In addition to warrants, Berkshire is also investing $8 billion in preferred equity yielding a juicy 9% annually. This is a spectacular yield, especially in times of ultra-low interest rates and for a company like Berkshire, which gets financing at exceptionally low costs. Heinz has generated between $800 million and $1 billion in free cash flow per year in recent years, and the preferred dividends should amount to something like $720 million – 9% of $8 billion – so Buffett is getting a big chunk of the annual cash flows generated by Heinz with the preferred shares.
Berkshire made several deals of this kind, involving preferred stock and warrants, during the credit crisis. Buffett negotiated a deal with Goldman Sachs Group, Inc. (NYSE:GS) in September of 2008 to invest $5 billion in preferred stock yielding 10% and warrants for 43.5 million shares at $115 per unit. The agreement was renegotiated this year, and Berkshire will become a major shareholder in Goldman Sachs under the new terms of the deal.
Under the new agreement, Goldman will deliver to Berkshire a number of shares that is equivalent to the difference between the average closing price over the 10 trading days prior Oct. 1 and the exercise price of $115 for the warrants. If the stock remains in the area of $150/$160, where it has been trading over the last weeks, for example, that means that Berkshire is getting a sizable position of between 10 million and 12 million shares of Goldman Sachs without putting any money down.
As things turned out, Buffett reduced the risk of his position in Goldman Sachs during the crisis while securing a juicy yield with the preferred stock, and the warrants provided a lot of upside potential to the transaction. When it comes to the risk and return tradeoff, the financing of this deal makes it very different than a simple purchase of Goldman Sachs common stock in 2008.
Other big deals like General Electric Company (NYSE:GE) and Bank of America Corp (NYSE:BAC) during the crisis were done under similar conditions, a combination of preferred shares and warrants to control the risks and maintain upside potential. These are smart moves, without question, but it’s not as extraordinary as making 50% annually by investing in smaller companies.
More importantly, it sounds like something that can be done by Buffett´s successors once he is not there to make investment decisions at Berkshire anymore.
Bottom line
Buffett is not investing in deeply undervalued hidden gems any more; he is using Berkshire´s access to cheap financing to invest in low-risk situations under convenient financing terms. Being Warren Buffett probably helps when it comes to getting these deals done, but there is no reason to believe his successors won´t be able to structure similar arrangements after he is no longer running the company.
Every person is unique, and Warren Buffett is truly out of this world. But when it comes to investing in Berkshire, investors should keep in mind that the Warren Buffett of 2013 is much easier to replace than the Warren Buffett of 1950, at least when it comes to his critical function of making investment management decisions at the company.
The article Warren Buffett Is Not Irreplaceable for Berkshire originally appeared on Fool.com and is written by Howard Cranford.
Andrés is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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