When Warren Buffett wrote a check for $5 billion from the treasury of Berkshire Hathaway and sent it to Charlotte so that Bank of America could beef up the amount of capital on its balance sheet, he negotiated the right to create a special warrant class so that he could purchase 700,000,000 shares of Bank of America at a price of $7.14 at any time he desires before September 2021. Obviously, it is an intelligent practice to wait until the last moment to purchase the shares—why assume the risk of a devastating financial crisis in August 2021 if you can avoid it?—so the degree of success for Buffett will be measured based on how much above $7.14 Bank of America’s stock price happens to be in September 2021.
If I had to take a ball-park swing at Bank of America’s value six years out, I would assume book value growth of 5.5% from 2015 through 2021 an then assume that Bank of America trades somewhere around 1.3x book value. If book value of $21.32 compounds at 5.5% between now and 2021, we would have Bank of America’s book value at $29.32 in 2021. If the stock trades at 1.3x book value at that time (before the financial crisis, Bank of America regularly traded at 2-2.5x book value so I don’t find this assumption optimistic), we would have an ending stock price of $38 per share.
Berkshire would have to pay $5 billion for 700,000,000 shares worth $26.6 billion if my calculation is correct. In other words, the shrewdness of this Buffett move would earn Berkshire a quintuple return within 10 years of his investment.
People aren’t talking about it yet because Bank of America’s earnings continue to be impaired by litigation—it actually made $13 billion in profit last year but because it had to pay even more mortgage settlements from its fateful Countrywide acquisition in 2008 (probably the worst takeover in American history; can you think of something worse?) that required over $8 billion in fines, settlements, judgments, and legal bills in 2014. That is why someone looking at Bank of America through a stock screener will only see $0.36 in earnings per share and will see Bank of America trading at a high P/E ratio.
The problem with thinking that way is it assumes the litigation costs will go on forever—it assumes that is what Bank of America perpetually is. The earnings power of the bank is something to the tune of $14 billion per year, but the continued payments towards financial crisis actions continue to cloud the depiction of the company. In a few years, when Bank of America is making $16-$17 billion free in the clear and paying out $4-6 billion in dividends, the story around the company will change and heightened interest in Buffett’s 2011 investment will emerge.
The enormity of the deal is notable—if my projections are even close, the Bank of America stake will closely approximate the size of Buffett’s investment in Coca-Cola which is so large that the profits from one out of every twelve Cokes, Diet Cokes, Fantas, Dasanis, and Sprites in the entire world are entitled to Berkshire Hathaway as part of Buffett’s 400,000,000 share investment in Coca-Cola. That’s valued in the $16 billion range, depending on Coca-Cola’s stock price. The $25 billion Bank of America stake could parallel where Coca-Cola might be five or six years from now. I suppose stuff like that is the natural consequence of being shrewd with large sums of money.
Bank of America could very well be paying out $1 annual dividends by the start of 2022. If that were to happen, Berkshire would instantly be collecting $700,000,000 in annual cash on a $5 billion investment for a yield-on-investment cost of 14%.
The truly amazing thing, which also rarely gets discussed, is the risk-adjusted appeal of this deal. Intelligent investing isn’t just about trying to make as much money as possible—it’s also about baking in contingency plans that protect you in the case of realistic bad case scenarios and hypothetical worst case scenarios. Buffett lent Bank of America $6 billion at 6% interest, and already renegotiated that part of the deal. The amount of capital he put at risk–$5 billion—has already been protected. As an additional term for that deal, Buffett received the right to buy 700,000,000 shares at $7.14 in 2021 if he so desires. If Bank of America were to completely obliterate into nothingness, he already got his $5 billion investment back and only lost the privilege to make another $5 billion investment that would instantly convert into big dollars. The Washington Post, See’s Candy, GEICO, and Coca-Cola investments get all the attention, but the long-term history books may remember the Bank of America investment as Buffett’s master stroke. There are several more Acts that need to happen before that Play is written, however.