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Buffett and Gutfreund developed a friendship while working together on the GEICO deal. In the years that followed they regularly discussed pressing issues on the telephone and in person; even the head of an investment bank needs someone he can trust to quickly grasp an issue or dilemma and help to talk through ideas. Buffett observed the way that Gutfreund would advise client companies to take actions that were in their best interests rather than prioritising the fees that Salomon might earn if another course is taken. Gutfreund might have a Wall Street reputation for being a domineering hardcase, but Buffett perceived a degree of honesty, energy and competence that he liked; and, perhaps, to run an investment bank full of aggressive egos pulling in various directions you need someone capable of cajoling, and swearing with the best of them, to gain some order.
In mid-1987 Minorco, the overseas investment arm of Anglo American and De Beers group of South Africa, made it plain to John Gutfreund they wanted to sell their 14% (£700m) shareholding in Salomon. They hawked it round Wall Street, and the aggressive corporate raider Ron Perelman showed an interest.
Perelman said that if he bought the 14% he would demand two seats on Salomon’s board. This put fear into Gutfreund and his executives, and the King of Wall Street decided to ask his old confidant, Warren Buffett, if he would act as a “white knight”, i.e. a large shareholder friendly to the managers.
The plan was that Buffett would inject money into Salomon, which could then buy-in its own shares from Minorco, thus making it difficult for Perelman to gain a large stake.
Buffett regarded Salomon’s common stock as far too risky for Berkshire, but nevertheless wanted to enjoy at least some of the benefit should the bank perform well over the following few years. He thus agreed to buy preferred stock which permitted him to convert into common stock starting three years after the deal, i.e. October 1990 (potentially amounting to 12% of Salomon’s common stock).
Until converted the preferreds gave a generous 9% yield; on $700m, that meant sending Berkshire an annual income of $63m.
Overall, he estimated that Berkshire could obtain a satisfactory 15% return per year if it could be assumed the common stock rose from the low $30s to more like $50 -$60 over the following few years.
If it turned out that the common stock did not rise above the convertible price of $38 Berkshire could always hold on and collect preferred dividends, and then the c………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
