The Snowball_ Warren Buffett and the Business of Life - Alice Schroeder [324]
Owning a company that sold vacuum cleaners was one thing. Even though Salomon was dominated by trading, which Buffett liked, the firm was muscling its way into investment banking and had recently caved to market pressure and set up a merchant banking business to finance takeovers using junk bonds, a technique he despised. The firm was late to the highly competitive merger business, still a novice.74 In trying to launch Salomon in these rough waters, Gutfreund seemed uncomfortable; he had aged visibly in just one year.75
Yet Salomon’s expertise in reshaping the bond market appealed to Buffett at a time when good stock ideas had become scarce.76 While he denigrated junk bonds, he didn’t shun the takeovers that were done using them. In fact, he opportunistically arbitraged those deals—shorting the stock of the acquirer and buying the stock of the acquiree. Since Salomon’s bond arbitrage unit made most of the firm’s profits, the firm in fact was an arbitrage machine, and he had a deep affinity and respect for this corner of Wall Street.
Moreover, Buffett’s nostrils had caught the rich warm scent of money, for Gutfreund had the air of desperation. So he said that Berkshire would buy $700 million of Salomon preferred stock, as long as it made fifteen percent.77 Gutfreund ordered his horrified employees to design a security that would deliver to Buffett the kind of returns normally earned only on a junk bond. Over the weekend of Rosh Hashanah, the Jewish New Year, when Gutfreund knew the observant Perelman would be neutralized, Buffett flew to New York, and he and Gutfreund met at Salomon’s lawyers’ offices. Buffett walked in by himself, without a briefcase or even a pad of paper in his hand. Over a handshake, he agreed to buy a preferred stock with a nine percent coupon that would convert to common stock at the price of $38.78
The nine percent yield gave Buffett a premium return until the stock went to $38, when he had the right to convert to equity. So the upside was unlimited. But if the stock went down, he had the right to “put” the security back to Salomon and get his money back.79 The deal worked out to an expected fifteen percent profit, on an investment that carried very little risk.80
The annual dividends on this preferred stock—$63 million—were more than Blue Chip and Berkshire had spent on the Buffalo Evening News and See’s Candies together. Inside Salomon, people were outraged.81 They felt that Gutfreund had dithered on the Minorco request, then called Buffett in desperation, and had to overprice the convertible as a result. And thus, for his huge fifteen percent return, Buffett was, as writer Michael Lewis would later explain, making “only the safe bet that Salomon would not go bankrupt.”82
What the firm had bought with all this money was Buffett’s reputation, which came partly at the expense of Gutfreund’s power. Along with the deal, Buffett and Munger each got board seats. Before signing the papers, Buffett climbed aboard his new jet and flew to New York. He met Munger at One New York Plaza to inspect Salomon.
Standing outside Gutfreund’s office next to the trading floor, he beheld The Room for the first time. Hundreds of disheveled people sweated in front of tiny green screens. Most had phones glued to each ear as they jostled, spat, puffed, and spun their way through multimillion-dollar deals. Curses and screams cut through the low roar that filled the air. Above the scene hung a hazy fog. So many traders calmed their nerves with tobacco, why bother to abstain? Everyone’s lungs were always filled with nicotine anyway.
Munger crossed his arms and turned to Buffett. “So, Warren,” he said. “You really want to invest in this, huh?”
Buffett stood, gazing out through the haze over the pandemonium that he was about to buy. “Mmmm-hmmmm,” he said, after a long pause.83
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