Wednesday, 24 September 2008

Buffet Extracts A Pound of Flesh from Goldman

The headlines since the US market closed on Tuesday were full of praise for Warren Buffets deal to sink $5 billion dollars into the former golden boy of Wall Street, Goldman Sachs. However, behind the cheery headlines the details are much less favourable for Goldman.

Buffet is an opportunist, he lives for times like the present. Just look at the deal he got today. First up he bought $5 billion of preferred stock paying a dividend of 10%, great for Buffet but a big ouch for Goldman as they now have to pay out $500 million to Buffet every year. On top of that, if they want to buy back those preferreds, they have to pay a 10% premium.

In addition, Buffet is getting warrants on approximately 43.5 million shares at a strike price of $115 per share (about $5 billion worth) with 5 years in which to exercise them. As Barry Ritholtz of the BIG PICTURE points out:

If Buffett were to go to the Street earlier today to buy 44 million calls with a $115 strike price (circa 2010), they would have cost him about $1.5 billion dollars. With GS now trading at $135, Buffett’s $5 billion investment is more like $3.5B, in terms of net cost to him. Hence, the 10% interest is more like 14%.

So it pays to have a look beyond the headlines, no doubt Buffet got a great deal, but it was a very expensive one for Goldman Sachs.