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Wednesday, September 24, 2008

Buffett Buys $5 Billion stake in Goldman Sachs

Goldman, a company known to mint money and who largely escaped the Subprime crisis. Warren being Greedy when others are fearful - a classic value play here.

NEW YORK ( -- In its first big move to raise capital, Goldman Sachs Group announced Tuesday that it will receive a $5 billion infusion from Warren Buffett's Berkshire Hathaway, an investment that could also raise confidence in the venerable Wall Street firm.

Goldman (GS, Fortune 500) will sell $5 billion of preferred stock to the insurance and investment giant, which will also receive warrants to purchase $5 billion of common stock with a strike price of $115 per share, the company announced Tuesday. Berkshire (BRKA, Fortune 500) has five years to exercise the warrants. Buffett will be paid a 10% dividend on his shares.

"Goldman Sachs is an exceptional institution," said Buffett in a statement. "It has an unrivaled global franchise, a proven and deep management team and the intellectual and financial capital to continue its track record of outperformance."

In addition, Goldman said it will raise at least $2.5 billion through the sale of common stock.

"This investment will further bolster or strong capitalization and liquidity position," said Lloyd Blankfein, Goldman's chief executive.

Shares of Goldman rose 3.5% Tuesday to close at about $125 and soared 9% in after-hours trading on the news. And the stocks of two Goldman rivals -- Merrill Lynch (MER, Fortune 500) and Morgan Stanley (MS, Fortune 500)-- also soared in after-hours trading Tuesday, rising 6% and 9% respectively.

The move by Goldman Sachs marks the first major capital raising effort that the company has undertaken since the credit crunch erupted more than a year ago.

Facing devastating writedowns and painful losses, many of Goldman's peers have had to issue shares or sell an equity stake to outside investors.

But investors have shied away from doling out dough to other firms, with devastating consequences. Lehman Brothers (LEH, Fortune 500) was forced into bankruptcy last week, while the federal government had to give an $85 billion loan to insurance titan American International Group (AIG, Fortune 500) to prevent its collapse.

By having a conservative and heralded investor like Buffett back Goldman, it signals his faith in the company, analysts said.

"It's a vote of confidence in Goldman," said Nancy A. Bush, founder of NAB Research. "I can't imagine something better than the good housekeeping seal of approval."

While Goldman is already well-capitalized, raising more cash would ease investors' concerns about its relatively high leverage ratio. Investment banks use leverage, or borrowed money, to boost returns.

The investment bank can use the money to scoop up smaller banks at cheap prices, analysts said.

Raising capital will "provide the firm with dry powder for distressed investment opportunities," said Patrick Pinschmidt, a Morgan Stanley analyst.

The announcement follows what has been a tumultuous time on Wall Street.

Late Sunday, both Goldman and Morgan Stanley were converted into bank holding companies by federal regulators, effectively closing the book on the stand-alone investment bank business model.

By becoming banks, the firms are subject to greater scrutiny by federal regulators and are required to have more capital and take fewer risks than they did as investment banks.

Just a day earlier, Morgan Stanley agreed to sell up to a fifth of the company to Mitsubishi UFJ Financial Group, one of Japan's largest banks.