If you are wondering why Goldman Sachs and Morgan Stanley jumped at the chance to take a piece of the government’s bailout fund despite having to pay a 5% dividend and offering covertible preferred stock, just take a look at how much they were paying in the private markets.
BreakingViews analysed who is paying the most for the capital raised this fall, and concludes that Morgan Stanley and Goldman Sachs are at the top of the cost of capital league tables. Each is paying around 17 cents for each dollar raised.
Morgan Stanley is paying a headline 10% dividend for 9 billion from the Japanese Mitsubishi UFJ, most of it in perpetual convertible stock. The converts turn into shares priced at 25.25 when Morgan Stanley stock hits 37.88. At that point, the Japanese get a 50% capital gain. The big question is how long it will take to get there. Well one approach is to assume the shares which traded at 18.10 just after the deal was announced rise by 10% a year. It would then take roughly seven years to hit the strike price. Amoritise that capital gain over the seven years and that amounts to an extra 7% a year, bringing Morgan Stanley effective rate to 17%.
Goldman Sachs isn’t far behind, effectively paying almost 17%25 for its capital. Goldman sold Warren Buffett 5 billion of perpetual preferred shares with a 10% coupon and gave him warrants over five years for another 5bn of common shares. Using a standard Black-Scholes option model with 35% volatility, the warrants were at the time worth 2bn. Netting that off, Buffett’s effective cost was only 3bn. Given that he will receive 500m a year from the prefs, the effective rate is 17%.
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