You’ve got to hand it to Warren Buffett: his sense of timing is perfect — no, better than perfect. On Wednesday he writes a thank-you note to Uncle Sam, and the very next day the White House announces that he’s to be awarded a Presidential Medal of Freedom.
Actually, it wasn’t the medal for which he was thankful. He was thanking the government (and Ben Bernanke, Hank Paulson, Tim Geithner and Sheila Bair) for bailing out Wall Street.
And well he should. TARP has been a veritable gold mine for Buffett. And his sense of timing was perfect there, too.
Consider: in September 2008, Buffett’s Berkshire Hathaway Inc. invests $5 billion in Goldman Sachs Group, Inc., receiving in exchange 10-percent preferred stock plus warrants to buy up to 43.5 million shares of common stock for $115 per share. Just weeks later Congress passes TARP and Goldman Sachs, having recently transformed itself into a bank holding company, qualifies for the bailout and receives $10 billion in TARP funds.
Buffett’s investment is earning Berkshire about $500 million per year in dividends. Not bad. Not bad at all, considering that the dividend yield on the common shares of bank holding companies is currently hovering somewhere south of one percent. “We love the investment!” Buffett exclaimed to Berkshire investors at the holding company’s annual meeting in May.
Goldman wants to get out from under this onerous dividend obligation. Under its agreement with Berkshire, Goldman can redeem the preferred shares at any time for $5.5 billion, and they’ve been trying for the last month. There’s only one problem: as a recipient of TARP funds, Goldman needs the approval of the Federal Reserve, and the Fed is taking its sweet time giving it.
TARP has turned out to be a great deal for Buffett and Berkshire. Even if Goldman gets its wish and redeems Berkshire’s preferred shares today, Buffett — assuming he exercises his warrants at the same time — will walk away with a $3.8 billion profit. That’s a 34 percent annualized return.
You can’t get that kind of return on investments that are open to us ordinary mortals. Buffett gets away with a lot of things that would bring down condemnation on almost anybody else. And it’s not just because of who he knows; it’s also because of who he is — a liberal.
Actually, Goldman Sachs stockholders should count their blessings. They got off easy, proportionally speaking, compared to the shareholders of Constellation Energy Group.
In September 2008, in the aftermath of the Lehman Brothers collapse, the Baltimore-based utility-company-cum-energy-trader found itself in desperate need of cash after its credit lines had dried up. Faced with a plunging stock price, an impending downgrade of its credit rating and possible bankruptcy, CEG sought a savior, and seemingly found one in Warren Buffett.
Buffett’s Berkshire subsidiary, Iowa-based MidAmerican Energy Holdings, agreed to invest $1 billion immediately in exchange for 8-percent preferred stock and an agreement to sell the company to MidAmerican for $26.50 per share.
Much of Maryland’s liberal establishment was almost ecstatic about the deal. A Baltimore Sun reporter was sent to Iowa and came back to report on what a noble corporate citizen MidAmerican Energy is. Liberal politicians hailed Buffett’s philanthropy (although they didn’t mention that most of it went to promoting abortion and other left-wing causes).
Almost lost amidst all the hosannas being sung to the savior from Omaha was the fact that there was another offer on the table that would pay Constellation stockholders $35 per share — $8.50 more than Buffett was willing to pay. The latter offer had been submitted by Électricité de France (EDF), which already owned 9.9 percent of Constellation’s common stock, in partnership with the private equity firm Kohlberg Kravis Roberts (KKR). Although the EDF offer was clearly better for the shareholders, the CEG board voted to accept the Buffett deal.
Now Buffett is famous for buying undervalued companies. He learned that from his mentor Benjamin Graham. But this was no ordinary case of an investor buying a stock because its market price has temporarily dipped below the discounted present value of its projected dividend stream. Buffett was getting CEG for a price he had negotiated with a self-interested management and board of directors.
Why did Constellation’s management and board think that Buffett’s offer was, to quote CEO Mayo A. Shattuck III, “the most superior offer”? Shattuck explained that the Buffett deal “provided us certain degrees of certainty around a number of issues or high degrees of probability around other important issues, such as regulatory approval”.
In other words, the regulatory skids would be greased for a Buffett-controlled energy company, while a company controlled by EDF and KKR would encounter numerous roadblocks. You don’t suppose this was because Buffett is a heavy contributor to the Democratic Party and liberal causes while Henry Kravis — the second “K” in KKR — is a Republican fundraiser, do you?
This was not yet a done deal. It had to be approved by Constellation’s shareholders (full disclosure: I am one of them), and they were not at all happy about this. A special stockholders meeting to vote on the deal was to be held a few days before Christmas. Every CEG stockholder I know was planning to vote against the deal.
As it happened, the meeting was never held. Just a few days before it was to take place, EDF came back with a new offer to buy half of Constellation’s nuclear power business for just a little less than Buffett was going to pay for the entire company. Suddenly, Buffett’s deal didn’t look like the “most superior” anymore. I’m sure that part of the attractiveness of the new EDF offer is that it gave CEG’s management and board an excuse to cancel the special stockholders meeting and thus avoid a no-confidence vote.
So, Buffett didn’t get Constellation Energy Group. But he still did very well, indeed. His breakup fee was $593 million in cash plus 10 percent of the company — over a billion dollars — and CEG would have to pay back the original $1 billion injection at 14 percent interest. In effect, Buffett received an annualized rate of return of over 300 percent on his $1 billion investment.
Now Buffett apologists are going to try to remind me that he can make this kind of money because he has cash, and in a liquidity crisis cash is king. These same folks will also tell you that another of Buffett’s virtues is that he doesn’t use leverage in his acquisitions.
That depends on how you define “leverage”. True, Buffett doesn’t go to the bank to ask for a loan so he can go out and buy a company. That’s because he doesn’t have to. He has his own source of cash — GEICO. That cute little green gecko raises all the cash Buffett needs.
Insurance companies have to set aside a portion of their premium revenue as reserves for paying claims. However, the money isn’t paid out all at once. This gives rise to “float”, and Buffett makes good use of it. I have no problem with this — as far as I know, GEICO has never been in a position where it couldn’t pay its claims.
My question is why the media give Buffett a pass. Somehow, I don’t believe that the practice of using liabilities to policyholders as a source of cash for acquiring companies would escape media scrutiny if the perpetrator were, say, the evil reactionary Charles Koch rather than the noble liberal Warren Buffett.
Morally, what Buffett is doing is not so different from a banker using depositors’ money to finance his own real estate deals. A savings-and-loan operator here in Maryland went to prison for that.
But Warren Buffett is Warren Buffett. He’s a big contributor to the campaigns of Barack Obama and other Democrats; he favors keeping the estate tax and advocates higher income taxes on the “rich”; and his foundations fund abortion and population control programs at home and abroad. What’s there for a liberal not to like? And, being a darling of the liberal elites, he can do things that would draw a lot of negative media attention if others did them.