The decision to purchase $5 billion of preferred shares (with an under-market value of a 6% coupon, albeit with bonus provisions) in conjunction with the 10-year warrants to purchase BAC shares for $7.142857 (7 and 1/7th for those that do not recognize the string of numbers after the decimal point) has been analyzed to death by others.
The warrants are the golden part of this agreement – it is essentially a binary bet on the bank – if Bank of America does not go belly-up, it should be able to produce sufficient cash after a ten year period to justify a stock valuation significantly higher than $7 1/7 per share. If the company does go belly-up, Berkshire should be able to retain some residual interest in the preferred shares while the common shareholders get wiped out.
There is about $150 billion in tangible equity on the balance sheet to clear through before this would occur, which is why I suspect that this deal is a very good one for Berkshire and Warren Buffett.
I generally do not like it when financial companies raise capital – this is no exception. It makes you wonder how well JP Morgan is doing in terms of their solvency and liquidity situation. Analyzing big banks such as BAC or JPM is essentially a leap of faith more than an informed investment decision.
“I generally do not like it when financial companies raise capital – this is no exception.”
“Analyzing big banks such as BAC or JPM is essentially a leap of faith more than an informed investment decision.”
Hopefully you understand the absurdity of these two statements being made in the same breath.
If a financial company raises capital at a level above intrinsic value per share, then that is accretive to the value of the company.
Yet your second statement implies that you would not even attempt to define intrinsic value for such a company.
So if you would never even attempt to value the company, it necessarily follows that you would never have ANY CLUE as to whether the capital raise was good or bad for the company.
About my second statement (regarding the leap of faith), while an analysis would give a number, I would not be confident on relying on that number, at least generated by myself.
I am not sure how that is inconsistent with my first statement.
I am pretty sure Buffett, at his ripe age, is sharper at putting a tighter estimate on the intrinsic value of such companies than I am.
It is inconsistent w/ your first statement, because your first statement categorically classifies all capital raises as detrimental.
Yet your second statement (and second comment) confirms that you would actually have no confident basis against which to evaluate whether said capital raise was accretive or dilutive.
Your logic is correct. I completely agree with you.
I said I suspected Berkshire got a very good deal, but really, I don’t know for sure.
But using strict logic, I “generally” do not like when financials raise capital. Not always. In BAC’s case, if they were healthy, why would they need to raise capital like they did? Why would you need to shell out $300M/year after tax money for five billion you supposedly don’t need since you’re still trying to loan out your nearly zero-cost of capital money to good creditors? Obviously there is some forecast out there on some spreadsheet somewhere that wants to put a buffer out there on a long-tailed probability financial event.
I remember what happened many years ago to Level 3 communications after Buffett invested in them – the common stock soared and the yields on the debt went down, but he was out for a quick trade when he converted his bonds to equity and sold out. It was a win-win for both entities but the people that held the bag were the common shareholders.
Fair enough.
My opinion on it is that those who are looking at it from the perspective of ‘why did they raise capital if they supposedly didn’t need it?’ are looking at the wrong way (or more accurately, are not looking at it the way BAC and Buffett approached the deal).
The $5B from Buffett lends BAC credibility. It was not about a capital cushion. If BAC did a transaction based around a needed capital cushion, it would be for more than $5B. Buffett got a sweetheart deal – that was the price BAC paid for his credibility.
But in my opinion, the deal was not as ‘sweetheart’ as portrayed by several media sources I have seen. If you believe BAC is worth $7-$8 or more, this deal was roughly 1% dilutive. If you think BAC is worth $1-$2 or less, this deal was actually accretive. Commentary that says it was a bad deal (for BAC) must then acknowledge that BAC is worth alot more than current prices. None have (that I have seen).
Interesting insights on Level 3. I was not aware of Buffett’s former involvement with them. Do you happen to remember the approximate time frame? I want to research it. Thanks –
Nevermind – I found that the LVLT investment was made in July 2002.
The Level 3 transaction:
http://www.secinfo.com/dsvrt.34p6.htm
http://www.secinfo.com/dsvrt.34p6.8.htm#1stPage
If the deal was about credibility (and certainly I agree it was a large element), then it will be very interesting to see whether that credibility extends into the future price of BAC common – people continue to gush as well about WFC, which I equivalently wouldn’t trust my own two cent opinion on.
Unfortunately I do not have anything really quantitative to contribute here without doing a lot more work. The only thing I know is that those warrants are worth at most $7 1/7 per warrant and greater than zero, which is not saying much.