Friday, November 28, 2008

The Warren Buffett Way: Chp 6 Part 8: Fixed-Income Marketable Securities

In 1991, AMEX was looking to raise capital at a time when their debt had been downgraded in the marketplace. A former chairman of GEICO and board member of AMEX at the time, suggested that the company contact Warren Buffett to see if he was interested in making a deal.

On Aug 1, 1991, Berkshire purchased $300 million worth of convertible preferred shares of American Express (AMEX). This was not a typical convertible preferred share deal for Berkshire, because there was an upside cap on their ability to profit from a potential conversion into common shares.

In this deal, the convertible preferred shares paid a fixed dividend of 8.85% and must be converted in three years into AMEX common stock, with the possibility of a one year extension. At the time of issuance, the AMEX common shares were trading in the market at $25 per share. The value of a conversion into AMEX common shares was capped for Berkshire at $414 million, regardless if the market priced the conversion to be worth more.

With regards to this deal, Buffett commented that "for me, it's what's available at the time". The alternative for Berkshire at the time included treasury bills that paid 6% or treasury bonds paying 7.5%. As it turned out, within two years of making this deal, the value of AMEX common shares had risen to $31 per share.

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