Buffett Drove Hard Bargain With Goldman

By SUSAN PULLIAM, KATE KELLY and MATTHEW KARNITSCHNIG

For six months, as the credit crisis deepened, billionaire investor Warren Buffett turned away a string of Wall Street firms that came hat in hand looking for help.

On Tuesday, Mr. Buffett says, he was sitting with his feet on his desk in Omaha, drinking a Cherry Coke and munching on mixed nuts, when he got an unusually candid call from a Goldman Sachs Group Inc. investment banker. Tell us what kind of investment you'd consider making in Goldman, the banker urged him, and the firm would try to hammer out a deal.

Warren Buffett

That midday call from Goldman's Byron Trott, who had done deals with Mr. Buffett for years, touched off a rapid chain of events. Within hours, Goldman had announced that Mr. Buffett's Berkshire Hathaway Inc. would invest $5 billion in Goldman -- a move viewed by many investors as a vote of confidence in the nation's reeling financial system.

The swiftness of the deal underscores the intense pressure now faced by Goldman, long regarded as one of the most financially secure firms on Wall Street. Over a 10-day stretch this month -- amid federal bailouts of Fannie Mae, Freddie Mac and American International Group and a bankruptcy filing by Lehman Brothers Holdings Inc. -- Goldman shares dropped 36%. Investors began asking questions about whether it had the capital to survive. On Sunday night, Goldman secured federal approval to become a bank holding company, ending 139 years as a securities firm.

On Wednesday, Goldman said it had completed a separate $5 billion stock offering, double the size of the offering announced on Tuesday. Its shares jumped $7.95 to $133 in 4 p.m. New York Stock Exchange trading, although they remain far below their 52-week high of more than $250. The deal with Mr. Buffett and the stock offering means Goldman shareholders could eventually have their stake diluted by as much as 20%.

Mr. Buffett's decision to invest now in Goldman gives an indication of how the famed investor believes the financial crisis might shake out. At a minimum, he regards Goldman as a survivor, although the firm's profits could be pinched as it adjusts to life as a banking holding company, taking fewer risks and facing heightened regulation.

In a telephone interview Wednesday morning from his office in Omaha, Mr. Buffett said he believes the proposed federal bailout will be approved by Congress and that it will succeed. "The government has a great opportunity," he says. "If they buy things at market prices with the government's cheap funding, they should make a lot of money."

If Congress fails to approve the bailout, Mr. Buffett says, all bets are off. His investment in Goldman will "get killed, and so will all our other investments."

Goldman's moves in recent days mark a repudiation of the strategy that catapulted the firm to enormous success. At one time, Goldman was a white-shoe investment bank that made its mark advising corporate clients on deals. In recent years, it became a hard-charging trading firm, more akin to a hedge fund than a bank. Run by Lloyd Blankfein, a former gold salesman, Goldman borrowed enormous sums to fund big trades. Profits soared, and the rest of Wall Street -- from Merrill Lynch & Co. to Lehman to Morgan Stanley -- followed suit.

Lloyd Blankfein

Neither Mr. Blankfein nor Mr. Trott, the Goldman banker who reached out to Mr. Buffett, responded to requests for comment.

This year, as the credit crunch tightened its grip, investment banks began to suffer. At first, Goldman reveled in its position as one of the strong players. Unlike many competitors, it hasn't posted a quarterly loss during the crisis.

But Goldman appeared to miscalculate how serious and how long the crisis would be. "We're probably in the third or fourth quarter," Mr. Blankfein said in April. "We're closer to the end than we are to the beginning." In June, Goldman's chief financial officer echoed those views. Even last week, as Goldman reported its worst quarter since becoming a public company in 1999, executives dismissed the notion that Goldman couldn't survive the storm without radical action.

'Should I Go On?'

Out in Omaha, Mr. Buffett had been fielding calls for months from Wall Street firms and other investors who wanted him to take part in rescue efforts. The first major pitch came on Saturday, March 15. Bear Stearns was reeling after clients had removed billions of dollars from the securities firm. Federal regulators were pushing for a white knight to buy Bear Stearns before the Asian markets opened late the following day.

Mr. Buffett received a call at 4:30 p.m. that Saturday from a private investment firm trying to assemble a group to buy the embattled financial giant. "I'm calling about Bear Stearns,'" the private investor began, according to Mr. Buffett. "Should I go on?'"

Mr. Buffett recalls thinking: "It's like a woman taking off half her clothes and asking, 'Should I continue?' Even if you're a 90-year-old eunuch, you let 'em finish." Mr. Buffett says he passed on the proposed deal. Bear Stearns was bought by J.P. Morgan Chase & Co. the following day.

A few weeks later, in April, Lehman executives made a pitch to Mr. Buffett to participate in a round of financing. Mr. Buffett says he felt the Lehman offer was unrealistic and he decided not to participate.

Lehman went on to raise billions of dollars more from other investors at terms similar to those it offered Mr. Buffett. But the pressure continued to build. Talks with a Korean bank failed to materialize. The government brought two ailing mortgage giants, Fannie Mae and Freddie Mac, into federal conservatorship. The financial markets were rickety.

By Saturday, Sept. 13, Lehman was collapsing and insurance giant American International Group Inc. was on the ropes. Mr. Buffett was in Edmonton, Canada, at a charity dinner when he started getting calls about AIG. Fielding calls throughout the weekend, Mr. Buffett considered a $5 billion insurance transaction, part of a larger effort to save the insurer that involved other investors. That transaction fell apart, and the Federal Reserve assembled an $85 billion bailout package for AIG three days later.

This past weekend, Goldman's top leadership -- Mr. Blankfein, co-presidents Gary Cohn and Jon Winkelried, and chief financial officer David Viniar, among others -- discussed ways to raise capital. The executives figured with the market's current emphasis on safety and soundness, the firm might need more capital, according to people familiar with the matter.

The executives soon zeroed in on Mr. Buffett as an ideal option. His holding company, Berkshire Hathaway, had often used Goldman as an investment banker on deals. His reputation, both for smart investing and solid ethics, would likely give investors the reassurance they needed, the executives reasoned.

Mr. Trott had approached Mr. Buffett before with at least one offer to invest in Goldman. "They had sounded me out in the past, as everyone else had," Mr. Buffett says. The previous offer, he says, was "nothing I would say 'yes' to."

“The swiftness of the deal underscores the intense pressure now faced by Goldman, long regarded as one of the most financially secure firms on Wall Street.”

On Tuesday, however, Goldman put the ball squarely in Mr. Buffett's court. Mr. Buffett is famous for making quick investment decisions based on his gut. For the Goldman deal, he says, "I didn't see a book. I just made a judgment." The quality of Goldman's management team and its franchise, he says, sealed the deal for him.

He didn't insist on a complicated term sheet, he says. Instead, he spent 15 minutes with Mr. Viniar, Goldman's chief financial officer, outlining points of the deal. "They asked me about this or that," he says. "It sounded fair."

By the time markets closed in New York at 4 p.m., Mr. Trott was sealing the deal with a final call to Mr. Buffett. Mr. Blankfein was in Washington for the day to brief members of Congress about the state of the markets. After the deal was struck, he called Mr. Buffett. "We talked for five minutes," recalls Mr. Buffett, who says he told Mr. Blankfein to "keep working."

Mr. Buffett left his office at 7 p.m. and spent the evening reading the newspapers and "nibbling" on Cheetos and licorice pastel candies. He says Mr. Trott "called me once or twice to tell me what was going on with the equity offering." Mr. Buffett was asleep by 10:30 p.m.

Goldman executives were working the phones in hopes of raising more capital. Armed with a list of about two dozen of the firm's top investors, executives canvassed shareholders to see if they'd be willing to add to their Goldman holdings. It was an all-night affair.

Mr. Winkelried fine-tuned the details of the Buffett investment, and David Solomon, the firm's co-head of investment banking, coordinated the stock offering. By 8 a.m. on Wednesday, the group had gathered on the 50th floor of a Goldman building in downtown Manhattan to figure out who would get shares and at what price. They finished in time to announce a $5 billion offering, shortly before 9:30 a.m.

Sweet Deal

For his $5 billion, Mr. Buffett receives "perpetual" preferred shares that aren't convertible into equity, but pay a 10% dividend. That payout equates to roughly $1.3 million each day. He also has warrants to buy Goldman shares at $115, which, if he exercised Wednesday would theoretically net him a profit of more than $600 million. If Goldman's earnings grow at a modest pace, he could make a tidy profit, some investors say.

Some investors are griping about what they say is a sweet deal for Mr. Buffett. But some Goldman shareholders say Wednesday's stock offering was too good to pass up. "The valuation was right, the business expertise, we feel, is unparalleled, and the money coming in from Warren Buffett at this time was a catalyst to add to our position," says Tom Marsico, CEO of Denver-based Marsico Capital Management LLC, one of Goldman's largest investors.

Mr. Buffett's investment isn't without risk. As a commercial bank, Goldman will be forced to curb much of the risk taking that generated big profits. Hedge funds and private-equity firms are likely to try to lure away Goldman's stars with fatter pay.

The question now: Will Mr. Buffett -- whose firm has invested a total of about $24 billion in a number of ventures in recent months -- plunk down more money on Wall Street?

He says he remains interested in some of AIG's businesses "if they are available." He adds: "I still have some money left."