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