The Buffett Way--The Goldman Cash Infusion

Warren Buffett finally entered the fray with his first investment in the financial sector. Many people are asking has Warren Buffet now become bullish on the financial sector as he has become an investor in Goldman Sachs? The simple answer is definitely not.

I am sure Mr. Buffett see value in some parts of the financial sector which may include distressed mortages, distressed loans, banks and insurance companies. However, he is not calling a bottom on the financial sector. Mr Buffett analyzes companies and tries to invest in world class organizations when he see long-term value created at cheap prices. That is what he sees in Goldman Sachs.

Goldman is and has been the premier investment bank that has come under some financial distress as the "market" has decided the investment banking business model is not effective in today's capital market environment. Today's montra is less leverage and stable sources of funding. Investment banks have historically been operated with high levels of leverage and short-term funding sources. This past weekend Goldman and Morgan Stanley recreated themselves and became bank holding companies. In Goldman's case they are the fourth largest bank in the United States.

As part of its transformation, Goldman probably wanted to calm the market attitude towards itself in two ways. First, they needed some added credibility and second, they chose to raise additional capital to reduce the leverage. There was only one quick way to do that quickly and it is called Warren Buffett. Goldman offered Berkshire Hathaway what appears to be a sweetheart deal in the form of a $5 billion preferred stock investment with a 10% coupon and a 10% premium call price forever. In addition, Berkshire was offered a 5-year warrant that gives it an option to buy $5 billion of Goldman common stock at a price of 115. As Goldman's price soared, they issued another $5 billion of common stock to other institutional and retail clients at a price of $123 so everyone could participate with Mr. Buffet, albeit not with the same cheap terms.

Goldman accomplished its goals and locked in the security of its future. Warren Buffett accomplished his objectives of investing in a world class global company with great management and he received terrific terms for his participation. This is not a fundamental statement about the financial services industry from what may be considered the greatest investor of all time.