On September 24, 2008, Berkshire Hathaway (NYSE:BRK.A), (NYSE:BRK.B) and Goldman Sachs (NYSE:GS) entered into an agreement in which Berkshire Hathaway purchased $5 billion of Goldman's preferred shares paying a 10% dividend. Berkshire also received warrants granting it the right to buy $5 billion of Goldman Sachs common stock at $115 per share (or 43.5 million shares) through October 1, 2013.
Goldman Sachs called the preferred stock for redemption on April 18, 2011 at a premium of 10% over par value, plus accrued and unpaid dividends. As a result, Berkshire Hathaway earned approximately $1.75 billion ($1.25 billion in dividends plus a redemption premium of $500 million) in 2½ years on its investment of $5 billion. This represents a return of 35% over this time period from the preferred stock alone.
At Goldman Sachs's closing price of $109.73 per share on January 30, 2012, what are its warrants worth? Although these warrants are currently "out of the money" since the underlying common shares are selling below the strike price of $115, they have considerable value which can be estimated using a Black Scholes calculator.
When applying a strike price of $115, stock price of $109.73, time remaining of 605 days, historical volatility of 38.8% (source: TD Ameritrade), and a risk free interest rate of 0.2% (2-Year U.S. Treasury), each warrant is valued at $19.76. Therefore, Berkshire's 43.5 million warrants have a total current value of $860 million.
When adding the current value of $860 million from its Goldman Sachs warrants to its return of $1.75 billion from Goldman's preferred stock, Berkshire's total return can be valued at approximately $2.6 billion, or more than 50% of its $5 billion investment.
This provides further evidence of how Warren Buffett has recently created shareholder value for Berkshire Hathaway. Furthermore, his willingness to invest $5 billion in Goldman Sachs at the peak of the financial crisis in September 2008, and his previously stated intention of not exercising Berkshire's warrants in Goldman Sachs until their expiration on October 1, 2013, are providing an indication of Mr. Buffett's confidence in the outlook for Goldman's common stock. Since shares of both Berkshire Hathaway and Goldman Sachs are currently selling at reasonable valuations, investors might wish to consider investing in them.
Disclosure: I am long BRK.B.