Buffett may struggle to repeat his Swiss Re exit

November 4, 2010

Warren Buffett may struggle to repeat his Swiss Re exit. The legendary investor bailed out three big beasts during the financial crisis: the Swiss insurer, GE and Goldman Sachs. The Sage of Omaha has allowed Swiss Re to buy back its expensive convertible stock early. He may have less scope to be as generous with the other two.

Of the three deals, Buffett’s $3.1 billion investment in Swiss Re convertible shares had the most strings attached. Negotiated at the depths of the market slump, the stock paid a 12 percent annual coupon until March 2012, when it would convert into ordinary shares at a price of 25 Swiss francs.

As Swiss Re’s share price is now twice that level, the insurer was keen to buy back the convertibles. But it had also agreed to pay Buffett a hefty 40 percent premium if it redeemed before March 2011, and a 20 percent premium after that.

Buffett is allowing Swiss Re to pay only a 20 percent premium as well as the interest he would have received next March. That means he collects $1 billion, rather than the $1.6 billion to which he was contractually entitled. That may look generous. But Buffett also owns 3 percent of Swiss Re’s ordinary shares, which will benefit from it redeeming expensive convertible stock. News of the buyback helped lift the shares more than 6 percent on Nov. 4.

At first glance, Buffett faces a similar situation with Goldman and GE, where he holds preferred shares worth $5 billion and $3 billion, respectively. Both companies would like to buy back the stock, which pays an annual coupon of 10 percent. Buffett also has warrants over shares of both companies, giving him an incentive to help boost their share price.

But there is less scope for a Swiss Re-style agreement. Goldman can redeem its preferred stock at any time for a 10 percent premium, so does not need Buffett to give it an early discount. GE’s stock cannot be redeemed until October 2011, opening the door for a negotiation. But Buffett’s GE warrants are deeply out of the money. That means he is unlikely to benefit from any short-term boost to GE’s share price.

Despite Buffett’s apparent generosity with Swiss Re, Goldman and GE shouldn’t assume he will take the same approach with them.

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