Goldman Sachs (NYSE:GS) announced March 26 that in October it will issue to Berkshire Hathaway (NYSE:BRK.B) exactly the number of shares equal to Warren Buffett's profit from the 2008 warrants he got as part of his $5 billion investment in the investment bank. The deal is a win/win for both companies. What does it mean for stockholders?
Think back to September 23, 2008, when the two parties made their original deal. Goldman Sach's stock was trading at $125.05, 24% less than just three weeks earlier. Its reputation in question after the collapse of Bear Stearns and Lehman Brothers, investors were skeptical about most investment banks. Warren Buffett rode in on his big white horse providing Goldman Sachs with the reputational shot in the arm it needed. Berkshire Hathaway bought $5 billion in perpetual preferred shares that paid a 10% dividend. As part of the deal it received warrants giving it the right to purchase 43.5 million shares of Goldman stock at $115 each anytime up to October 1, 2013.
Goldman was paying $500 million in dividends annually on the preferred shares--an untenable amount--so it bought back the shares for $5.5 billion plus a special, one-time dividend of $1.64 billion. What happens next depends on what Goldman's stock does between now and October 1. For example, should the 10 trading days prior to October 1 average $150 per share, Berkshire Hathaway's profit would be $1.52 billion, meaning it would receive 10.15 million shares of Goldman Sachs. Buffett ends up with approximately 2% of the investment bank and a $2.14 billion profit while Goldman reduces its potential dilution by 77%.
Regardless of what happens to Goldman's stock price over the next six months you have to consider Berkshire Hathaway shareholders are the big winners. Its annualized total return from the deal over the last five years is 11.6%. That's 180 basis points higher than the SPDR S&P 500 (ARCA:SPY). But of course that's not the final tally. Should Buffett hang on to its stock perhaps even building a larger position, then it could become the gift that keeps on giving. Time will tell how enthusiastic he is about owning Goldman but clearly it's not red hot because if it were he'd force the issue and buy the 43.5 million shares outright at $115 each. If I had to guess I'd say it will become one of the billion-dollar holdings we read about in every Berkshire Hathaway annual report but not one of his big four - Wells Fargo (NYSE:WFC), IBM (NYSE:IBM), Coca-Cola (NYSE:KO) and American Express (NYSE:AXP).
As for Goldman Sachs, it gains a partner and loses a quasi-lender. It was an expensive deal for the company but one that probably needed to be done. By coming up with a creative solution, Goldman Sachs reduces its dilution by 33 million shares and Berkshire Hathaway reduces its cash outlay by $5 billion, which it can now put toward one of those "elephant" deals Buffett always speaks of. If Berkshire had to buy all 43.5 million shares in order to crystalize its profit, it's very possible the company could have sold its entire investment. This way Buffett stays in the game which is good news for Goldman Sachs shareholders.
Warren Buffett didn't get to where he is by being stupid. In Goldman, he's acquired a piece of one of banking's biggest and well known firms. Even better, Berkshire Hathaway was paid $2.15 billion over five years to do so. Anytime someone offers to pay you to acquire something they own, especially when it has real value, the answer should always be yes.
If you're a Berkshire Hathaway shareholder this is just another example why you already own its stock. If you're a Goldman Sachs shareholder, and have been for some time, this is the end of a very difficult time in the company's history. Would I own either stock? I'd have no problem owning Berkshire Hathaway. As for Goldman Sachs, I'd consider its stock but only if Buffett remains a shareholder.