Euphoria Over Buffett's $5 Billion BofA Investment Subsides

The euphoria that greeted Warren Buffett’s $5 billion investment in Bank of America Thursday has subsided as this day has worn on, but the boost in confidence brought on by having the world’s best known investor step into the weakest of the U.S. big banks is still being felt, if only modestly.

Warren Buffett
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Warren Buffett

With its shares up roughly 9 percent as of this writing, Bank of America is well off the highs of the day (much of the early move was likely short covering).

Mr. Buffett, however, is still getting a nice deal, receiving what is essentially a 6 percent convertible with the right to convert up 2 percent (his strike price on the 700 million warrants is $7.14 and the stock was $7).

Perhaps not quite as good a deal for BofA, which was probably happy to take the money in hopes it will put an end to concerns about any lurking capital hole.

Nonetheless, its debt spreads, which shrank considerably with the announcement, have given a lot of that move back.

No one but Mr. Buffett could avail himself of the terms he has received from BofA. And it’s important for investors to realize that simply following Mr. Buffett into the shares at this price may not produce the desired result. In the two previous instances when Mr. Buffett’s pedigree was sought to bring calm to otherwise volatile financial situations, his stock picking acumen (so far) has proved lacking.

While his $5 billion investment in Goldman Sachs (now having been redeemed) made Berkshire Hathaway nice returns given its 10 percent coupon, Berkshire’s warrants, which were struck at a negative premium to the stock price at the time of the deal, are currently out of the money (the strike price is $115).

A week later in October of 2008, Buffett followed his Goldman deal with a $3 billion investment in General Electric that has also been paying him 10 percent a year (it has not yet been redeemed).

But in that case, his warrants are still far out of the money given a strike price of $22.25. In both cases, Buffett has roughly two years to go before the warrants expire.

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