Is Buffett on a buying spree?

In the last fortnight, Buffett seems to have started buying more assets in the US. There's the $5 Billion Constellation Energy Group deal, then, followed by another $5 Billion (+ another $5 Billion) Goldman Sachs deal, then, a $3 Billion General Electric deal, and now, it seems Well Fargo (where Berkshire is by far the largest shareholder with 9% outstanding shares compared to the next institutional investor at 3.6%) now plans to bid approximately $15 Billion (Wachovia shareholders will receive 0.1991 shares of Wells Fargo for every Wachovia share, valuing Wachovia at about $7 per share based on Wells Fargo share price of approximately $35) for Wachovia (at one stage, 4th largest bank in the U.S. last year) and scuttles with Citi's earlier bid which had goverment backing. Wells Fargo Chairman Dick Kovacevich claims that he did not discuss the proposed bid with Buffett (despite Buffett being the major shareholder). Wells Fargo's latest bid is higher (Citi originally proposed to pay just a paltry $2.2 Billion plus partial government guarantees on $312 billion of Wachovia's mortgages), although it does not carry the same extent of government guarantee as Citi's, and Wells Fargo is still exposed to what appears to be very large risks.

It appears the major risks for Wells Fargo is that it will be acquiring $122 billion of "option pay" mortgages, where borrowers can choose every month whether to only pay interest on their mortgages, pay down some portion of their loan, and sometimes to pay less than the interest due. In a plummeting housing market, such assets are seen as highly toxic, and Wells Fargo said it expects to write the assets down by $32 billion over time. Given Wells Fargo's proven history of managing risks successfully with its prudent banking practices (the bank thrived the last year when its peers are going bust), my guess is that the $32 Billion contains elements of prudence. Note that $32 Billion is approximately 30%, suggesting that Well Fargo themselves probably think there is still more downside to the U.S. Housing markets. If one is optimistic, perhaps another 15%-20% more downside to go, suggesting that we are still not quite bottom yet, although it could be time to start nibbling (not gobbling) US assets.

The bank estimates the total assets it is taking on will have to be written down by $74 billion in the years following the deal. Wells Fargo will issue up to $20 billion of securities, likely mostly common equity, to help offset those losses. These are big numbers for Wells Fargo, whose net worth as a company as measured by balance sheet shareholders' equity, was about $48 billion at the end of June. In other words, there is still - according to Wells Fargo - the risk of going bust, although obviously, the bank does not expect to go bust from this deal, when it appears to outbid Citi for Wachovia.

Given the huge risk, why is Wells Fargo doing it? According to analysts, the strategic benefits to Wells Fargo are "compelling". Wachovia has a strong branch presence on the East Coast, patching a major gap in Wells Fargo's network. U.S. banks have been scrambling to build or buy branches, which allow them to raise money from depositors. In a credit crunch, deposit funding can be cheap compared to borrowing in bond markets. The Wachovia bid, if successful, would help bolster Wells Fargo's network of U.S. branches from 3,400 to 6,700. Naturally, this bid would be a huge loss to Citi, whose own network of U.S. branches is only 1,000 at the moment, notwitstanding the much lower bid. Furthermore, Wells Fargo's deal will keep Wachovia's retail brokerage operations (14,600 brokers) intact unlike Citi's deal which intended to only acquire the banking operations.

US markets cheered Wells Fargo's bid very loudly, by sending Wachovia's stock price up by a whopping 59% last night, and penalized Citi's price down substantially by 18%. At the time of writing, Wells Fargo's capitalization ($114B at $34.56) is now larger than Citi ($100B at $18.35). To say Citi is pissed off is under-stating it, and they will take this to court, since this deal was apparently in the bag with "exclusivity agreement" (whatever this means - http://www.independent.co.uk/news/business/news/citi-threatens-legal-action-as-wells-fargo-swoops-on-wachovia-950874.html) before Wells Fargo's entry, even though Wells Fargo's bid is a much better deal for Wachovia's shareholders. The powerful Federal Deposit Insurance Corp., Sheila Bair, said her agency "stands behind its previously announced agreement with Citigroup." It's not exactly clear to me what FIDC statement means, since Wachovia's shareholders would eventually need to approve deals like this, so, it's a no brainer that unless Citi sweetens the deal substantially (the previous Citi's deal would only value Wachovia's shares at around $2 apparently taking into account the entirity of the deal), then, Wachovia's shareholders will not turn down a $7 offer, and Mr Market seemed to understand this very well by bidding Wells Fargo share price up by 59% last night to $6.21. My guess is that the FIDC - which was previously a part of Citi's bid to provide insurance - is merely stating that IF Citi's bid was successful, then, FIDC will honor its earlier obligations, since Wells Fargo's latest bid does not require FIDC involvement. Wells Fargo also issued this press statement "From what we have learned to date, the transaction is in the best interests of shareholders, creditors, the deposit insurance fund, other stakeholders and taxpayers." (http://www.marketwatch.com/news/story/statement-major-shareholders-wachovia-corporation/story.aspx?guid=%7B38E3EDA1-F7CF-45A7-A74D-9CD9A72FA25B%7D&dist=hppr)

Wachovia's employees were apparently happy with this latest bid by Wells Fargo. At Wachovia's headquarters in Charlotte, N.C., where 20,000 employees had anticipated draconian cuts, there was elation in the hallways. "Even in bull markets, I've never seen people this happy," said one Wachovia employee. (http://online.wsj.com/article/SB122303190029501925.html) :-)

Buffett buys Constellation

(Source: Constellation Energy Group 2007 Annual Report)

No, it's not AIG even though there were talks that it could be, but Constellation Energy Group (CEG). In its website (http://www.constellation.com/) CEG describes itself as "A Fortune 125 competitive energy company based in Baltimore", "The nation’s largest supplier of competitive electricity to large commercial and industrial customers", "The nation’s largest wholesale power seller", "A major generator of electricity with a diversified fleet of power plants strategically located throughout the United States", etc., and 2007 highlights include "Provided a 52 percent total return to shareholders, assuming reinvestment of dividends", etc. In essence, a very large, apparently very profitable utility stock in the S&P500, and yet the share price got whacked hugely from a 52 week high of $107.97 on Jan 8, to a low of $13 on Sep 16, before Buffett steps in on Sep 19. Des Moines, Iowa-based MidAmerican which is owned by Buffett will pay $26.50 per share in cash for Baltimore-based Constellation. This puts the deal at $4.7 billion and MidAmerican has also given CEG an immediate $1 billion infusion after shares of the nation's largest wholesale power seller plummeted and until then, liquidity concerns had analysts worried it would go out of business.

On the surface, $26.50 isn't the best deal. The French electricity giant Electricitie de France's (EDF) has revealed that last week it teamed with the private equity firms Kohlberg Kravis Roberts and TPG Capital to make a bid of $35 a share for Constellation. That's $8.50 more than the $26.50 Constellation agreed quickly with Buffett. Apparently, the EDF's bid is "still valid.", since despite Buffett's $1 Billion injection last Friday, the deal isn't a completely done deal. According to a source, "In the end, it'll be up to (Constellation) shareholders to decide. EDF hopes they'll opt for the best price." Whilst the boards of both MidAmerican and CEG have approved the deal, the shareholders and regulators have yet to sign off. The transaction is expected to close within nine months.

The capitulation on CEG's share price happened on Tuesday, Sep 16, when the stock plummeted more than 50 percent before recovering somewhat in the afternoon. Analyst reports were out like vultures as usual. The next day, Standard & Poor's Ratings Services placed Constellation's investment-grade "BBB" debt ratings on CreditWatch "developing," meaning they may be revised higher or lower, or maintained. S&P said Constellation needed to shore up its balance sheet in the face of a broad loss of market confidence by closing a $2 billion credit facility, getting an infusion of $750 million to $1 billion of new equity, and selling assets -- or by selling the company outright. S&P said the inability to execute on a transaction or a series of transactions in the very near term would cause a downgrade to sub-investment grade. That would force the company to post an additional $3.3 billion in collateral, which is beyond the company's current available liquidity. That would put the company out of business. Citi Investment Research analyst Greg Gordon said in a report Wednesday that Constellation would have to settle for the best deal it could even though it may be less than the company's intrinsic value, much like Merrill Lynch & Co. did when it agreed to be bought by Bank of America Corp. recently.



So, why didn't CEG accepts EDF's offer when it plans to pay higher at $35 bearing in mind, EDF already owns almost 10 percent of Constellation and is a joint venture partner in the construction of four new nuclear power plants? The answer seems to boil down to 3 things. First, Buffett is a fast mover and a lot less bureaucratic than everyone else - he can make a major decision for Berkshire in less than 5 minutes. Second, he can immediately inject $1 Billion into any entity without the red tapes that everybody else has to go through. Third, there simply isn't any white knight stronger or as reputable as Buffett. Constellation Chairman & CEO Mayo Shattuck called the MidAmerican deal "the best overall solution for all our stakeholders." and added "Regardless of how you might interpret the various sources of a billion dollars of equity, there was no question in our minds that the billion dollars of equity coming from this source (Berkshire), with this backing and this history, meant a lot more than it would have in some other cases." The WSJ's Deal Journal calls it the "power of Buffett. Nothing soothes like Buffett's involvement. In a volatile world, he is as close to a sure thing as the finance world sees."

However, it will not be plain sailing for CEG and Buffett from here onwards. Everything that Buffett does "looks easy" but in reality is fraught with great danger, unless you really and absolutely know what you are doing. A shareholder lawsuit filed Tuesday calls into question the $4.7 billion sale to MidAmerican. “The price isn’t right and the process isn’t fair,” said John Isbister, an attorney with Baltimore-based Tydings and Rosenberg, the law firm that filed the suit. The action came as at least four other lawsuits were filed opposing the deal, and state lawmakers continued ratcheting up the rhetoric, calling for state regulators to reject the union with the Warren Buffett-owned company. Yes, Buffett may have bought at close to rock bottom prices which some say are perhaps only a quarter of its intrinsic value, but he buys when everyone is completely afraid (see the obvious 50% capitulation in price in one day in the chart above), and even then, it's still not plain sailing from here onwards. But in typical Buffett deal, he has nothing to lose - either he gets Constellation or he gets a $200m payment if he has to walk away. The desperation to secure a quickfix at Constellation was such that the company agreed to pay Mr Buffett a break fee of $175m plus another $25m for any fees and expenses incurred.

So if EDF's higher bid finally wins the day - and the French have until the Constellation shareholder meeting in December to convince the board - then Mr Buffett will get $200m and will have made a 20 per cent return on the $1bn cash injection he has paid into Constellation's account.

And what did yours truly did last night? He dipped his little toe in and followed Buffett by buying a small amount of CEG at $26.30. The stock price fell a little last night, to close at $26.11. Shucks. Never mind - no one can consistently buy at the bottom, especially when I simply haven't heard of CEG until recently, and simply don't monitor the US markets on intra-day basis (which is really intra-night and intra-morning here in Malaysia). And in the extremely unlikely scenario that should CEG reject both Buffett and EDF, then, I'm "hoping" the share price will at least go up higher than my cost **grin**. If I close both eyes (ignore the 20% factor and the time value of money), I can console myself that I did buy slightly cheaper than Buffett at $26.30 vs his $26.50! **grin**