Buffetts sweet deal

Two weeks ago we wrote about how Warren Buffett asked the government to “Stop Coddling the Rich,” in an op ed piece in the New York Times. While his piece angered some conservatives, the important point he made was that wealthy investors, like himsef, look for profitable investments and do not greatly alter their strategy due to tax policy. So those arguing against any increase in taxes for the top tier of earners or changes in the carried interest rules due to its impact on investment and job growth are making a false argument.

Recently he made news by investing in— or bailing out depending on your point of view — Bank of America. BofA stock had dropped significantly, to a low of $6.01, due to worries it still had a large exposure to mortgage backed securities and it lacked appropriate capital to back these positions.

Buffett’s firm Berkshire Hathaway, similar to deals he made with Goldman Sachs and GE in the heart of the credit crisis, pumped $5 billion into the struggling bank. Canaccord Genuity provided some details and based on what we have seen, we aren’t any more confident in BofA but we understand how Buffett got so rich.

If the details of the deal are correct it seems to underscore how desperate BofA is and also how Buffett has become so successful.

According to Canaccord Genuity, Buffett will receive a 6% annual dividend for the preferred stock, which BofA can buy back at any time by paying Buffett a 5% premium. Berkshire Hathaway will also receive warrants to purchase 700 million shares of BofA common stock at an exercise price of about $7.14 a share at any point over the 10 years following the closing date of the transaction.

That means if some time in the next 10 years BofA stock rises to say $27.50  per share, roughly half of its pre-crisis high of $55.08, Berkshire Hathaway and Buffet would profit roughly $14 billion. Heck the stock was above $15, more than double the exercise price, at the beginning of 2011.

The deal helped BofA stock rise 40% from its more than two-year low. Despite this BofA appears not to be in the clear as they continue sell off assets and others are seeing the details of Buffett’s investment and drawing similar conclusions.

About the Author
Daniel P. Collins

Editor-in-Chief of Futures Magazine, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange. Dan joined Futures in 2001 and in 2005 he was promoted to Managing Editor, responsible for overseeing all the content that went into Futures and futuresmag.com. Dan’s incisive reporting and no-holds barred commentary places him among the most recognized national media figures covering futures, derivative trading and alternative investments.

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