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Buffett’s Goldman Warrants Show The Riskiness Of Time Sensitive Investments

March 26, 2013 | About:
CanadianValue

CanadianValue

212 followers
Today Goldman Sachs announced that it had reached an agreement to amend its warrant agreement with Berkshire Hathaway.

The announcement is as follows:

The Goldman Sachs Group, Inc. (GS) today announced that it has amended its warrant agreement with Berkshire Hathaway Inc., and certain of its subsidiaries (collectively, Berkshire Hathaway) from cash settlement to net share settlement.

"We intend to hold a significant investment in Goldman Sachs, a firm that I did my first transaction with more than 50 years ago," said Warren Buffett, Chairman and Chief Executive Officer of Berkshire Hathaway. "I have been privileged to have known and admired Goldman's executive leadership team since my first meeting with Sidney Weinberg in 1940."

"We are pleased that Berkshire Hathaway intends to remain a long-term investor in Goldman Sachs," said Lloyd C. Blankfein, Chairman and Chief Executive Officer of Goldman Sachs.

The warrant had provided Berkshire Hathaway the right to purchase 43,478,260 shares of Goldman Sachs' common stock, par value $0.01 per share, at an exercise price of $115 at any time until October 1, 2013. Under the amended agreement, Goldman Sachs will deliver to Berkshire Hathaway the number of shares of common stock equal in value to the difference between the average closing price over the 10 trading days preceding October 1, 2013 and the exercise price of $115 multiplied by the number of shares of common stock covered by the warrant (43,478,260).

These warrants, along with the preferred shares (with a 10% dividend yield) that Buffett purchased from Goldman at the height of the 2008 financial crisis are going to turn out to be a great investment for Berkshire.

What the warrants once again reinforce for me is just how risky it is to invest in naked options and time sensitive derivatives.

The warrants that Buffett was granted along with the preferred shares had an exercise price of $115. At the time they were granted Goldman was trading at $122, but were seemingly headed to zero (everything was back in those days).

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By November 21 of 2008 Goldman Sachs was (unbelievably) trading for $53 per share and Buffett’s warrants were way out of the money.

Of course the world did not end and it looks like these warrants are going to make Berkshire a nice amount of money in the form of Goldman shares.

If the current share price of Goldman ($146) is the share price in the 10 days leading up to October 1, 2013 Berkshire will receive 43,478,260 x ($146 - $115) = $1.35 billion worth of Goldman common stock.

Nice.

What really struck me today though was that as recently as September of 2012 with Goldman Sachs shares trading near the exercise price these warrants had very little value. There was a real risk that Buffett wouldn’t have realized any gain from owning them.

That would have been hard to imagine one year after the deal was originally made when Goldman shares had already risen to almost $190 per share.

That is way I avoid options. I have a hard enough time picking the right stock, never mind picking the right stock and the timing of when the price might move.

Buffett has regularly repeated the famous Keynes saying that “The market can stay irrational longer than you can stay solvent”, and that concept certainly could be applied to the time value of options as well.

About the author:

CanadianValue
http://valueinvestorcanada.blogspot.com/

Rating: 4.0/5 (7 votes)

Comments

waup7707
Waup7707 - 1 year ago
It's true that when you purchase an option, the time value diminishes day after day. In most cases, time is your enemy.

How about making time your friend by position yourself as an option seller? Before acquiring entire BNSF in 2010, Buffett sold significant amount of BNSF put options with the intention of acquiring more shares at lower costs. Upon option expiration, you either buy the shares at reduced cost (strike price - premium collected) or collect the premium for free.
waup7707
Waup7707 - 1 year ago
We know that Buffett loves insurance float, especially when he is paid to use the float. One less noticed "float" on Berkshire's balance sheet is the float (in billions) generated by writing various options (most stock index options).
jonmonsea
Jonmonsea premium member - 1 year ago
To me, this is a statement from Buffett (implicit) that even the best investment bank is not going to be as profitable as other investments going forward, whether because of increased regulation or increased competition or government intervention in interest rates. He could have had many more shares but instead he chose fewer. I think that is a viable way to view his choice. What do others think?

Then, is it not surprising that he agreed to take whatever the average ten day price til' 10/1 is as the exercise differential. Does that mean he is certain the stock will not precipitously drop from today's levels? How does he know that? Isn't that very, very, very strange, in particular from Buffett? Isn't he introducing price risk into the equation?

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