Thursday, October 02, 2008

The World According To Buffett

What can you say about the man.. look at his forays over the last couple of weeks while the rest of the financial world were biting their finger nails.

Warren Buffett literally swooped in to buy Constellation Energy Group for $4.7 billion. At the beginning of the year, Constellation traded for over $100 and now its shares had slumped below $25 prior to Buffett’s acquisition announcement. At a $26.50 take-over price, Buffett is paying about an $11.5 billion price tag for Constellation, including net debt and retirement obligation. EBITDA: $1,925 million, which means Buffett paid less than 6 times EBITDA for Constellation. By the way, property, plant and equipment [PPE] are worth $10.4 billion alone.

When we say cash is king, its pretty useless not to deploy the cash when valuations get out of whack. The cash is not really king, because you did not deploy them at the right time. To be fair, the trouble is most of us do not know when the right time is. Maybe we all can follow Buffett. Mathematically alone, he has been through more crisis, booms and busts. The funny thing is that Buffett can roll a six 9 out of 10 times, but even now when he starts to buy, most investors still fear jumping along with him. Fear still over-rides sensible deduction.

The other deal was Goldman Sach. That deal is not as "committed" as it appears. The $5 billion deal involves two parts:

1) $5 billion in preferred stock
These preferred shares are senior to common stock and pay a 10% annual dividend. Think of them as unsecured bonds paying 10% interest. He is not buying common shares with the initial $5 billion. If Goldman ever wants to retire these preferred shares, the company has to pay Buffett a 10% premium to their face value. That would further boost the yield on those papers. Buffett got a wonderful deal because these papers are usually callable at par and not at a premium.
2) Warrants to buy $5 billion of common stock at $115 per share
Buffett has the option to buy $5 billion of common stock at $115 per share at any time over the next five years. There is absolutely no risk for Buffett on these warrants, the option cost him nothing. Buffett earns a profit of $43 million for every dollar GS stock trades above $115 per share.

The only thing Buffett is confident on is that Goldman Sachs will be around 5 years from now, and that he has a very good chance to get back his money plus a high yield. His equity interest in Goldman Sach cost him zilch, what a wonderful deal (for him).

Berkshire Hathaway also disclosed that it has doubled its stake in Conoco Phillips to 17.9M shares and picked up new positions in General Electric totalling 7.8 million shares, and a smallish stake in United Parcel Service (1.4 million shares).

General Electric is getting $3 billion in new capital from Buffett's Berkshire Hathaway. GE is "the backbone of the American industry," Buffett said. "They're going to be around five or 10 or 100 years from now." Buffett's deal is very similar to the one he got when he bought into Goldman Sachs last week and very, very different from what the normal investor would get.

Buffett is getting $3 billion in perpetual preferred stock offering a dividend of 10 percent. It is callable, at a premium of 10 percent, in three years. He also got warrants to buy $3 billion in common shares at $22.25 over three years.

Both the GE and Goldman deals does not present big risk to Buffett, but the moves send a very strong signal to all with capital that is it OK to start injecting capital into troubled firms. Buffett has also mentioned a few important points during his CNBC interview last night. One, that he would have liked to take up 1% or $7bn in the bailout fund as he believes that the fund will make good money within a few years. Two, he also reiterated that the fund is very likely to be crucial for the American economy and should make money in the end, thus an important view to the politicians who later voted the bailout plan through.

Will other investors get such a good deal like Buffett? Probably not, the SWFs and PE firms are probably gnashing their teeth on the wonderful deals struck by Buffett. But Buffett is bringing more than just cash to the table. When he invests, he brings with it a "seal of approval" on the company's fundamentals, valuations and prospects relative to its price. That seal of approval is from years of proven track record. When Buffett buys, it basically means your company is more than OK. Its a great premium to pay to Buffett by GE and Goldman as the premium is a very cheap way to restore confidence in yoru stock, boost employees' morale, and even get banks to trust your company and give out generous lines of credit.

Its not just in the US, Buffett has started to buy in Asia as well. On Monday, a subsidiary of Warren Buffett's Berkshire Hathaway spent $230 million on a 10% stake in Chinese rechargeable battery manufacturer BYD Company. Interesting indeed.

To Buffett, its time to get back in.

p/s photos: Shama Sikander


Avatar said...

Buffett just keeps on going, doesn't he?

Talk about being at the right place, at the right time, with the enough cash... He's the man with the Midas Touch.

Andrew Abraham said...

We have been discussing on My Investors Place Buffetts purchase of Goldman and now GE... I think he is following in the steps of Ben Graham...What am I missing... What is your opinion?

Andrew Abraham said...

We have been discussing on My Investors Place... Buffetts purchase of Goldman and now GE... I think he is following in the steps of Ben Graham...It took Buffetts Teacher almost 10 years to get back to Break Even...What am I missing...

Salvatore_Dali said...

Andrew Abraham,

Yes Buffett is a student of Graham. I think Graham's principles are still valid till today. Yes Graham did have a long gestation in some of his investments - poor timing, miscalculation on recovery catalysts. Graham is a fine teacher but may not be a reasonable market timer. One should also take into account that he lived during a time where a lot of the research, insights and findings on stock market movements and over-riding factors HAD NOT YET been published. One can safely say that the bulk of value-add stock market information was discovered in the 60s and 70s, which Buffett has been able to take into account. Hence it is safe to say that Buffett has added to Ben's principles.

Last word, Buffett has has certain stocks which he had to hold for more than 5 years before seeing returns of any sort. Will his recent purchases face similar fate - I really don't think so. One, the subprime credit, derivatives mess is pretty much out in the open now. We are probably in the last 25% of the mess being unwound... the remaining 25% is the period where some who cannot survive will collapse, and where all will be feverishly trying to restructure and improve their capital structure.

If you look at Buffett's exposure in Goldman and GE, its a very very safe bet. He also bought into the VERY BIG firms. Going forward, Goldman and JP MOrgan will get much much bigger as the others fall by the wayside. Do you think Goldman will be allowed to fail 3 years down the road???

Andrew Abraham said...

Thank you for your response ... possibly you can express your views to our community at My Investors last wekk there was a great deal of discussion...and of course disagreement....I can not think of too many people that thought Bear or Lehman would fail other than David Einhorn from Greenight.. I believe anything can happen ...that means that Goldman is not immune nor is GE..

thank you in advance...


KoSong Cafe said...

How about 'Bankers' lender of last resort'?

When you need finance, you go to a bank. When the bank needs finance, you go to Warren Buffet.

He is the undisputed 'King of Investors' with a big safety margin and loads of cash ready for the kill. When people need you, you certainly have bargain powers.

Andrew Abraham said...

Nice point..but what happens if he is early...on the forums of my investors place members point out what happened in Japan..20 years almost...buffet recieved terms non of us mortals could get..but still if he is early..

P S Lak said...

Warren Buffett sure drives a hard bargain. He exacts fantastic terms from his acquirees when they are down and desperate. This makes him and Berkshire Hathaway shareholders a very happy lot. But what about the shareholders of the acquired companies? Or the CEOs of those com. Couldn't he show them some compassion?

WB is the richest man in the world. He has already committed to giving most of his wealth to charity. So why does he still try so damn hard to make more money? Is there still a point for him to prove? Maybe he should use more of his heart than brain in his wheeling and dealing.

I think this is the best time for him to do some National Service. Resign as CEO of BH. Volunteer to be in a position that can help solve the credit crunch. Use his own money to help if need be. This way, he will leave a much better legacy.

Andrew Abraham said...

I think this crisis is above his ability... Did you see that GE fell about 9% yesterday... alot of members of My Investors Place were discussing this...some vote of confidence... all the best... have a nice weekend...

H said...

Thanks Dali. Cash is not king until it is deployed. Right! :)

Why deploy yourself when you can get WB to do for you?

Brk is a fabulous buy.

Andrew Abraham said...

For a long term investor possibily...but how did one feel in 2000 -2002 when BRKA went from approx 80k to 40k... not the warmest draw down feeling...there are members of that expressed that feeling several monthts ago after purchasing at 150k and the shares going close to 100k..and another mentioned he bought at 73k only to take many years to get to break even... need patience...and believe anything can happen

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