Thursday, August 25, 2011

Buffett Illustrates Private Deals Can Be Sweeter

Berkshire Hathaway just invested $5,000,000,000 (yes, the zero count is correct) in an investment vehicle that didn't exist last week: 50,000 shares of 6% preferred Bank of America shares with a 6% par value, coupled with a sweetener – warrants totaling some 700,000,000 shares of common stock, exercisable over the next decade at about $7.14. On the news, shares spiked to $8.15, but expect that number to change over the decade.

Given that Bank of America is making me a car loan at less than 4% and a home loan at something close to 5% (I never applied to BoA for a loan, but it bought both notes), I consider Berkshire's 6% coup – coupled, as it is, with a hefty equity upside opportunity – to be pretty slick. Not too long ago, Berkshire Hathaway made a similar deal with Goldman Sachs and General Electric, but with 10% preferred. Capital was tighter in late 2008, so Warren Buffet had more leverage.

Under FAS 157, Berkshire Hathaway must value its warrants using a methodology that will take into account the fact that the warrants are at least hundreds of millions in the money, and that it's got as much as a decade of time premium. It'll also be getting a quarterly dividend at a rate that's fairly respectable. At some point, when it makes sense to exercise the warrants at $7.14, it'll also get whatever the prevailing dividend is on the common shares – but will have a rate of return based on its strike price, not the market price.

Deals like this aren't available directly to small investors. To get involved in a custom-negotiated investment with a counterparty with carefully-examined risks, and a deliberately-engineered upside opportunity, one invests in a firm that makes private deals.

That was my original investment thesis in American Capital: it was (my theory went) Berkshire Hathaway diversification with small-company investment performance. Presently, American Capital is making few new investments, despite the economic climate and its current cash hoard, but instead is paying down a secured debt that it undertook restructuring pre-'08 deals that required it maintain net asset levels that the post-crash value of its illiquid assets didn't make possible. American Capital may be full of these sweet deals, but it's hard to tell because we don't see much deal stream right now. Berkshire Hathaway is clearly making deals, but it's not making them at a high rate and it can't meaningfully invest in anything that isn't enormous.

Anyone else have a line on interesting vehicles for participating in privately-negotiated deals?

UPDATE: ACAS just announced a $50m senior subordinated investment to finance the merger of two opinion survey companies, one of which had previously borrowed from American Capital in 2006. Apparently, the debt pay-down is at levels – or the deals are now at levels – at which it is willing to deploy capital to new investments.

No comments: