Which is all ver interesting, given:Analysis: Buffett bonds...

Which is all ver interesting, given:



Analysis: Buffett bonds break bard's Golden Rules

Thursday, May 23, 2002

By GENE COLTER, Dow Jones News Service



NEW YORK — Warren Buffett deserves his bard status.

Pithy aphorisms about not investing in something you don't understand and the right time to sell a stock (never) may not be highfalutin', but they've worked wonders for the famously loyal shareholders of Buffett's Berkshire Hathaway Inc. investment firm.

Which is why it's pretty hard to fathom what the Sage of Omaha is doing with a new offer of bonds called Squarz. These securities are being billed as "negative-coupon convertibles." To apply the Buffett slide rule, they aren't easy to understand, and they obviously aren't meant to be held forever.

Does this strike anyone as more than a little ironic?

Squarz are a hybrid breed consisting of both a bond and a warrant to buy Berkshire Hathaway stock. Were that it, they'd be pretty plain vanilla — as plain vanilla as a single scoop with no toppings at the Berkshire-owned Dairy Queen — at least by the standards of institutional investors used to trading convertible securities.

But there's more — or less, depending on how you want to look at it. Squarz also have two-way cash flow. They pay a 3 percent coupon, but to get that coupon investors have to make "installment payments" on the warrants. Those installment payments total up to 3.75 percent — in other words, more than the coupon payment, and thus a "negative coupon" for the holder.

It's essentially like making a premium payment for the right to sell the bonds back to Berkshire when they convert to the stock. Put another way, investors are being asked to pay Berkshire a 0.75 percent coupon.

Is this really a convertible? Or is it more properly a synthetic security, akin to a derivative?

More to the point, who would go for it? Well, Berkshire and underwriter Goldman Sachs sized the offer at $250 million worth of these doohickies Tuesday, but upped the deal size to $400 million Wednesday.

OK, but whose buying? Probably hedge funds that are looking for some way to trade on the difference between Berkshire shares and the warrants.

Some hedge-fund managers reportedly didn't get what Squarz had to offer or found them too expensive, and they noted that the securities were unchanged in skimpy volume in their Wednesday debut.

That lack of volume may be understandable, however, if the buyers of Squarz are holding on to the securities and arbitraging with the stock. Consider: the warrants allow conversion into either Berkshire's A- or B-class shares.

A little over 600 Berkshire As, which go for $76,000 a pop, had changed hands by mid-afternoon, more than double average daily volume. The stock was down about 2 percent. Meanwhile, Berkshire Bs — those "Mini Buffetts" that go for just $2,500 each — were also seeing greater-than-average volume and were also down 2 percent.

So presumably at least some hedge-fund managers get this one. But Imagine what Buffet's legions would make of Squarz. These are the people who worship him for Berkshire's ownership of straight-ahead businesses like the aforementioned Dairy Queen and insurer Geico.

Hold on, though. Those investors clearly aren't the target audience for Squarz. It's the pros — the really informed pros.

Or, more to the point, the really informed pros who are willing to give Buffet money for the chance to play with his triple-A rating. And given that Squarz require more in installment charges than they pay out in coupon, "give" is probably the right word, not lend.

OK, so these negative-coupon Squarz aren't for everyone, and they aren't simple. But it sounds like Buffett's genius status is still intact.