The Ponderings of Woodrow

What comes to mind and doesn't leave before I have time to write about it...

Buffett invests in GE...should we smile or frown?

You've got to hand it to him, Warren Buffett knows how to make a splash.

Last week, the world's greatest value investor stepped into the maelstrom and invested $5B in Goldman Sachs. At the time, a lot of us wondered whether Buffett's move would calm the markets -- it hasn't. Tomorrow we'll get another chance to see if the Oracle of Omaha's confidence in bellwether U.S. equities will help stem the tide of investor uncertainty.

That's because today Warren Buffett invested $3B in General Electric. The terms were similar to those he received from Goldman Sachs:

  • Berkshire will invest $3B in exchange for perpetual preferred stock that pays a 10% annual dividend
  • Berkshire will receive rights to purchase an additional $3B in common stock at $22.25 per share, exercisable for the next 5 years
  • GE will raise an additional $12B in common stock through a spot secondary [pricing tonight]
  • GE can call in the preferred stock at any time over the next three years for a 10% premium

In discussing the deal, Buffett spoke of the opportunities he's seeing in the equity markets as well as GE's stature as an American institution:

"Frankly these markets are offering opportunities that weren't available six months or a year ago," Buffett said in an interview on CNBC. "So we're putting money to work."

"GE is the symbol of American business to the world. I am confident that GE will continue to be successful in the years to come."

So should investors look at Buffett's actions enthusiastically as a sign that it's safe to get back in the water OR are his investments actually cause for concern and indicative of just how serious the credit crisis has become?

The Bull Case -- Buffett is putting money to work

Buffett has invested $8B in the last week in two respected U.S. domiciled companies. Both are on the SEC's no-short list and both have suffered difficult times and lagging stock prices. Many people have made a career out of following in Buffett's footsteps, and there is unquestionably a symbolic component to seeing him put Berkshire's capital to work at a time when so few investors are willing to commit.

Mike O'Rourke, the Chief Market Strategist for Baypoint Trading (BTIG) summed up the bullish side of Buffett's actions in his nightly newsletter:

Once again, we find the cynicism surrounding another Buffett investment stunning.  For twenty years, market participants clamored to follow Buffett into any transaction, and now that he is finally putting money to work, the common response is that companies are giving him too much. In a capital constrained world, if you can get Buffett’s capital, you are well ahead of the competition.

The Bear Case -- Buffett is naming his terms, and they're not cheap

10% perpetual preferred plus warrants = hardly the same as going out and buying common shares in the open market. Buffett is no altruist, he and his investors expect him to act aggressively when opportunity arises. He's getting extremely attractive terms because GE and Goldman Sachs feel those terms are warranted; and there's the rub. GE is an American institution and carries a AAA credit rating. The fact a AAA-rated firm of GE's caliber would feel compelled to offer a senior perpetual preferred to any investor, even Warren Buffett, is a testament to just how tight liquidity remains throughout the system. To take a page out of my friend Roger's book...companies are paying a premium for option liquidity.

So is Buffett signaling a market bottom? Impossible to say. Buffett doesn't need the equity markets to rally for his investments to pay off. He just needs GE and Goldman Sachs to stay solvent and pay him 10% dividends year in, year out. Furthermore, Buffett is telling anyone who listens just how tenuous a situation the capital markets are in and the necessity of a bail out and then a lot of hard, smart decisions to follow.

One last point...To be a truly great value investor you have to zig while others zag. You have to be willing to put capital to work in an area where most won't. That's why great value investors pounce during periods of extreme sentiment. Buffett has the benefit of hindsight, great instincts and, most importantly, an ability to be patient in a market that, by definition, favors impatience. Stock prices are quoted in the blink of an eye, returns are followed in real time, funds are put to work and redeemed based on what happens over the course of days, weeks and months. To make money the Buffett way, you have to be willing to forgo all of that and treat equity stakes as though they were private investments with long-term horizons. That's MUCH easier said than done. Most public equity investors, particularly those running hedge fund money, are compensated [and rebuked] based on what they do in shorter time intervals. Buffett doesn't need to worry about that; if Berkshire Hathaway's stock were to meander for years, it wouldn't change his functional wealth, his buying power, or his reputation.

Disclaimer: At the time of writing, neither the author nor the firms affiliated with the author maintained an position, long or short, in the publicly traded companies mentioned or any related instruments. The author and the firm reserve the right to alter their investment positions at any time in the future. The content on this site is provided as general information only and should not be taken as investment advice. Content should not serve in any way as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of firms affiliated with the author. Any action taken as a result of information or analysis on this blog is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

October 01, 2008 in Bail Out, Buffett, Finance, GE, Investing, Warren Buffett | Permalink | Comments (6) | TrackBack (0)

Can Buffett do what Paulson and Bernanke couldn't?

It's hard not to appreciate the symmetry of today's events.

Less than a week ago, Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke met with Congressional leaders and painted such a bleak picture of our financial system that they compelled the legislators into action, signaling initial support for a $700 blank check mechanism meant to overpower all the fear, uncertainty and doubt freezing up the liquidity of our capital markets. For good measure, SEC Chairman Cox piled on an ill conceived ban on select short sales.

The impact on the equity markets was short-lived, to say the least, as was the pledge of bipartisan support for getting something done in a timely fashion. As we braced for today's hearings, the equity markets staged a powerful sell off yesterday and many began to question the Paulson plan from seemingly every angle.

Having watched much of the hearings today, I was absolutely stunned at how unconvincing Paulson and Bernanke were in conveying their message of financial Armageddon to the Congressional committee. Let's hearken back to comments made by Senators Dodds and Schumer following last week's late night emergency session:

Congressional Leaders Stunned by Warnings [NY Times]

“When you listened to him describe it you gulped," said Senator Charles E. Schumer, Democrat of New York.

As Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Banking, Housing and Urban Affairs Committee, put it Friday morning on the ABC program “Good Morning America,” the congressional leaders were told “that we’re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.”

Mr. Schumer added, “History was sort of hanging over it, like this was a moment.”

When Mr. Schumer described the meeting as “somber,” Mr. Dodd cut in. “Somber doesn’t begin to justify the words,” he said. “We have never heard language like this.”

For those of you who listened to the hearings today, you heard those very same Senators (and their fellow committee members) paint a decidedly different picture. Where was the sense of urgency? Where was the "something must be done right now, and it's not about partisan politics" mantra?

More importantly, where was the eloquent, descriptive state of the financial union that so many of us expected to hear from Paulson and Bernanke today?

Today, Bernanke and Paulson HAD to be better than they were. Realistically, these men were asking for a $700 billion bail out package with a broad, sweeping expansion of their powers and had, to date, offered up a 3-page (or 6-page in the revised version) memorandum in defense of the maneuver. They needed to scare the American people with the severity of the realities facing them.

They had to know that the American people had spoken loud and clear to their elected officials in the preceding days. "Main Street" just wasn't seeing how the Paulson Plan helped them. And in an election year, particularly September of said election year, if you can't get "Main Street" to see the validity of the proposal you have ABSOLUTELY NO HOPE of getting Congress to sign on the dotted line. But didn't Bernanke and Paulson know that before sitting down to testify today?

I assumed they did. Which means either they a) simply failed on the grandest of public stages to convey the actual severity of the situation or b) made a calculated bet against coming across as the heavies to the American people; knowing that a significantly reduced version of the bail out plan was a best case scenario to begin with.

The Markets Didn't Seem to Put Much Faith in the Paulson Plan

The U.S. indices finished at the lows of the day today, following a dramatic sell off on Monday; signaling to many that investors simply weren't putting much credence in the state of the Paulson Plan to stem the bleeding in a timely and optimal manner.

Sept23chart

Enter the Berkshire Call Option: Buffett Announces Investment in Goldman Sachs

Berkshire Hathaway has agreed to invest in Goldman Sachs, Buffett's first investment in a Wall Street firm since his much ballyhooed involvement with Salomon Brothers in the early 90s. The terms of today's agreement:

  • Berkshire will invest $5B in exchange for perpetual preferred stock that pays a 10% annual dividend
  • Berkshire will receive rights to purchase an additional $5B in common stock at $115 per share, exercisable for the next 5 years
  • Goldman will raise an additional $2.5B in common stock through a secondary [it's first equity issuance since 2000]
  • Goldman can call in the preferred stock at any time for a 10% premium

The Perceived Value of Buffett's Endorsement

As I type this, shares of GS are trading at $134.75 [up 7.9% after hours]; signaling the market's enthusiasm for Buffett's investment. Broadly, equity futures are up on this news. There are plenty of rational reasons for the market's enthusiasm tonight:

  • Buffett is, without question, one of the best investors walking the Earth
  • He's heretofore avoided stepping into the Wall Street malaise; his willingness now will be perceived as a signal of bottoming
  • A lot of investors are more than happy to follow Buffett's lead
  • This move puts Goldman on sounder financial footing and signals that the government's moves last week to stem the fire sale are working
  • We're collectively (and justifiably) more impressed by the actions of a private free market participant than we are by the bazooka of forced socialism

But Let's Not Confuse Buffett's Investment in Goldman with What the Paulson Plan is Trying to Solve

The market is beaten up. Conviction is low. Volatility is (relatively) high. Buffett will make people feel better. Whether it's a temporary tonic or the siphon that gets the investment pump churning again very much remains to be seen. But I remain skeptical of this move as a harbinger of a broader fix for several reasons.

  • This is a move to invest in a storied financial entity, Buffett's investment does NOTHING to help set a fair market price for the toxic assets the Treasury is trying to get $700B to acquire
  • Buffett is just the latest investor willing to invest in a Wall Street firm under attractive terms; he's not blazing the trail here. For example, it was announced just a day ago that Mitsubishi UFJ is buying 20% of Morgan Stanley
  • Buffett is getting extremely attractive terms; Goldman didn't provide Buffett with a $500mm annual dividend in perpetuity plus call options for 7% of the company's equity because it had offers pouring in. Few firms will be able to ask for, and get, those kinds of terms

It's not about this investment, it's about whether Buffett can convince the market of reasonable marks for all the toxic assets in the system. The market is tired and frustrated. A lot of people have been looking for "the sign" of a bottom in the financial sector and whether this helps spark the private sector to put money to work remains to be seen. One would hope that Buffett's willingness to get involved will also signal his willingness to actively vocalize thoughts on the appropriate way to value and dispose of the toxic assets which plague the system. If he can convince private buyers to start taking troubled assets off the banks' balance sheets, he may actually accomplish more with $5B than Paulson and Bernanke can with $700B. A scary thought to be sure, but one that's not out of the realm of possibility.

Disclaimer: At the time of writing, neither the author nor the firms affiliated with the author maintained an position, long or short, in the publicly traded companies mentioned or any related instruments. The author and the firm reserve the right to alter their investment positions at any time in the future. The content on this site is provided as general information only and should not be taken as investment advice. Content should not serve in any way as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of firms affiliated with the author. Any action taken as a result of information or analysis on this blog is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

September 23, 2008 in Bail Out, Finance, Goldman Sachs, Investing, Splurge, Warren Buffett | Permalink | Comments (2) | TrackBack (0)

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