Debt Market

Buffett's New Custom Convertibles
Joseph McCaffertyJuly 1, 2002

Warren Buffett’s Berkshire Hathaway turned some heads in late May when it completed the first-ever issue of negative-coupon convertibles. But other market-watchers were left scratching theirs.

The Omaha-based conglomerate issued $400 million in Squarz, a vehicle created by sole underwriter Goldman, Sachs & Co. The convertible bond consists of a Berkshire senior note due in 2007 and a warrant to purchase Berkshire stock at a premium. The notes will pay holders a 3 percent coupon, but require 3.75 percent installment payments on the warrants. Hence the negative coupon.

“We’ve seen zero percent yield, so I guess negative coupon was the next logical trail to blaze,” says Robert Willens of Lehman Brothers. “And who better to do it?” he adds. Willens says that the issue, while small, has tax advantages for Berkshire. The company gets to deduct the 3 percent interest it pays to bondholders, while the 3.75 percent it collects is not taxable. There’s another advantage as well. “It certainly sends a message that you are bullish about your stock,” says Willens. “It means that you expect the stock to trade through the strike price.”

In fact, the issue created quite a buzz on Wall Street. “The main reason for the unusual structure was to attract attention,” says Whitney Tilson, managing partner at Tilson Capital Partners LLC, in New York. “Buffett wants to remind Wall Street that he is looking for private companies to buy.”

In fact, during a conference call, Buffett, who normally keeps a low profile, admitted that raising awareness about the company’s interest in acquisitions was an objective. “If doing this deal causes one or two people…to think of Berkshire when it comes time to sell their business, then [the offering] will have more than accomplished its purpose,” he said.

The Oracle of Omaha, famous for keep-it-simple investing, puzzled some with the deal. “It’s a bit of a surprise coming from Berkshire,” says Ravi Arcot, director of Kynex Inc., a convertible-bond research firm in Fair Lawn, N.J. “It makes sense for them, though,” he adds. “Effectively, they get a very low cost of capital. But we’re not convinced it makes sense for investors.”