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09/23/2008

Buffet Makes It Official: Even Goldman Sachs is Junk

Lots of press this afternoon on Warren Buffet's investment in Goldman Sachs.  For $5BN it looks like he will receive $5BN face value in perpetual preferred with a 10% coupon callable at 110, plus 5 year warrants on another $5BN worth of stock @ $115/share (which equates roughly to warrants on about 43.5 million shares @ $115/share).

I am not an options guy, but if you take the take the implied volatility on Goldman 120 Jan-2011 calls and apply that out to 5 years (which I realize is a generous leap of faith), it looks like the warrants are worth in the neighborhood of $50-$55/share depending on your assumptions (options pros please correct me if I am way off here) which means the 43.5M in warrants are worth around $2.2BN to $2.4BN at issue.  That means that Buffet is really investing only about $2.8 to $2.6BN at a yield to maturity (assuming 5 years) of around 27% to 29.5% and that's not even counting the 10% preferred redemption premium. With the 110 call on the preferred and the upfront warrant coverage, the YTMs are even higher if Goldman decides to call the preferred earlier.

Obviously, Buffet is getting a healthy discount because he's the ultimate in smart money, but still, when Goldman, the Gold standard in investment banks, is selling perpetual preferred at theoretical yields to maturity of 25%+ you have to wonder what the market rates really are for your average investment or commercial bank.

I assume the market will heartily applaud this deal, but I don't know if I should be excited that Buffet thinks it is finally a good time to buy or scared to death that the best global franchise in investment banking has to raise money at interest rates that would make a sub-prime credit card issuer blush.

September 23, 2008 in Wall Street | Permalink

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