Warren Buffet the White Knight of Goldman Sachs


The infusion of $5 billion in cash from the Oracle of Omaha may save Goldman Sachs, but the bank’s faltering financial health and hazy outlook have robbed it of its luster. Warren Buffet is decidedly a powerful man whose support is a guarantee of security and pride in the world of finance. Less than 14 hours after it infused $5 billion and praised the world’s ailing largest investment bank, Goldman Sachs on September 24 found other investors who have put his hand in his pocket to the tune of 5 billion dollars to acquire shares in the company allowing the latter to bail out its accounts damaged by the financial crisis. The placing on the market of some 40, but the deal is difficult to present as a guarantee of Goldman’s financial solidity and its confidence in a better future. Some analysts say Buffet’s investment and capital raising is extremely costly for the firm, which will face years of turmoil, retrenchment and poor results as it battles through the current financial crisis. Regarding the capital raising, Oppenheimer analyst Meredith Whitney said in a note to clients: “For GS, the flagship of investment banks, the terms of this deal seem very expensive and raise the question of what are the true current market conditions. »

The shares were sold at half price compared to the listing price a year ago. This will significantly dilute the value of GS shares, about 16% as a result of Buffet’s investment and capital raising by Whitney’s calculations. The initial enthusiasm of investors was dampened by the discovery of the implications that this would entail. The stock initially rose above US$133 on the announcement of Buffet’s investment, but then fell on the announcement of the terms of the capital raise. On September 24, it recovered a little by 6% to rise to US$132.

Investors were stunned

Goldman and Morgan Stanley, the other major investment bank that survived the financial tornado that swept away Merryl Lynch, Bear Stearns and Lehman Brothers stunned investors when they announced plans to transform in commercial banks. The action taken in coordination with the Federal Reserve will force them to greater regulation on the part of the public authority and it is hoped that this will allow them to recover better or revise downwards the risky investments “several of them such as the underwriting of mortgage-backed securities have already dried up”. It is no longer expected to see them flirting with the huge debt ratios to which they have accustomed us in past years.

Both banks can now count on strong cash infusions. While Goldman scooped up US$10 billion from Buffet and public investors, Morgan got more than US$8 billion from Japan’s mega-bank Mitsubishi UFC in exchange for 20% of its shares. Yet they have barely left the inn. “They are going to have to tighten their belts and be led to lay off thousands of people without this being due to any charter” says Richard Bove analyst at Landerburg Thalmann “this is due to the fact that the profession has changed. From my point of view this financial crisis will last three (3) or four (4) years”.

Buffet pour Bove made a very good deal by investing in Goldman Sachs. He acquired $5 billion of perpetual preferred stock and obtained 10% of the dividend and warrants to purchase $5 billion of common stock at a price of $115 per share. He will be able to exercise the warrants at any time over a period of five years. With the action costing above the purchase price, he is a big winner. This is not a good deal for Goldman Sachs but rather for Warren according to the analyst, adding “Goldman had no choice anyway because he risked bankruptcy without it”. Lehman Brothers is bankrupt, while Bears Stearns collapsed and was sold cheaply to JP Morgan Chase.

Goldman officials said they had never been in the same condition as their counterparts. Lucas Van Praag, a spokesman for the firm, said Bove’s assertions about possible bankruptcy were misleading and outlandish. “Other firms had a huge concentration in mortgages or were overly dependent on short-term revenue streams, and that kind of business like mortgage-backed securities or even subprime mortgages made up a tiny fraction of Goldman’s investments.” he declares. He added that “the change in status to a more regulated commercial bank was necessary because we ignore market sentiment at our peril. It has become clear in this turbulent market that the sentiment is clearly moving towards more safety and security associated with being regulated by the Federal Reserve. In other words, investors have more confidence in banks closely monitored by the Federal Reserve.

Distrust of investment banks

Nevertheless Buffet could be the balm that Goldman needed for a long time. He has long used the firm’s services even when he disdained investment banks in general. When the Oracle of Omaha dealt with the Pritzker family to buy Marmon Holdings for $7 billion, he proudly claimed that he and the wealthy Chicago family arrived at that price without the help of any advisor, a style which allowed them to avoid possible quibbles. Buffet accepted an initial payment of 60% of the shares at 4.5 billion with the possibility of increasing the capital over time. But Berkshire Hathaway, Buffet’s investment company, needed the services of Goldman Sachs to finalize all the details of the deal. And the firm has done the job so well that in his annual letter to shareholders last year Buffet highlighted banker Byron Trott as “the rare investment banker who steps in his clients “. Buffet added that he and his partner at Berkshire Charlie Munger have complete confidence in him.

It is unclear whether Trott, who is still associated with Goldman, had anything to do with the deal that allowed Buffet to take a big chunk out of Goldman. But there is no doubt that Buffet has a high regard for the firm and its partners have returned the courtesy. Lloyd Blankfein the CEO of Goldman was very enthusiastic to announce the news “we are pleased to announce in view of the seniority of the relationship that binds us that Warren Buffet who is undoubtedly the most admired and most informed investor of the world has decided to make a significant investment in Goldman Sachs.

Calling Buffet’s move “a solid validation of our client franchise and future prospects” Blankfein added that “the investment will sustainably consolidate our strong capitalization and liquidity position.” For his part, Buffet called Goldman “an exceptional institution” adding “it has a franchise unrivaled in the world, a very competent management team, the intellectual and financial capital to continue to obtain excellent results”.
Profitability could decline

The operations of Goldman and Morgan will certainly change as a result of the evolution of the financial markets and the fact that they have opted for commercial banking status, but no one can know to what extent. Analysts say their profitability will decline because of the exit from risky equity trading that has inflated their results all these years. The banks will be watched by a multitude of regulators “including the Federal Reserve, the Treasury Department, the FDIC” to surely prevent their most aggressive and dangerous activities. Other analysts say returns on equity, which averaged 22.1% at Goldman and 19.

They will continue some of their results-boosting business operations that are outside the scope of a conventional bank. Goldman and Morgan have been granted the option to include oil in their commodity trading operations and they will certainly want to make this exemption permanent. Normally commercial banks do not have the right to buy and hold oil or other physical assets. But companies such as Citigroup have obtained this exemption.

There is also no possible doubt that Buffet expects Goldman to continue to have excellent results as in the past so that its encouragement of support continues. In a letter to Berkshire Hathaway shareholders in 2003, the finance mogul hailed banker Trott for helping Berkshire buy out a subsidiary of Wal-Mart. While saying that neither he nor any other Berkshire official did a full review of the deal, but trusted Wal-Mart representatives after just two hours of meetings, Buffet said Trott was very important in the closing of the deal and two other purchases of Berkshire.

Joseph Weber translation J3A

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