People seemed to like our post yesterday calculating a mumbo-jumbo implied equity price at which Warren Buffett invested in BAC. Particularly gratifying was that some smarter folks than us came within a few cents of my $5.28 guesstimate. You could certainly quibble with some of my assumptions – in particular Bronte Capital points out that BAC’s TARP warrants imply a higher long-dated vol than I arbitrarily threw into the model, while some of their prefs imply a higher pref discount rate than the 8.25% I used – but that’s why there’s a spreadsheet. Quibble away.
Others used different valuation methods to get different numbers, but everyone basically used the same general approach as I did. That approach is pretty intuitive: you value the preferred shares at some discount rate. Then you value the warrants based on Black-Scholes or whatever. Then you add those two numbers.
Turns out that’s wrong.
The actual securities purchase agreement released yesterday afternoon includes a form of warrant with the following terms:
3. Exercise of Warrant; Term. Subject to Section 2, to the extent permitted by applicable laws and regulations, the right to purchase the Shares represented by this Warrant is exercisable, in whole or in part by the Warrantholder, at any time or from time to time after the execution and delivery of this Warrant by the Corporation on the date hereof, but in no event later than 5:00 p.m., New York City time, September 1, 2021 (the “Expiration Time”), by (A) the surrender of this Warrant and Notice of Exercise annexed hereto, duly completed and executed on behalf of the Warrantholder, at the principal executive office of the Corporation located at 100 North Tryon Street, Charlotte, North Carolina 28255 (or such other office or agency of the Corporation in the United States as it may designate by notice in writing to the Warrantholder at the address of the Warrantholder appearing on the books of the Corporation), and (B) payment of the Exercise Price for the Shares thereby purchased at the election of the Warrantholder by (i) tendering in cash, by certified or cashier’s check payable to the order of the Corporation, or by wire transfer of immediately available funds to an account designated by the Corporation and/or (ii) the surrender to the Corporation of shares of the Corporation’s 6% Cumulative Preferred Stock, Series T (“Preferred Stock”), valued for purposes of payment of the Exercise Price at the per share sum of (x) $100,000 per share of Preferred Stock and (y) the amount of any accrued and unpaid dividends on each of such surrendered shares of Preferred Stock (including all past due dividends) with such accrual computed from the last dividend payment date through the applicable exercise date of this Warrant.
Buffett’s warrant to buy 700 million shares is a stock option: to get his 700 million shares, he has to pay the $7.14 exercise price, which works out to $5 billion. Where is he going to get $5 billion? He’s not exactly short of cash, but coincidentally he’s also got $5 billion of BAC preferred shares lying around. And the warrant agreement lets him hand in those shares to pay the $5 billion exercise price.
Does this matter? Well, it wouldn’t, if he had to hand in $5 billion worth of cash or BAC preferred or gold or anything else, at fair value. Paying $5 billion is paying $5 billion. But he doesn’t have $5 billion worth of BAC preferred. He has preferred shares that say “$5 billion” on them, but given their below-market coupon those shares are worth anywhere from $3.3bn (using a high-estimate 9% BAC preferred yield from before the deal was announced) to maybe $4.0bn (using a 7.4%-ish yield on BAC-I today).
In other words – if he exercised the warrant today, he could pay $5 billion in cash and get stock worth $X for some X. Or instead of doing that he could hand in $3.3-$4.0bn worth of BAC shares and still get stock worth $X. Handing in the shares saves him at least $1 billion.
Of course he doesn’t need to exercise the warrants until 10 years from now, at which time the preferred shares might be worth closer to $5 billion – as rates stay low and BAC credit improves with sound management, aggressive lawsuit settlements and the continuing Buffett halo. (They might even be worth more than par, in which case he’d just pay cash.) Or, y’know, the reverse. In any case, the option to pay with shares has value.
I leave as an exercise for the reader the task of reflecting this in calculations of “implied BAC equity price.” For what it’s worth, on a fairly simple method of reflecting it I see a $4.64 implied stock price on the same assumptions as yesterday.
No chart r picture of a clown stuck in a sewer?
why is this on dealbreaker. this is extremely weird
Amateur
-14 year old Excel World Champion
I am BEYOND lost right now
Fucking commie should have bought the common like the rest of us……he is UNAMERICAN!
there is a hurricane on the way and this is how you chose to spend your final hours?
God Bess us everyone…
You're all fucked regardless.
Not sure I agree with your logic there Matt… Not sure how he can save a billion when he DID fork over $5b for the preferred stock and the right to buy the common… Yes, the market value of the preferred stock is only like $3.3b-$4.0b but he paid $5b for it (with the warrants). Now, if I could buy his preferred stock and warrants in the secondary market at $3.3-$4.0b and convert them, then yes, that could be a good deal. But that's not what's happening here… I think you were closing to being right yesterday – although Buffett hates the Black & Scholes pricing model, especially for long-dated options.
I think you mean Black & Decker?
~ SEC VP
How does this Levine clown get to post crap like this and still work close to Bess????!!!!! Ugh!
My brain doesnt work that hard on a Friday afternoon (*belch*).
the value loss in the pfds is taken out of the original calculation. Allowing the pfds to exercise the warrants would mitigate some of that value loss. Thus the price decrease in the implied value of the BofA stock. A win for, I endorse your company (at a huge discount to public markets), Buffet.
Where are the charts. WHERE ARE MY CHARTS!!
WTF? You´re saying he didn´t pay for it?? Well if BAC was that deperate lets all short this junk…
Right: He pays $5B for the structure, which includes the value of the preferreds, the value of the warrants, and an ITM put on the preferreds.
The value of the put, though, is significantly reduced by the correlation between common & preferred.
What do life jackets (pdfs) have to do with this, I think you are confusing the markets with the impending flood.
What value loss on the pfds? A 10yr call option has significant value… Converts typically have lower yields than straight debt?
Not only does every Dealbreaker reader despise you, but also imaginary character Stewie Griffin hates your guts after your using the word "guestimate." At least Goldman still likes you…
Seriously, your batting average in posting pales in comparison to McGuire's post steroids.
-Someone who gives commercial bankers more respect than capital markets peons
Okay
BMAP STRM [GO]
Again, I stopped reading at "Matt Levine"
~ guy who sometimes thinks we are being too hard on the newbie, but then quickly realizes that he deserves every ounce of shit that we give him because we are all just jealous fucks who would give our right nut to work alogside Bess the Beauty for just one hour of our dismal lives
You're an idiot. You're thinking of PFDs (personal flotation devices). PDF stands for portable document format and created by Adobe so people could share files regardless of software, hardware, and/or operating system… Geez
- AIG FP MD
Matt
This one time at CFA camp, I stuck a calculator up my ass.
Jesus Christ please go back to Yahoo! or better yet….kill yourself
cool reference.
@24 – hopefully it was a Texas Instruments BA II Plus (including the BA II Plus Professional) or the Hewlett Packard 12C (including the HP 12C Platinum)…
This is way too complicated. I would never have done a deal like this.
The pfds are worth less than their nominal face, not including the option. That value loss. (which I guess only makes sense in the original context of Matt's first calculation when they couldn't be thought of as part of a synthetic convert). But InfiniteGuest's point about the correlation is good.
It shows how much I like my job that I'm engaging in this rather than working..
Long story short, Buffet got a coosh deal cuz he knew in advance obama would announce some nonsense "homeowner bailout" (in reality a BAC bailout). Not to diss the calculations, which appear workmanlike and competant enough, but this is simply another example of ol' uncle warren cashing in on crony capitalism.
Me too..
Don't you have some trades to close out?
Surprised the Dealbreaker community let Matt get away with this comment: "Buffett’s warrant to buy 700 million shares is a stock option". Really, a warrant is a stock option? Duh! I think most ppl on these boards know that Matt
Matt, you've changed my opinion this week. Well done.
Lazy, I bet you're hell on wheels at Etrade!
Hey!
You rats. Crawl back into your holes.
Gaddafi
Jim Cramer says invest In Toya Motor corporation
McGwire
yHLk6L Really informative post.Thanks Again. Cool.
Very neat blog post.Really thank you! Fantastic.
Muchos Gracias for your post. Really Great.