Jan 132012
 

On August 25, 2011, Bank of America announced the sale of $5 billion of 6% Cumulative Perpetual Preferred Stock to Berkshire Hathaway.  The preferred stock is redeemable by Bank of America at any time at a 5 percent premium.

In conjunction with this agreement, Berkshire also received warrants to purchase 700,000,000 shares of Bank of America common stock at an exercise price of $7.14 per share. The warrants may be exercised in whole or in part at any time, and from time to time, during their 10-year life.

At Bank of America’s closing price of $6.87 per share on January 11, 2012, what are these warrants worth?  Although these warrants are currently “out of the money” since the underlying common shares are selling below the strike price of $7.14, they have considerable value which can be estimated using a Black-Scholes calculator. 

When applying a strike price of $7.14, stock price of $6.87, time remaining of 3520 days, historical volatility of 59% (source: TD Ameritrade), and a risk free interest rate of 2% (10-year U.S. Treasury), each warrant is valued at $4.59.  Therefore, Berkshire’s 700,000,000 warrants have a total current value of approximately $3.2 billion. 

Warren Buffett’s $5 billion investment in Bank of America’s 6% preferred stock is not only earning $300 million per year in dividends, but has also added $3.2 billion in shareholder value from the 700 million warrants that it has acquired.

It is interesting to note, that in The Government Employees Insurance Company’s  third quarter 2011 filing with the National Association of Insurance Commissioners, this Berkshire subsidiary showed that it had acquired 229.6 million Bank of America warrants at a cost of $328.0 million, or $1.43 per warrant on September 1, 2011.  Using Bank of America’s closing price of $7.89 on September 1, each warrant would have had a value at that time of $5.52.  Therefore, it appears that Berkshire had used very conservative accounting and assigned a total value to its Bank of America warrants of $1.0 billion.

Many discussions of Berkshire’s $5 billion investment in Bank of America omit a valuation of the warrants since they are currently out of the money.   However, these warrants have added considerable value to Berkshire Hathaway.

This article has been published by Seeking Alpha and GuruFocus:

http://seekingalpha.com/article/319303-bank-of-america-warrants-add-considerable-value-to-berkshire-hathaway

http://www.gurufocus.com/news/158531/bank-of-america-warrants-add-considerable-value-to-berkshire-hathaway

It has also been published by Business Insider  and FOREXPROS:

http://www.businessinsider.com/berkshires-700-million-bac-warrants-have-been-ignored-by-many-but-theyre-currently-worth-32-billion-2012-1

http://www.forexpros.com/analysis/bank-of-america-warrants-add-considerable-value-to-berkshire-hathaway-111946

 Posted by at 1:17 pm

  One Response to “Bank of America Warrants Add Considerable Value To Berkshire Hathaway”

  1. Buffett is the guru of value investing and this will go down as one of his best investments in the last 5 years. Thanks to the global turmoil and the credit crunch which made even the biggest banks raise funds from the market. Not all the big banks were as lucky as Bank of America, though.

    Its also interesting to see that analysts had not factored in the value of warrants while valuing the investment. These are complex finance problems and need clear understanding of finance. For any information on how to solve such problems, do visit our blog at http://www.courseworkwriters.com/blog

Sorry, the comment form is closed at this time.