NEW YORK (MarketWatch) — When it comes to Warren Buffett, an old axiom comes to mind: “It takes money to make money.”
For Buffett’s legion of copycats, there is an addendum: “… and unless your name is Warren Buffett, even if you have money, you might not make money at all.”
That’s the reality facing investors after Buffett shocked Wall Street on Friday by announcing a $5 billion investment through Berkshire Hathaway Inc in star-crossed Bank of America Corp.
Simply put, this is a great deal for Warren Buffett. For everyone else, it’s probably a loser.
Two big reasons stand out. As many have noted, Buffett’s investment is a sweetheart deal aimed at giving B. of A. a much-needed lift through both a cash infusion and the cachet of having Warren Buffett as a big investor. He may end up owning as much as 6.5% of the Charlotte, N.C.–based bank.
Secondly, and more importantly, nothing has changed at B. of A. It’s still one of those “too big to fail” institutions that the government must support. So, even though it’s added some short-term capital — a drop in the bucket of what the bank actually needs — the deal will actually end up hurting shareholders by cutting into profits (if the bank actually makes some).
Indeed, Buffett’s deal actually makes things worse by creating a new cost.
And yet, many investors are now willing to pay a premium for the privilege of forking over their money to Buffett. The bank’s stock jumped 24% in the first hour of trading following the announcement. It’s trading even higher after the bank announced Monday it was selling its stake in a Chinese bank. Read full story on Bank of America’s sale of its stake in China Construction Bank.
The only thing surprising about this rush to slaughter is that Buffett has played this game before. His investments in bailout babies General Electric Co. /quotes/zigman/227468/quotes/nls/ge GE +0.53% and Goldman Sachs Group Inc. /quotes/zigman/227468/quotes/nls/ge GE +0.53% have played out terribly for mini-Buffetts who love to follow the oracle.
For instance, those who purchased GE when Buffett made his $3 billion investment in 2008 bought the stock at about $24. It’s trading close to $15.50 today.
Goldman investors have been pounded the same way. Buffett bought his preferred stake when the stock was at $115, about four bucks a share more than its recent price.
Meanwhile, while Buffett collected his special dividends — 10% annually on both holdings — investors in common stock were getting anywhere from 1% to 5%. GE investors had to cringe when the company cut its dividend by two-thirds less than six months after Buffett’s investment.
Goldman paid off its Berkshire investment this year, but it cost shareholders more than $1.7 billion — two years of dividends and a special payoff bonus of $500 million. GE, likewise, has coughed up $1 billion in dividends.
That’s why the rush into B. of A. stock is so maddening. Its terms are much like those investments. The bank will pay 6%, or about $300 million annually, for the privilege. Buffett can buy another $5 billion during the next 10 years at $7.14, less than the stock is trading for after the announcement.
None of this, of course, has anything to do with Bank of America’s fundamentals. The bank is being dragged down mostly through the legacy mortgage problems of Countrywide Financial and Merrill Lynch, which it bought in 2008. The bank paid $8 billion to settle claims related to bad mortgages last quarter.
B. of A. has lost nearly $14 billion since the start of 2009, and, despite the protests of its chief executive, Brian Moynihan, the bank will have to turn to more Buffett-like infusions if it hopes to meet the stronger capital standards demanded by regulators.
Confidence in Moynihan among investors is weak, mostly because of his tendency to talk tough and then back down. Even in his talks with Buffett, Moynihan reportedly balked at first, telling Buffett that B. of A. didn’t need additional capital.
Much of this risk was built into a stock price that was hovering at or below $7 a share. Now that Buffett has entered the fray, there’s a 20% premium for a bank taking on $300 million in additional costs and Buffett’s right to undercut shareholders by buying more B. of A. at a discount.
This isn’t to slam Buffett, who has made another great deal with a bank that has an implicit government guarantee.
But for those who rush into the stock — which has just added another hefty charge, and given the track record — what’s the pleasure in being a follower?
That’s not following. That’s masochism.
David Weidner covers Wall Street for MarketWatch.