Buffett: The Pied Piper of Financials
Company Research, Market Commentary
The financial sector is in the midst of a crisis of confidence and Treasury Secretary Paulson and Fed Chief Bernanke are in need of a savior. The Bush Administration’s $700 billion rescue plan appears stalled in the halls of Congress, as both sides wrangle over the structure and terms of the bill. Both Paulson and Bernanke are quick to point out that this rescue plan must be passed as quickly as possible as our now fragile financial landscape cannot wait for Washington. As fear reigns over the future of the market, there appears a ray of hope in Warren Buffett’s latest deal, investing $5 billion into Goldman Sachs (GS). Mr. Buffett, an advocate of Ben Graham’s value style of investing, clearly sees value in GS and his action should give a shot in the arm to the sputtering financial sector.
Now, before getting too deep in this, let me be clear in saying that $5 or $10 billion is not going to single-handedly end the misery on Wall Street. We are witnessing a transition from what we used to know as Wall Street and what it will become. Stand alone investment banks have gone the way of the dodo bird, and surviving financial firms will be sorting out their place in the system for some time. However, what Mr. Buffett has done is certainly noteworthy as he is known in many circles as the world’s smartest living investor. His record is undeniable as his company’s stock—Berkshire Hathaway “A” shares—have returned an annualized 15.9% over the last 18 years. He is as shrewd an investor as there is and his willingness to step up to the plate to invest in Goldman Sachs right now may signal that a bottom is forming in this battered, but crucial sector.
As we posted just a few days ago (Not All that Glitters is Goldman), Goldman Sachs is a very well run company that has avoided the worst of this crisis and is still making money in an extremely challenging market. As Buffett—who is famous for his blunt but clear style—said this morning in a statement, “Goldman Sachs is an exceptional institution. It has an unrivaled global franchise, a proven and deep management team and the intellectual and financial capital to continue its track record of outperformance.” He also said that he feels good about where Goldman has marked its risky assets, as compared to where Lehman and other failed entities valued the risky assets on their books.
Buffett is not a savior but an investor. The terms of his investment are extremely favorable in our view. They needed to be enticing to move Buffett into an investment bank as this represents his first major investment in an investment bank since his 1987 deal to rescue Solomon Brothers. First, he has purchased $5 billion of preferred stock which yields a 10% annual dividend. Furthermore, he has warrants to purchase another $5 billion in common stock at any point over the next 5 years for a share price of $115. Considering that—aside from the last month’s turmoil—the last time Goldman sold below $115 was three years ago, he must feel that it is a pretty safe bet that he will get to exercise those warrants at some point. Based on Goldman’s historical average of Price-to-Sales and Price-to-Cash Flow, we have a rationally expected price (given normal circumstances) of about $210 on GS shares.
Clearly, this a sweet deal for Buffett that the “Average Joe” would never be able to obtain. However, when Warren Buffett gets in, many others follow. Indeed, there was such demand for today’s Goldman secondary offering that the company doubled its size from $2.5 billion to $5 billion. Today was a big step in re-capitalizing Goldman and restoring confidence in a company that we believe has been unjustly beaten down too far. After the $10 billion injection, Goldman’s leverage ratio has dropped from 23:1 to 18:1.
So, now that Mr. Buffett has thrown his chips in, perhaps more investors will begin to find value in this deeply oversold sector. As for Ockham, while we like Goldman Sachs, there are still a great many unknowns in financials and the risks are likely to persist while a brave, new financial landscape emerges.
Ockham Research Staff @ September 24, 2008
Nice piece on the myth the man the legend Warren Buffett. This guy should have run for President and would have balanced the budget a long time ok.
Way to go Ockham and WB
That’s nice. Citi is paying over 10% on loans from the Saudis and now GS is also paying in the double digits. 500 million dollars a year in interest… Then again, US will all of the cronies with the Super Bail Out.