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Buffett's Goldman Deal Has Big Benefits, but What Else is Berkshire Up To?

By Jason Simpkins
Associate Editor

Investing icon Warren Buffett took his own advice Tuesday – getting "greedy when others are fearful" – when he ignored the banking-sector bonfire and slapped down a cool  $5 billion for a stake in Goldman Sachs Group Inc. (GS).

By putting his money where his mouth is, Buffett's actions – and reputation as a shrewd bargain hunter – restored some of Goldman's luster and helped bolster investor confidence in the U.S. banking system.

And the "Oracle of Omaha" isn't done, yet.

Buffett's Berkshire Hathaway Inc. (BRK.A, BRK.B) agreed to buy $5 billion in perpetual preferred Goldman shares that pay 10% interest.  In addition, Berkshire receives warrants giving it the right to buy $5 billion worth of Goldman's common shares at any time over the next five years at a price of $115 per share. The shares closed Tuesday at $125.05 and  yesterday (Wednesday) at $133, up $7.95, or 6.36%, each.

"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."

Based on Tuesday's closing price of $125.05, Buffett made an almost instantaneous paper profit of about $437 million on the warrants. With yesterday's advance, that paper profit rose to $783 million.

Scott Roth, management partner at Severn River Capital Management, told Bloomberg News that by his calculations Buffett is buying the preferred stock for about $3.2 billion, after accounting for the warrants. Roth worked at Goldman more than a decade ago and is betting the stock won't drop.

"As usual Mr. Buffett has struck an extremely attractive deal," Guy Moszkowski, an analyst at Merrill Lynch & Co. Inc. (MER), wrote in a note to clients. "He is, we believe, getting a better deal than he did in 1987 when he bought a Salomon Bros. convertible with a 9% yield, for a company that is considerably more attractive than the '87 Salomon."

Goldman Sachs, which has booked roughly $5 billion in losses and write-downs, and which has lost about 40% of its market value this year, is benefiting, too. In addition to Berkshire's cash infusion, the firm gets a vote of confidence from Wall Street's greatest legend at a time of extreme uncertainty. 

The collapse of The Bear Stearns Cos. Inc. and Lehman Bros. Holdings Inc. (OTC: LEHMQ), and the hurried sale of Merrill Lynch to Bank of America Corp. (BAC), sent shockwaves through the industry. And many investors, up until this point, were unsure of just how successful Goldman's transition to a holding company would be.

Buffett is "getting very attractive terms, but Goldman is getting very attractive affirmation of their value from an investor with Warren's stature," Tom Russo, a partner at Gardner Russo & Gardner in Lancaster, Pennsylvania, which manages more than $3 billion, including Berkshire shares, told Bloomberg.

Goldman got an immediate lift in its share price, which rose 4% over the past two days, as investors and mutual funds mimicked Buffett's strategy.

Buffet also gave a boost to the overall market, as he braved the treacherous terrain of financials.

The purchase "is a significant sign, as Mr. Buffett is of course known for making prudent, long-term investments in companies with good fundamentals and solid growth potential," Sacha Tihanyi, a currency strategist at Scotia Capital told The Wall Street Journal. "The ‘Oracle of Omaha' believes not only in Goldman, but also the industry's prospects over the medium term."

Jim Cramer Backs Buffett

In an article that appeared on the TheStreet.com, site director and co-founder Jim Cramer broke down both Buffett's Goldman stake, as well as his recent bid for Constellation Energy Group Inc. (CEG).

"These investments are the first sign that someone, some grown-up, is coming in from the sidelines, not because he has been talked into something that he doesn't want to do or understand – which has been the case in all of the other bank financings – but because he sees a delicious rate of return that will be hard to take away now that he has put his balance sheet to work, one of the last with any firepower to make a difference," said Cramer.

Earlier this month Buffett's MidAmerican Energy Holding Co. offered $4.7 billion, or $26.50 a share for Constellation. MidAmerican displaced Electricite de France SA (PINK: ECIFF), Europe's biggest power producer as Constellation's top shareholder Monday, after paying $1 billion in cash for a 19.9% stake.

Both Goldman and Constellation fit into the typical Buffett model of having strong management and well-established business models. But they're facing problems that have transformed them into bargain-basement profit plays.

"It is more than ironic that [Buffett] came in after a multitude of articles that talked about how Goldman is worth far less than it was before it became a commercial bank, because the truth is that it is worth far more as a commercial bank because it can do more and have access to more capital and is safer," Cramer said. "The press didn't believe it because the press gets its information from the [short-sellers]. But Buffett did. Perhaps we should be thinking more like Buffett and less like the press."

What Buffett's Been Buying

According to a recent study, buying what Buffett has bought – even a month after his purchases – is a pathway to superior returns. In fact, over the past three years, this strategy has delivered double the return of the Standard & Poor's 500 Index, according to research by professors at both American University and the University of Nevada at Las Vegas.

That means it's well worth the time to revisit what Warren's been up to.

In February, Berkshire took an 8.6% stake in Kraft Foods Inc. (KFT), becoming the foodmaker's biggest shareholder.  That was followed in March by the $4.5 billion purchase of Marmon Holdings Inc. In April, Buffett supplied Mars Inc. with $6.5 billion to help the candy company acquire Wrigley Jr. Co.

Last month, filings with the U.S. Securities Exchange Commission (SEC) shed more light on just what Berkshire was up to during the second quarter.

Prior to putting $3 Billion into Dow Chemical Co.'s (DOW) $15.4 billion takeover of Rohm & Haas Co. in July, Berkshire reduced its investments in Anheuser Busch Cos. (BUD) and Trane Inc., and added positions in NRG Energy Inc. (NRG), Ingersoll-Rand Co. Ltd (IR), and Sanofi-Aventis (ADR: SNY).

According to the SEC, Berkshire in June reduced its stake in Anheuser Busch to 13.85 million shares, less than half the 35.56 million shares it held as of March 31. Also in March, Berkshire dumped its 10.9 million shares of Trane Inc. That stake was valued at more than $500 million as of March 31.

After unloading in the spring, Buffett treated Berkshire Hathaway to a $4 billion shopping spree. By the end of the second quarter, Berkshire's stake in French drugmaker Sanofi Aventis had shot up by 317,200 shares, to reach 3.9 million. Berkshire also added 5 million shares of Ingersoll-Rand, and announced new holdings in NRG Energy, the second-biggest power producer in Texas. Berkshire held 3.24 million NRG shares as of June 30.

Then, in a move that highlighted Buffett's bullishness on railroad stocks, Berkshire doubled its stake in Union Pacific Corp. (UNP), taking its holdings from 4.45 million shares at the end of March to 8.91 million shares as of June 30.

But the acquisitions disclosed to the SEC were only a fraction of the $3.98 billion Berkshire spent on stocks in the April-June period.

Even if Buffett bought the shares at their highest second-quarter prices, which he almost certainly did not, the total cost would only have been about $260 million. That means more than $3.5 billion went into smaller amounts of unnamed stocks the company was not required to disclose.

At the year's mid-point, Berkshire had $31.2 billion in cash, down from $44.3 billion at the end of 2007, Bloomberg News reported. 

"It's nice to have a lot of money, but you know, you don't want to keep it around forever," Buffett recently told Bloomberg. "I prefer buying things. Otherwise, it's a little like saving sex for your old age."

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  1. […] of Paulson's bailout plan. [A related report in today's issue of Money Morning analyzes Warren Buffett's investment in Goldman Sachs […]

  2. […] Buffett's preferred stock deal with GE comes just a week after he made a $5 billion investment…. (GS).  In that deal, in addition to agreeing to buy $5 billion in perpetual preferred Goldman Sachs shares that pay 10% interest, Berkshire Hathaway receives warrants giving it the right to buy $5 billion worth of Goldman's common shares at any time over the next five years at a price of $115 per share. Goldman Sachs shares closed at $134.50 yesterday, up $6.50 each, or 5.08%. Based on that closing price, Buffett has a potential paper profit of $847.83 million on those Goldman warrants. […]

  3. […] Buffett’s preferred stock deal with GE comes just a week after he made a $5 billion investment…. (GS).  In that deal, in addition to agreeing to buy $5 billion in perpetual preferred Goldman Sachs shares that pay 10% interest, Berkshire Hathaway receives warrants giving it the right to buy $5 billion worth of Goldman’s common shares at any time over the next five years at a price of $115 per share. […]

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