The Goldman Sachs Group Inc. (GS) announced on Friday its decision to redeem preferred shares worth $5 billion, constituting the investment made by Warren Buffett in 2008.
During the 2008 financial crisis, Warren Buffett’s company Berkshire Hathaway Inc. (BRK.A) invested $5 billion in Goldman. Buffett’s investment followed the collapse of Lehman Brothers and the government’s bailout of American International Group Inc. (AIG) during the crisis.
According to the deal, Goldman was paying 10% interest on preferred shares annually, representing an annual expense of $500 million. Goldman will pay $5.65 billion to buy back preferred shares sold to Berkshire. The purchase amount includes 10% premium on investment, $125 million first quarter dividend and $24 million in accelerated dividends.
Though redemption will take place, Berkshire will continue to hold warrants to buy 43.5 million common shares of Goldman at $115 per share before 2013.
Due to the inclusion of one-time preferred dividend, the repurchase will inch down Goldman’s first quarter 2011 earnings by $2.80 per share. Like other major banks, Goldman also passed the Federal Reserve’s stress test last Friday.
Goldman was one of the 19 banks that were subjected to “stress tests” conducted by the Federal Reserve. Due to the recession, the Fed had put restrictions on increasing banks’ dividends and share buybacks in exchange of the bailout money.
Following the repayment of the bailout money, many banks started pressuring the regulators to let them restore their dividends. Finally, in January, all 19 banks had submitted their capital plans to the Fed.
This long expected decision was a major milestone for the banking sector, signalling that the notified banks have fully come out of the effects of the financial crisis. This paved the way for these banks to reinstate dividends and buyback shares.
Like Goldman, Buffett also invested $3 billion in General Electric Co. (GE) preferred stock in 2008. After Goldman’s redemption, if same action is followed by GE, Berkshire’s earning power will inch down further as it will be deprived off the special high dividends.
While the redemption comes at a high price for Goldman, it reduces the expenses and indicates Goldman’s financial strength in the market.
Fundamentally, we expect Goldman to benefit from its well managed global franchise, strong capital base and industry leading position in trading and asset management. Goldman’s prudent business model and strong fundamentals are expected to deliver better earnings in the upcoming quarters.
Goldman currently retains its Zacks #3 Rank, which translates into a short-term Hold rating. Also, considering the fundamentals, we maintain a long-term Neutral recommendation on the stock.
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