How Investors Can Get In On Buffett's Goldman Play

It's not often that the average investor can out-Buffett Warren Buffett. But at the moment, there's a rare opportunity to invest on terms that may be even better than Mr. Buffett got.

Rarely is the playing field level, let alone tilted in the average investor's favor. And there are good reasons why a Warren Buffett gets vastly better terms than either you or me. His investments are seen as instant votes of , which are more valuable than ever in the conconfidencetext of the current financial crisis.

It was front-page news less than two months ago, when Mr. Buffett's Berkshire Hathaway made a big injection of capital -- and confidence -- into Goldman Sachs. The investment bank was in what seemed to be a shocking downward spiral after the failure of Lehman Brothers and the rescue of AIG caused investors to question the solvency of every counterparty, even one as well-capitalized as Goldman.

Mr. Buffett agreed to inject $5 billion into Goldman in return for $5 billion in preferred shares paying a 10% dividend and warrants to buy $5 billion of Goldman common shares at $115 apiece. As a longtime Goldman shareholder, I was slightly resentful at the generous terms, especially given that shares were then trading at $125.

Still, the Buffett play seemed to work its usual magic. Goldman shares stabilized and within days rose to $137. Goldman transformed itself into a bank holding company, the Treasury Department force-fed billions in capital to it and the eight other seemingly healthy giant banks in return for more preferred shares, albeit at much lower interest rates than Mr. Buffett's. (It's yet another measure of Mr. Buffett's stature that he could command much better terms than the U.S. Treasury.)

And then, Goldman shares resumed their descent. They not only reached the Buffett strike price of $115, they sank below it. When Treasury Secretary Henry Paulson said last week that the government would no longer buy the banks' troubled assets, Goldman shares fell to near $61.

Goldman bonds were also caught in the downdraft. The result, according to recent trading data compiled by the Financial Industry Regulatory Authority, is that various issues of senior Goldman bonds, highly rated by both Standard & Poor's and Moody's, are now yielding more than 8%. (Bond yields rise as prices -- and thus, demand -- fall.)

Note that these Goldman bonds are senior to both Mr. Buffett's preferred stock and the government's, which means bond interest and principal gets paid before either Mr. Buffett or the Treasury. Even in the unlikely circumstance that Goldman would be facing default, the U.S. would have a strong incentive to inject more capital into Goldman.

So here's the Buffett alternative available to any investor: You can't get the warrants he got, but you can get something quite similar for far less than $5 billion. When I last checked, Goldman call options with a strike price of $105 expiring in January 2010 were trading for about $10 each. (A call is an option to buy a security at a specific price.) That's the equivalent of the right to buy Goldman shares at $115, which is what Mr. Buffett got.

Instead of preferred stock, you can buy Goldman bonds. A week ago, I bought some at a yield close to 10%. When I last checked the Finra Web site, the best I saw was a little over 8%.

True, this strategy only makes sense if you believe in the future of Goldman. The firm may never return to the glory days when shares were $250 (circa Halloween 2007). But it still has the talent and the resources to be the world's pre-eminent investment bank. That should be worth far more than $60 a share, not to mention bonds trading at 80 cents on the dollar.


Source