When will Goldman ditch Buffett?

It hasn’t even been 12 months since Goldman Sachs took on US$5 billion of pref shares (see prior post “Life imitates art as Buffett invests in Goldman” September 24-09) from Warren Buffet’s Berkshire Hathaway (BRK:NYSE), and I wouldn’t be surprised if Goldman is already thinking of ways to pay back his investment.

Berkshire’s perpetual preferred shares came with a 10% dividend, but Goldman can buy them back at a 10% premium to face value when the day comes that they can issue prefs in the public markets at a cheaper yield. Back in September, Goldman’s 2031 6.75% subdebt was trading at $76, implying a yield of 8.9%, 110 bps below the yield on Berkshire’s prefs.

Today, that 2031 subdebt is trading around $91. Although not yet at par, it suggests a yield of 7.4%…about 150 bps better than last Fall Indicating that Goldman may well be able to issue prefs below 10% pay.

Goldman would have to save enough on their annual interest costs to cover the 10% penalty (US$500 million), and that day may not be today. But if Goldman could issue 25 year prefs with even a 9% yield, the interest savings would be US$1.25 billion, which will have a present value in excess of Buffett’s prepayment penalty. 46 months ago, Goldman was issuing perpetual prefs with a 6.2% interest rate. In light of their current financial performance, you know they’ll be able to get much better than even 9% in the near term, which will likely force their hand to refi Mr. Buffett.

Don’t cry for Mr. Buffett if this does happen, however. His common share purchase warrants are in the money right now, to the tune of US$1.82 billion. A nice 36% FMV bump to his September 2008 investment.

MRM
(disclosure – I own GS shares and GS subdebt)