I’ve spent quite a bit of time in the past discussing the world’s most misunderstood investor. This folksy old man from Nebraska doesn’t lurk like a lion in the shadows waiting to pounce on his prey. No, he just comes up and gives you a nice big “hug” as the someone described the B of A deal.
Let’s be clear here. This is a distressed play with sophisticated hedging involved. And it’s classic Buffett. He is essentially stepping on Bank of America’s throat when they are vulnerable and extracting his billions in future cash flows. If you’re not familiar with the terms, Reuters breaks them down:
“Buffett’s Berkshire Hathaway will in many ways make out even better financially than Bank of America did in the deal. Berkshire had a position in the bank that he sold in the fourth quarter of 2010 when the stock had an average price of $12.24.
The warrants to buy 700 million shares of common stock he gets in this deal are priced at just over $7.14 per share, with an unusually long 10-year exercise period.
One long-term Berkshire shareholder said the warrants were the best part of the deal by far.
“He could well make a 100 percent return on his investment in a few years,” said James Armstrong, president of Henry H. Armstrong Associates. “It’s amazing how much a little hug from Buffett is worth these days.”
Bank of America will also sell Berkshire 50,000 shares of cumulative perpetual preferred stock with a 6 percent annual dividend, it said. Bank of America can buy back the investment at any time by paying Buffett a 5 percent premium.
It is virtually a mirror of the deal Berkshire did with Goldman in the depths of the crisis in fall 2008, except in Goldman’s case it paid a 10 percent dividend. The Goldman deal paid Berkshire $15 a second in dividends until Goldman bought Buffett out earlier this year.”
Just like the Goldman deal, Buffett is buying a distressed stock in which he has embedded a fairly substantial downside hedge. I have no idea if Bank of America is actually solvent and I can’t and won’t speculate over the balance sheets of a banking industry that I believe are not entirely understandable, but I am sure Buffett has done the math at least well enough to believe that the risk of insolvency is low. I don’t know if he’s right. But I know one thing – this wasn’t your average “buy great brands at a great value and hold forever” sort of investment. This is classic Buffett. Savvy, cunning, aggressive and 100% Wall Street, 0% Omaha. It’s a step on your throat deal. Not a “hug”. But the myth of folksy “buy and hold” Warren lives on….
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.