Warrants - The Fed and the U.S. Government
Warrants have been frequently mentioned in the main stream news the last couple of weeks. Most recently warrants were being mentioned as a component in the failed $700 billion bailout plan. It is unlikely that most investors even know what warrants are, much less understand the financial implications and the benefits associated with warrants. So give us a few minutes and let us bring you up to speed.
Warrants are not new to government bailouts as there is precedent for the government receiving warrants which previously worked out great for U.S. taxpayers. The current question is what is going on with the mention of warrants in connection with AIG and separately with Warren Buffett?
Some readers may remember back in 1980 when Chrysler Corporation received government backed loans in the amount of $1.2 billion. Warrants were issued by Chrysler as a sweetener for the loan guarantees and the warrants entitled the government to buy 14.4 million shares of Chrysler at $13.00 per share. With Chrysler shares then selling at $5.50, few believed the warrants would ever be exercised.
As business improved at Chrysler in the next couple of years, the common shares were trading close to $30 per share and the warrants were worth a fortune. Eventually, the government received approximately $311 million and the loan guarantees were repaid 7 years early.
Simply put from the above example and use of warrants, readers can understand that warrants give investors the right, but not the obligation, to purchase the underlying common shares (Chrysler) at a specific price ($13.00) and expiring on a specific date in the future (June 15, 1985).
Fast forward to today's news. On September 17th we heard, according to a news release from ABC News titled, "AIG and the Government's New Line in the Sand," that the government would receive warrants in connection with the $85 billion bailout/rescue of AIG. The warrants in effect would give the government and taxpayers an 80% interest in AIG.
Then on September 20th, Bloomberg News, in an article entitled, "AIG Filing on Takeover Omits Reference to Shareholder Meeting", reported that, "AIG made no mention of issuing warrants or seeking shareholder approval as part of the deal."
What in the heck is going on? We didn't hear a word about this for several days. During the first day of the announcement of the $85 billion deal, all the financial TV reports mentioned that warrants were to be issued to the government. Then no one mentioned anything for days about the warrants. We congratulate the reporters at Bloomberg for bringing this to our attention.
On September 24th Associated Press reported in a, "AIG takes $85B deal from Fed" article, in part:
"The agreement provides a two-year, $85 billion emergency loan at an interest rate of about 11.5 percent to AIG, which teetered on the edge of failure because of stresses caused by the collapse of the subprime mortgage market and the credit crunch that ensued.
In return, the government will get a 79.9 percent stake in AIG.
The agreement leaves "AIG essentially nationalized," Bijan Moazami, an analyst at Friedman, Billings, Ramsey, wrote in a note to investors on Wednesday. "Shareholder efforts to prevent the government from taking an equity stake in AIG will prove fruitless."
Some of AIG's shareholders had wanted to help the company raise enough money to avoid taking the loan and ceding a majority stake in the company.
It wasn't immediately clear whether AIG's signing of the agreement ended any of those efforts."
Taxpayers should be outraged. Full details of the 'plan' never seem to be available. Did taxpayers receive warrants or not? It seems there are still back-room negotiations taking place, no doubt to the detriment of the U.S. taxpayers. If warrants are being considered the taxpayers should be notified of the details and terms of these warrants. I am suspicious that taxpayers once again will be receiving the shaft.
On September 23rd, Warren Buffett came to the rescue of Goldman Sachs by purchasing $5 billion in preferred shares with warrants. Berkshire Hathaway Invests $5 Billion, Receives Warrants for Further $5 Billion. "...GS announced today that it has reached an agreement to sell $5 billion of perpetual preferred stock to Berkshire Hathaway, Inc. in a private offering. The preferred stock has a dividend of 10 percent and is callable at any time at a 10 percent premium. In conjunction with this offering, Berkshire Hathaway will also receive warrants to purchase $5 billion of common stock with a strike price of $115 per share, which are exercisable at any time for a five year term..."
The purchase of the preferred shares appears to be a price of $123 while the exercise price of the warrants was set at $115, only $1 above the lowest price in two years on Sept 23rd. Incredibly, Buffett/Hathaway had a built in profit on the warrants from day 1 with the shares closing on Sept 23rd at $125. It is extremely rare in my experiences to find the exercise price of warrants to be lower than the sales price of the shares. In many cases, the exercise price will be 50% to 100% above the share price. We can only assume that the bargaining of Buffett/Hathaway was such that they were able to 'negotiate' one heck of a good deal for themselves.
From the website of Goldman Sachs,
"New York, September 24, 2008 -- The Goldman Sachs Group, Inc. (NYSE: GS) announced today that it has priced a public offering of 40.65 million common shares at $123 per share for total gross proceeds of approximately $5 billion. In addition, Goldman, Sachs & Co. has an over-allotment option of 6.10 million common shares.
This offering, combined with the recently announced $5 billion strategic investment by Berkshire Hathaway Inc. in the form of perpetual preferred stock, brings total capital raised to $10 billion. In addition, Berkshire Hathaway Inc. will receive warrants to purchase $5 billion of common stock with a strike price of $115 per share, which are exercisable at any time for a five year term."
Did you read what I just read? Goldman sold 40.65 million common shares to the public at $123.
Goldman sold $5 billion preferred shares (at the same price) to Buffett/Hathaway with warrants and paying 10% interest per year. Buffett's $5 billion bought much more than the public's $5 billion. Seems the public shareholders got the shaft on this one also.
Why didn't the shareholders get warrants attached to their common shares?
And you probably missed the news over the weekend that Congress passed the $25 billion loan assistance to the Big Three Auto Company's. Why didn't the government try to get warrants as part of this assistance? Is no one is looking out for the taxpayers? Again, we all know the answer to that question.
There are lots of missing pieces of information and again, we know who will get the short end of the stick. Think about it? Paulson and Bernanke are not negotiating on behalf of the taxpayers. Their primary and immediate mission is to save the system, save the banks and keep the U.S. afloat, if possible. Good luck guys.
Bringing the news back home...
Think about all of the dollars being printed by the Fed. It's been a rough month of September with probably a trillion or two being printed. It's only paper so who cares, right? If you ever doubted the reason to purchase gold you had better think again! The dollar was hanging by a thread even before this month and I believe the world's investors now understand the necessity of owning gold, silver, mining shares and long-term warrants on selected mining shares. We have advocated this position for some time now and our reasons are validated by the news of the day.
Many of you may have no knowledge about warrants even though they have been around since the 1920's. For those readers, interested in warrants which you can purchase, I encourage you to visit my website. You will find a wealth of information on warrants in our learning center which will assist in your understanding of the current use of warrants by the government.
For subscribers, we also provide a database for all companies with call options and leaps trading on the natural resource shares in addition to the warrants. A valuable tool for all investors.