Warren Buffett, Goldman's White Knight

The Oracle of Omaha's $5 billion cash infusion may save Goldman Sachs, but the tottering bank's health and prospects have lost their shine

by Joseph Weber

Warren Buffett has powerful coattails. Within 14 hours of Buffett's ride to the rescue of Goldman Sachs (GS), with a $5 billion cash infusion and warm praise for the struggling investment banking titan, Goldman on Sept. 24 found other investors to snap up $5 billion worth of its stock. The outfit's rapid-fire stock offering, for 40.65 million shares at $123 each, raised twice what Goldman managers originally expected.

But the deal is hardly a glowing statement about Goldman's health and upbeat prospects. Some analysts say both the Buffett investment and the offering are highly costly to the firm, which is likely to be facing years of trouble, retrenchment, and subpar returns as it struggles through the financial crisis. Looking at the stock offering, Oppenheimer (OPY) analyst Meredith Whitney told clients in a note, "For GS, the blue chip of financials, the terms of this deal seem exorbitantly expensive and provide insight into how truly challenging current market conditions are."

Goldman did the offering at less than half the price per share that the firm was worth only a year ago. It will sharply dilute the value of its outstanding shares, some 16%, as a result of the offering and the Buffett investment, Whitney calculates. The initial enthusiasm for the deal among investors has been cooling as they've sorted out the implications: The shares climbed past 133 in after-hours trading on Sept. 23, on the Buffett news, but they slipped slightly after terms of the public offering were announced. In afternoon trading Sept. 24, the stock was up 6%, to 132.

Investors Left Stunned

Goldman and Morgan Stanley (MS), the other big investment bank left standing after the financial typhoon that has swept up Merrill Lynch (MER), Bear Stearns (JPM), and Lehman Brothers, stunned investors over the weekend when they announced plans to convert themselves into commercial banks. The move, done in conjunction with the Federal Reserve, will put them under more severe regulation and is expected to force them to scale back on risky businesses, many of which—such as the underwriting of mortgage-backed securities—have already shriveled away. They are not expected to operate with anywhere near the high debt levels they have in the past.

Both banks now can count on hefty cash infusions. While Goldman collected $10 billion from public investors and Buffett, Morgan has garnered more than $8 billion from Japanese megabank Mitsubishi UFJ (MTU) in exchange for a stake of up to 20%. Yet they are hardly out of the woods. "They're going to have to retrench and lay off a lot of people, and it's not due to the bank holding company charters," says Ladenburg Thalmann analyst Richard Bove. "It's due to the fact that the business has changed. In my view, it's going to take three to four years to work out the financial crisis."

Buffett, Bove says, got an outstanding deal in his investment in Goldman. He is taking $5 billion worth of perpetual preferred stock and getting a 10% dividend and warrants to buy $5 billion of common stock with a strike price of 115 a share. He'll be able to exercise the warrants at any time over five years.