The Real Cost to BofA
2:48 p.m. EDT
"If I knew for a certainty that a man was coming to my house with the conscious design of doing me good, I should run for my life, as from that dry and parching wind of African deserts called the simoom, which fills the mouth and nose and ears and eyes with dust till you are suffocated, for fear that I should get some of his good done to me -- some of its virus mingled with my blood. No -- in this case I would rather suffer evil the natural way. A man is not a good man to me because he will feed me if I should be starving, or warm me if I should be freezing, or pull me out of a ditch if I should ever fall into one. I can find you a Newfoundland dog that will do as much."
-- Henry David Thoreau
If Bank of America (BAC) can borrow at close to zero percent, many are justifiably now questioning why the company agreed to pay a 6% dividend on the $5 billion preferred issued to Berkshire Hathaway (BRK.B).
In reality the cost of capital on the $5 billion Berkshire investment is well in excess of the 6% annual dividend. As was the case in similar deals with Goldman Sachs (GS) and General Electric (GE) several years ago, Berkshire receives a large warrant. (In today's transaction, Berkshire gets the right to buy 700 million shares of BAC at an exercise price of $7.14 a share over a 10-year period).
This was my point in an earlier post on the transaction today.
By my calculation, Berkshire Hathaway is receiving an annual rate of interest on its $5 billion investment of about 10.5%, when incorporating the value of the attached call options on top of the 6% annual dividend on the preferred and the redemption premium of 5%.
Assuming BAC's share price is at $7.72/share and a 45 vol, a 10-year option on 700 million shares of BAC that mature on Sept. 1, 2021, that are exercisable at $7.14/share is valued at about $3.40/share (times 700 million shares), or about $2.4 billion! Add another $250 million of redemption premium -- that makes $2.650 billion in value (or immediate profits today!) incurring to Berkshire.
In other words, the current value of the warrants -- taken over the 10-year period -- provides an additional 4.5%-per-year return on top of the 6% dividend on the preferred, for a total cost of capital per year to Bank of America of nearly 10.5%. (Taken another way, deducting from the exercise price of $7.14/share the value of the call option ($3.40/share) means that Berkshire Hathaway may be paying, if exercised, less than $4/share for BAC!)
If Bank of America didn't need the extra capital (as CEO Brian Moynihan reportedly told Warren Buffett), was the imprimatur of Berkshire Hathaway really that valuable?
From my perch, Moynihan got fleeced by Buffett, the savviest of wolves who slipped out of his bathtub wearing sheep's clothing.
Say it ain't so, Brian Moynihan!
You have a lot of 'splaining to do.
Copyright © 2012 ::: Seabreeze Partners :::: All Rights Reserved. Legal Disclaimer
