Lending money to businesses
An investment structure that
Warren Buffett (Trades, Portfolio) has increasingly resorted to a loan structure in recent decades.
Buffett, and by association, Berkshire Hathaway (BRK.A, Financial) (BRK.B, financial), have been lending money to other businesses for decades. While the Oracle of Omaha’s preferred investment route remained investing in stocks, when an opportunity presented itself, Buffett was quick to build up a pool of debt, with stocks or loans. privileged, to help finance an institution.
Berkshire began to set up these large deals in the late 1980s. It was around this time that the conglomerate began to become a force to be reckoned with in the financial markets.
The size of the company meant that it had become increasingly difficult for Buffett to deploy large amounts of liquidity that would move the needle in the stock markets. By this point, his reputation had also grown significantly, which would have made it difficult for him to buy a large position without the stock reacting.
One of the first deals that really made headlines was Berkshire’s $ 700 million investment in Solomon Brothers preferred stock in 1987. In this case, the stock had to pay 9% and be convertible to. after three years in common shares of Salomon at $ 38 a share.
Two years later, in 1989, Buffett invested $ 600 million of Berkshire cash in Gillette preferred stock with a yield of 8.75%.
These weren’t the only deals Berkshire made using a similar structure at this time. Over time, Buffett repeated the playbook. He was especially active during the financial crisis, when he used $ 5 billion to buy Goldman Sachs preferred stock (SG, financier) and invested $ 300 million in motorcycle manufacturer Harley-Davidson (PORK, financial) with an interest rate of 15%.
I have already noted that these transactions allowed Buffett to deploy large amounts of capital relatively quickly at high rates of return. Yet there was another reason why Oracle decided to go this route rather than buying the capital of these companies. He explained why at the 2010 Berkshire Annual Investor Meeting when discussing the Harley-Davidson position:
âNow there were obviously different risk profiles in investing. And the truth is, I don’t know if Harley-Davidson stock is worth $ 33, $ 20, or $ 45. know, or I thought I knew, and I think I was right, that, A) Harley-Davidson was not going to close its doors. And that, B) 15 percent was going to look pretty darn attractive … lend them the money, I didn’t know enough to buy the equity. And that is often the case … I think I can make a lot of money, like we did on Harley-Davidson, with a very simple decision, just a question of, “Are they going to go broke or no ? As opposed to a more difficult decision: “Will the motorcycle market decline significantly?” And, you know, are the margins going to be a little bit tight? “And all that. I’m going to leave with a simple decision.”
Put simply, Buffett admitted that he didn’t know much about the company and its market, but he knew it wasn’t going to go bankrupt and that he could earn a high return.
The chances of success
The chances of success were quite high for this kind of investment. It’s a simplistic way of looking at investing, but it’s a way that works. No matter how successful the business was, as long as they could pay off their debts, Berkshire would make an easy profit.
Unfortunately, these kinds of opportunities don’t present themselves very often, especially for individual investors. Buffett can help bail out big companies and dictate the terms of his deals. Individual investors cannot.
Still, there were two things we can take away from this. First of all, not all of Buffett’s offers are as straightforward as they seem. He often gets better terms that should make investors think twice before copying his trades (an easier way to copy Berkshire trades is to simply buy Berkshire).
Second, good investors are flexible and focus on the likelihood of success as well as financial return. If the odds are attractive, one may be able to invest with limited information.