The Oracle had spoken. “I’m impressed with the profit generating abilities of the franchise”, Buffett said of Bank of America.
“This is a vote of confidence by a savvy investor”, touted Bank of America’s chairman.
Buffett followed up with an investment of $5 billion in the beleaguered bank. Nervous investors heard what they needed to hear and followed the pied piper in hordes. The bank’s depressed shares, soared by 10%.
Two of my favorite quotes from Warren Buffett:
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”
“I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will”
Is Bank of America truly a wonderful company?
- Mortgage fraud – check
- Muni-bond fraud - check
- Federal bailout – check
- Foreclosure robo-signing – check
- Sub-prime loans – check
- Using bailout money for executive bonuses – check
- Class action lawsuit on overdraft fees and account manipulation – check
- AIG lawsuit on defrauding investors – check
- Worst company in America finalist – check
- Number 1 spot in 2011 Customer Service Hall Of Shame – check
This is not the first time Buffett is bailing out companies. GE and Goldman Sachs too were recipients of his stamp of approval. The stories are in fact, quite similar.
Buffett’s investment in Goldman Sachs
After the collapse of Lehman Brothers in September of 2008, the once invincible Goldman Sachs looked vulnerable and its stock was taking a pounding. Fear and uncertainty was everywhere and investor confidence was at its lowest.
Within a week after the collapse, a deal with the devil was struck.
- Buffet will infuse $5 billion in Goldman Sachs as preferred shares carrying a 10% annual dividend
- Buffett will retain rights to buy additional $5 billion worth of Goldman Sachs shares anytime within 5 years at $115 a piece, at 9% lower than GS’ closing price that day
- A penalty of 10% if Goldman Sachs decides to buy back the preferred shares
The $5 billion investment of Buffett returned Berkshire Hathaway $6.5 billion in just 3 years! Goldman Sachs realized with a 10% dividend, Buffett was making out like a bandit. In March this year, Goldman Sachs did what Buffett knew all along, bought out the preferred shares after paying the 10% penalty terminating the deal.
The devil in this deal turned out to be Buffett.
What of the GS investors who followed Buffett?
The deal was announced on September 23, 2008. Assuming a ‘savvy’ investor had bought Goldman Sachs shares on September 24, 2008 at $133.00 (closing price), the investor will be sitting at an unrealized loss of 16.5% today.
Buffett hasn’t exercised his right to buy Goldman Sachs’ common shares at $115. GS is trading at $111 as of this post.
Buffett’s bailout of GE
GE has a similar tale to tell. In 2008, GE’s finance arm was threatening the rest of GE. GE couldn’t maintain its own earnings estimates. By October, it’s shares were down more than 40%. At it’s lowest ebb, Buffett once again, made his move.
- Buffett agreed to invest $3 billion in GE as preferred stock carrying a 10% annual dividend
- The shares can be repurchased after 3 years at a 10% premium
- Buffett reserves the right to purchase additional $3 billion worth of GE common shares anytime within the next 5 years at a fixed price of $22.25.
GE literally had to pay a steep price with the 10% payout. Berkshire Hathaway earned a sweet $900 million just in dividends. GE plans to buyback the shares this fall after paying the 10% premium.
What of the GE investors who followed Buffett?
Let’s see. The announcement was made in October 1, 2008. If an investor had purchased GE shares the next day, which at that time was trading at $22.15, he would be sitting at an unrealized loss of 29.8% today!
What to make of Buffett and his Bank of America endorsement?
I do not think Buffett truly believes Bank of America is a wonderful company. There seems to be no end in sight to BofA’s woes. The lawsuits keep coming and analysts still don’t know the extent of BofA’s frauds.
Buffett is an opportunist. The deal like the ones before, is cleverly structured and heavily in Buffett’s favor.
- Buffett’s investment will get him preferred shares of BofA carrying a 6% annual dividend
- Buffett also gets to buy an additional $5 billion worth of BofA shares at a fixed price of $7.14 anytime in the next 10 years!
An individual investor is not in the same boat as Mr. Buffett. It is hard to predict in which direction BofA’s stock price will swing, but either way, Buffett will make money, not so for the individual investor who follows Buffett blindly. Those who followed Buffett with GS and GE are still licking their wounds and both, in my opinion, are healthier than BofA.
Am I investing in BofA? No, but I’m investing in Berkshire Hathaway!
Disclosure: Long BRK.B