
Average Closing Price ($/share) | <115 | 130 | 150 | 170 | |
Berkshire's Additional Investment | 0 | $5 billion | $5 billion | $5 billion | |
# of Shares Received | 0 | 43.5 million | 43.5 million | 43.5 million | |
Total $Value of Holdings | 0 | $5.65 billion | $6.52 billion | $7.39 billion | |
Unrealized Capital Gains | 0 | $650 million | $1.52 billion | $2.39 billion | |
Restructured Deal | |||||
Average Closing Price ($/share) | <115 | 130 | 150 | 170 | |
Berkshire's Additional Investment | 0 | 0 | 0 | 0 | |
# of Shares Received | 0 | 5.02 million | 10.15 million | 14.07 million | |
Total $Value of Holdings | 0 | $650 million | $1.52 billion | $2.39 billion | |
Unrealized Capital Gains | 0 | $650 million | $1.52 billion | $2.39 billion | |
Can't Get Something for Nothing
So how is Berkshire able to receive the same value gain as before, only now without having to make any additional investment? Surely if Berkshire is gaining, somebody must be losing, right? Well, not exactly. As it turns out this deal is in Goldman Sachs' best interest as well. As the deal was structured before, the share count would have been buoyed by about 9% when Berkshire did make the purchase. As it is currently structured, that number stands to be far less, most likely around 2%. Since Goldman Sachs has been repurchasing shares consistently over the last few years and has plans to do so in the future, issuing far less shares means far less shares that they need to buy back.
So What Is Buffett Saying About Goldman Here?
The key to this deal is to remember the groundwork was laid out almost five years ago now, and both parties are merely restructuring to their mutual advantage. As the table above shows, Berkshire is in essence simply deciding not to be locked into buying an additional $5 billion in shares at the October 1, 2013, share price. Since he gave up nothing to restructure the deal, can you blame him? This makes no statement about whether Berkshire views Goldman Sachs as a good value or not, it merely condenses the gains he made from a previous deal into fewer shares. This leaves flexibility to invest the remaining $5 billion as he sees fit.
What do you think? Is this a statement about Goldman's value, or simply the move that gives Berkshire the most options and flexibility? Leave a comment below.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
