Buffett Buys A Piece of Goldman

It's a good time to be teaching Corporate Finance. Buffett's latest move (making a substantial investment in Goldman Sachs) is bound to make it into a lot of class discussions. The Wall Street Journal's take (at least, as expressed by Georgetown finance professor James Angel) is

Berkshire's plan "is a sign of confidence from one of the nation's most respected investors," said James Angel, a finance professor at Georgetown University, who added that "sharp investors" now are "sniffing around the wreckage of the credit crunch to pick up good assets on the cheap."

I think the second part of the statement is closer to the truth than the first. Here's what the Sage of Omaha gets for his money

The deal is structured in two parts, giving Berkshire a stream of cash and potential ownership of roughly 10% of Goldman. Berkshire will spend $5 billion on "perpetual" preferred shares of Goldman. These are not convertible into equity but pay a fat 10% dividend.

Berkshire also will get warrants granting it the right to buy $5 billion of Goldman common stock at $115 a share, which is 8% below the 4 p.m. closing share price Tuesday of $125.05. At Goldman's roughly $50 billion market value, based on that closing price, exercising those warrants would give Berkshire about a 10% stake in Goldman.

So, while the preferred isn't convertible, he gets what is essentially "synthetic convertible preferred". In essence, he gets his preferred payouts if the stock price doesn't rise, and the option to buy stock at a discount if the price is above $115. So, in effect he has a combination of preferred stock and an in-the-money call option. Barry Ritholtz prices the warrants at approximately $1.5 Billion, giving Buffett an effective yield of 14%, and cites another source who estimates their worth at $3.5B, and a yield of 17%.

Once again, Buffett has been able to make an investment at a very attractive price. In times where there's a lot of turmoil, having cash on hand makes it easy to buy companies (or parts of them) at a bargain, and according to Berkshire's first quarter, they had $31 Billion on hand. So, Buffett had cash at a time when Goldman desperately needed it. As a result, he got a great deal.

Just Damn. That guy is smart.

What Non-Finance Courses Should Finance Majors Take?

Since school just started here at Unknown University, that means undergraduates with questions about majors, classes, internships, and so on. This is the first time I advise students her at my current school (I got a pass for the first year). Our program is such that they don't have a lot of options for the finance part of their curriculum, but I get a lot of questions about what other classes (besides finance) to take. So, I though y'all might also benefit from my take on things (or at least get a good laugh):

• Financial Accounting: The typical undergraduate finance major takes one or two introductory level accounting classes. Then, when they get their first entry-level job, they often find themselves doing tasks that use a lot of financial statement information. Accounting can be hard and (to many finance majors) a bit dry, but taking more accounting classes definitely sets you apart from other new graduates. Back a few years, I used to place a number of students with the credit analysis unit of Bank of America. They didn't even look at most students unless they had three or (preferably) four accounting classes. There's not that much advantage to taking Tax or Auditing for a finance major, but there is to taking Financial - I'd recommend at least Intermediate Accounting I (and if you can manage it, Intermediate II).
  
• Macro Economics - Although the undergraduate business curriculum typically requires an introductory class in macro, most students come out of it with only the barest hint of what's going on. A second class in this area will help you to get a much better understanding of the larger economic forces that effect equity (and to an even greater extent, fixed income) markets.
• Money and Banking (from the Econ department)- Similar to the above, it's also good to see the money and banking material twice. Although you often get a money and banking class in the finance department, it's good to see the same topic taught from a different perspective.
  
• Statistics and Econometrics - The undergrad finance curriculum usually has an introductory statistics class. Almost everyone can benefit from more exposure to this material. But most importantly, make sure the class is "hands on". There's no substitute for analyzing real data.
  
• More math - You might not use linear algebra or higher-level calculus, but taking extra math (and getting getting good grades in those classes) serves as a pretty good signal that you're either smart or hard working (or both). Today's finance world is math and stat -driven. So, the more you take of these topics, the better.
• A programming class - like math, programming is also hard. Having a little more background in a commonly used language always helps.
  

Of course, this is only my opinion, and a lot of it has been shaped by what I hear from employers (or see on the CFA exam). If you have other thoughts, I'd love to hear them.

Warren Buffet's Annual Letter

Berkshire Hathaway has just come out with their 2004 annual report. Warren Buffett's letter to shareholders is always worth reading, both for what he says and for the clarity and style with which he says it. A couple of sections deserve particular note:

Over the 35 years, American business has delivered terrific results. It should therefore have been easy for investors to earn juicy returns: All they had to do was piggyback Corporate America in a diversified, low-expense way. An index fund that they never touched would have done the job. Instead many investors have had experiences ranging from mediocre to disastrous.

There have been three primary causes: first, high costs, usually because investors traded excessively or spent far too much on investment management; second, portfolio decisions based on tips and fads rather than on thoughtful, quantified evaluation of businesses; and third, a start-and-stop approach to the market marked by untimely entries (after an advance has been long underway) and exits (after periods of stagnation or decline). Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.

He also mentions that BH has a big stockpile of cash ($43 Billion), and that they resisted the temptation to spend it (negative-NPV projects, anyone?):

I didn’t do that job very well last year. My hope was to make several multi-billion dollar acquisitions that would add new and significant streams of earnings to the many we already have. But I struck out. Additionally, I found very few attractive securities to buy. Berkshire therefore ended the year with $43 billion of cash equivalents, not a happy position. Charlie and I will work to translate some of this hoard into more interesting assets during 2005, though we can’t promise success.

This provides a good setting for discussing the agency problems related to free cash flow, managers' incentives to build empires, and so on (like I've said before, I'm an agency/governance kind of guy - unlike Haley Joel Osment, I see agency problems everywhere).

Click here for the whole letter.

On day 1 in my advanced corporate course, we go over a case based on a takeover executed done by Berkshire Hathaway. As a part of it, we go through Buffett's investment philosophy and compare/contrast it to commonly held finance theory. In his various writings, Buffett repeatedly mentions "intrinsic value".

It's also pretty instructive for students to read Berkshire's "Owners' Manual (starting on page 73 of the 2004 annaul report).