New York Times - May 22, 2002
Is Lending Money to Buffett a Privilege Worth Paying For? By FLOYD NORRIS
Warren E. Buffett wants to borrow up to $287.5 million, and he thinks he should pay a negative interest rate on the money. That is, he thinks the lenders should pay him money.
And what do the lenders get in return, aside from negative cash flow? They receive the right to buy shares in Berkshire Hathaway at a premium over the current market price. That right will be good for five years, by which time, the lenders will hope, Berkshire stock will have risen enough to make the investment a good one.
The offering is a private placement that was unveiled to institutional investors yesterday afternoon by Goldman, Sachs, which designed the structure. In its announcement, Berkshire Hathaway said it was "the first-ever negative-coupon security." It is being offered in a private placement only to institutional buyers. The exact pricing is expected to be disclosed today.
Under the proposal made to investors, Berkshire would pay perhaps 3 percent a year on the bonds it is issuing. But the investor would also receive a warrant allowing the purchase of Berkshire stock.
To keep the warrant alive, investors would have to pay a higher rate, perhaps 3.75 percent, at the same time Berkshire made the interest payments. The net effect would be that Berkshire would receive a negative interest rate.
The warrant is expected to be priced at about a 12.5 percent premium over Berkshire's current stock price. The deal was disclosed after the market closed yesterday, with Berkshire shares up $300, to $77,900, in New York Stock Exchange trading.
The bonds would have a five-year life, but the holder would have the right to sell them back to Berkshire for face value on each annual anniversary of the offering. That would be expected to happen if Berkshire stock were to fall sharply. If it did, Berkshire would have borrowed money at a negative rate for the intervening period.
On the other hand, if the warrants are eventually exercised, Berkshire will have sold stock at a premium over the current market price.
Berkshire said the new securities are called Squarz (pronounced squares) but did not say just what those letters stood for. Investment banks love to copyright such names because they cannot protect financial structures from imitators if they prove to be popular.
Berkshire said it planned to borrow $250 million under the deal, with an additional $37.5 million available to cover overallotments if the deal sells well.
While a negative interest rate breaks new ground, Berkshire is far from the first company to take advantage of the combination of low market interest rates and the extraordinary volatility of the stock market. That volatility increases the value of an option to buy a stock, and that added value can offset the interest that a company would otherwise pay to borrow.
A number of companies have borrowed money at zero percent while offering warrants to buy their stock at a 30 percent premium or more over the price that is current when the bonds are issued. Berkshire is offering a lower conversion premium, which is good for the buyer, while demanding in return an effective negative interest rate.
It is able to do that because it requires periodic payments for the warrant, whereas warrants are usually sold as part of the original deal and require no additional payments.