Goldman Sachs Group Inc. won the backing of Warren Buffett, the world's preeminent stock-picker, as the Wall Street firm seeks to raise cash from investors whose faith in the investment-banking business model has been shaken.
For Goldman, Buffett's endorsement came at a price. Berkshire Hathaway Inc., led by the 78-year-old billionaire, is buying $5 billion of perpetual preferred stock with a 10 percent dividend. Berkshire also gets warrants to buy $5 billion of common stock at $115 a share at any time in the next five years. The common stock closed yesterday at $125.05, providing Buffett with an instant paper profit of $437 million.
``It's a hell of a deal for Buffett,'' said Brad Hintz, an analyst at Sanford C. Bernstein & Co. who rates Goldman stock ``market perform.'' ``The key thing for Goldman is making it through the credit cycle, and they're doing the right stuff.''
Goldman Chief Executive Officer Lloyd Blankfein is turning to Buffett, the second-richest American after Microsoft Corp. founder Bill Gates, to boost market confidence even though the investment bank hasn't reported a quarterly loss since it went public in 1999. The bankruptcy of Lehman Brothers Holdings Inc. and emergency sale of Merrill Lynch & Co. to Bank of America Corp. on Sept. 15 have fueled fears about firms that rely on bond markets for funding.
In addition to raising money from Buffett, Goldman said it plans to sell at least $2.5 billion of common stock to the public. It will be the firm's first common stock offering since 2000. No details of the planned offering were disclosed in a statement released by the New York-based company yesterday.
Lehman's Lesson
Sumitomo Mitsui Financial Group Inc., Japan's second-largest bank, will invest several hundred billion yen in Goldman, Kyodo news reported, without saying where it obtained the information. Chika Togawa, a spokeswoman for the Tokyo-based bank, said it hadn't decided to do so. Goldman spokeswoman Hiroko Matsumoto declined to comment.
Goldman surged in trading after the close of the New York Stock Exchange, following the announcement of the agreement with Buffett. The shares, which closed at $125.05 in composite trading, jumped as high as $138.88, an 11 percent increase, at 5:50 p.m. in New York.
``At this point you're better safe than sorry, I think that's the moral of Lehman,'' said David Hendler, an analyst at CreditSights Inc. in New York. ``Everything's different because of the extraordinarily weak market conditions, as vividly described by our Treasury Secretary and Fed Chairman'' in congressional testimony yesterday, Hendler said.
Fickle Funding
Federal Reserve Chairman Ben S. Bernanke joined Treasury Secretary Henry Paulson in urging skeptical lawmakers yesterday to quickly pass a $700 billion rescue for financial institutions, saying the U.S. economy will shrink if markets don't begin functioning normally.
Wall Street's biggest firms lost investors' confidence this year as writedowns and losses on mortgage assets and other high- risk, high-yield loans swelled, wiping out profits and eroding shareholder equity at companies including Merrill and Lehman, both based in New York.
Bear Stearns Cos., the smallest of the five biggest U.S. securities firms, was forced into a government-assisted fire sale to JPMorgan Chase & Co. in March after losing access to short- term funds in the markets. JPMorgan, the third-largest U.S. bank by assets, is based in New York.
Lehman's collapse and Merrill's sudden sale this month reignited concern that Wall Street's depreciating assets and reliance on fickle bond-market funding mean the industry's ability to generate profit has diminished.
The Oracle
The decision to seek a cash infusion marks a reversal for Goldman, which this week transformed itself from the biggest U.S. securities firm to the nation's fourth-largest bank holding company. Less than a year ago, Goldman was posting record profits and awarding record bonuses: Blankfein and his two top deputies reaped payouts totaling more than $67 million apiece in 2007.
The company, while suffering from a decline in trading and investment banking revenue, has booked $4.9 billion of losses on devalued assets, a fraction of the writedowns taken by rivals such as Citigroup Inc., Merrill and Morgan Stanley.
``The investment will further bolster our strong capitalization and liquidity position,'' Blankfein, 54, said in the statement. Berkshire's commitment ``is a strong validation of our client franchise and future prospects,'' he said.
Known as the ``Oracle of Omaha,'' Buffett has become a cult figure among investors, drawing 31,000 people to an Omaha arena for his annual shareholders meeting this year.
`Affirmation'
Mutual funds and individuals mimic his stock picks in an effort to duplicate his success, and an academic study in 2007 found that using this strategy for 31 years would have delivered annualized returns of about 25 percent, double the return of the S&P 500.
Buffett transformed Berkshire over four decades from a failing textile manufacturer into a $200 billion holding company by buying out-of-favor stocks and companies whose business and management he deemed superior. In the process, he became the second-richest man in the U.S., according to Forbes magazine.
Buffett is ``getting very attractive terms, but Goldman is getting very attractive affirmation of their value from an investor with Warren's stature,'' said Tom Russo, a partner at Gardner Russo & Gardner in Lancaster, Pennsylvania, which manages more than $3 billion, including Berkshire shares.
The last time one of the biggest U.S. securities firms received an investment from Buffett was in 1987, when New York- based Salomon Inc. turned to him for a $700 million infusion to fend off an unwanted takeover.
Bank Conversion
The Goldman warrants Buffett is buying may themselves be worth $1.8 billion, according to Scott Roth, management partner at Severn River Capital Management, a $200 million hedge fund based in Greenwich, Connecticut. He said he calculated that Buffett is buying the preferred stock for about $3.2 billion, after accounting for the shares he's getting through warrants.
In contrast, Morgan Stanley agreed on Sept. 22 to sell as much as 20 percent of itself for about $8.4 billion to Mitsubishi UFJ Financial Group Inc., Japan's largest bank.
Both Goldman and Morgan Stanley said this week that they are converting to bank holding companies supervised by the Federal Reserve, a move that allows them permanent access to borrowing from the Fed and permits more flexible accounting for some assets.
``It's a good move for Goldman, but at a very expensive price,'' said Roth, referring to Buffett's investment. Roth said he's betting on an increase in shares of Goldman, where he worked more than a decade ago. Buffett's getting ``more value than when he bought Salomon.''
`Intellectual Capital'
Berkshire's preferred stock in Goldman can be repurchased by the investment bank at any time at a 10 percent premium, according to the terms of the agreement. The stock's 10 percent dividend offers a lower yield than securities issued by Merrill Lynch in April and by Citigroup Inc. in May, Bloomberg data show.
``Goldman Sachs is an exceptional institution,'' said Buffett in the statement. ``It has an unrivaled global franchise, a proven and deep management team and the intellectual and financial capital to continue its track record of outperformance.''
Buffett and Goldman have long-standing ties. Buffett has a close relationship with Byron Trott, a Goldman banker based in Chicago, and has singled him out for praise in his annual reports to shareholders.
Goldman's stock has dropped 42 percent since the start of 2008 and 19 percent since the beginning of last week. The cost of credit default swaps used to insure against a default in the firm's debt jumped 0.9 percentage points to 3.8 percentage points yesterday before the Buffett announcement, according to broker Phoenix Partners Group in New York.
Leverage Ratio
At that price, it cost $380,000 a year to protect $10 million of Goldman debt for five years. Last week the price reached a record $685,000.
One concern for investors has been the firm's leverage, or the amount of assets held with every dollar of shareholder equity. Goldman owned $23.70 of assets for every dollar of shareholder equity at the end of August, making the firm dependent on raising debt in the markets to help finance its $1.08 trillion balance sheet.
With an additional $7.5 billion of equity, the leverage ratio will drop to 20.3 times. That's more consistent with the level regulators will likely allow for commercial banks, which are overseen by the Fed, Bernstein's Hintz said.
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