Thursday, August 25, 2011

Warrants Warrant Warren's Investment

The big news for a while this morning was Steve Jobs' resignation as CEO of Apple. But it wasn't long before Warren Buffett stole the headlines. On Berkshire Hathaway's behalf, Buffett decided to invest $5 billion in Bank of America. Berkshire is buying cumulative preferred stock that pays 6% dividends. But that's not all. The preferred stock also comes with warrants that give Berkshire the right to buy 700 million shares of common stock at $7.14 per share.

Yesterday, before the deal was announced, shares of Bank of America rallied 11% to close at $6.99. Today, after the deal was announced, the stock opened at $8.29. That means the warrants immediately went into the money.

I discuss this kind of deal, known as a PIPE (private investment in public equity), in my book Even Buffett Isn't Perfect. PIPEs are not available to ordinary investors. Buffett used this structure not too long ago to invest in Goldman Sachs and General Electric. So far, at least, those stocks haven't done very well.

It remains to be seen if Bank of America pays off for Berkshire in the long run. But given the exercise price on the warrants, the odds are certainly in Berkshire's favor.