Friday, July 17, 2009

The Arrogance of Wall St.

Goldman Sachs is a smart firm...very smart. But their recent position on the re-purchase of warrants from the Treasury has me a little perplexed. Allow me to explain. Goldman took over $10 billion in TARP money from the Treasury to insure against insolvency. In exchange for the $10 billion or so of cash from the Treasury Goldman issued warrants to the Treasury (read: taxpayers). Warrants give one the right, but not the obligation, to purchase shares of a company's stock at a certain price. It's very similar to an "option" with the key difference being the length of time one has to exercise the warrant (the life of a warrant is typically 5-10 years while an option is generally shorter than that, sometimes only months). Here's an example using the Goldman case (I'm too lazy to look up the exact numbers but I think an approximation will suffice).

The treasury receives twelve(12) million warrants that allow them to buy Goldman stock at $122/share. Last I knew, Goldman was trading at $150 (or thereabouts). If the Treasury exercises its right to buy the shares, it would buy them at $122/share and sell them for $150/share, making a tidy profit of $372,000,000. By my rough calculations, that's about a 5% internal rate of return. Not bad for 12 months. But, it's not quite that easy. The contract Goldman signed with the Treasury allowed them to buy these warrants back from the Treasury. But price is negotiable. So what should Goldman pay? Whatever the Treasury wants. I'm guessing the Treasury won't give up their warrants for the $372,000,000 because of the tremendous long-term potential they see in Goldman. Remember, as Goldman's stock increases, so does the Treasury's profit. Since Goldman is one of the first to pay pack their loan, I would bet the treasury is eager to show the taxpayer what a good deal the TARP is for them and is asking for a little premium on their warrants. In other words, more than $372,000,000 and more than Goldman is willing to pay. If I'm the Treasury (and it's a good thing I'm not), then I would NOT let go of those warrants for any less than $750,000,000, yielding an attractive 10% IRR. That's a nice double digit number. It's O.K. for Goldman to 'stick it to the man' as long as the "man" is not the Treasury/tax payer/life saver.

If somebody saves your life, you take what they give you. I'm firmly rooting for the Treasury on this one!

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