Fresh Signs of Recovery Or Just Opportunism?

By Heather Landy and Thomas Heath
Washington Post Staff Writers
Thursday, September 25, 2008

In a market largely paralyzed by a credit crunch and a crisis in confidence, there are stirrings of activity by deep-pocketed investors.

In the past week, Warren E. Buffett put up nearly $10 billion to acquire Constellation Energy Group and a stake in Goldman Sachs. Japan's largest bank company has agreed to invest billions of dollars in Morgan Stanley. Private-equity firms, meanwhile, are lining up funds so they can pounce on assets that are priced to move quickly.

The renewed dealmaking suggests that a few big investors are ready to brave the markets again.

"When history is written, this could be seen as the turning point," said David Rubenstein, co-founder of the Carlyle Group, a Washington private-equity firm with $40 billion in cash that it would like to put to work.

With the markets searching for direction, investors are debating whether the recent crop of deals should be viewed as bellwethers for a recovery or as opportunistic exploits by select buyers who can wrangle good terms in exchange for taking on risk.

"Nobody is smart enough to call the absolute bottom, but when you see a lot of smart money like this coming in, it's a pretty good indication that you are near that bottom," said Frederic V. Malek of Thayer Capital Partners, a private-equity firm that buys and operates hotels.

Keith Trauner, a portfolio manager at Fairholme Capital Management, said the latest batch of deals is probably more reflective of the sharp drop in asset values than of a surge in optimism about the markets.

"When you see Buffett do a deal for Constellation and Goldman Sachs, it's not so much a bet that things are about to turn on a dime. It's simply saying that a couple things that he understands and that make sense have popped onto the radar screen," said Trauner, whose firm holds shares of Berkshire Hathaway, Buffet's company.

Donald Marron, founder of Lightyear Capital, a New York investment firm specializing in the financial sector, said he expects to see more such investments in coming weeks.

"There is a lot of capital throughout the world in many more hands than it used to be, and they are looking for opportunities," said Marron, who is a former chairman of Paine Webber Group.

Whatever the motives, the intentions of Buffett and other buyers may not matter as much as the market's interpretation of them.

"Maybe even more than the federal bailout program, it could help as a sort of self-fulfilling prophecy," said Lawrence Cunningham, a George Washington University law and accounting professor who has written several books about Buffett.

Buffett for decades has provided a seal of approval to the firms brought into the fold of his Berkshire Hathaway, a holding company. His $4.7 billion bid for Constellation Energy, owner of Baltimore Gas & Electric, prompted a competing bid by a French company. His $5 billion investment in preferred shares of Goldman Sachs, announced Tuesday after the close of trading, helped send the firm's stock up by more than 6 percent in Wednesday's session.

Buffett followers said both deals fit the Omaha native's style of value investing in brand-name businesses that he understands.

He picked up Constellation Energy for half of what it had been worth a week earlier after financing concerns knocked down the company's stock. And he will collect a 10 percent dividend on his preferred shares of Goldman Sachs -- and a 10 percent premium if the firm ever decides to buy them back from him.

Buffett also got in-the-money warrants giving him the right to buy as much as $5 billion of Goldman Sachs's common shares at $115 apiece. The stock closed Wednesday at $133.

Smart trading bets helped Goldman Sachs avoid much of the suffering unleashed on Wall Street by the subprime mortgage crisis. But the firm was stung in recent weeks by broader concerns about the ability of securities firms to refinance their heavy debt loads.

Robert Millen, a portfolio manager with Jensen Investment Management, said he doubts that Buffett would have pumped cash into Goldman Sachs if he did not expect Congress to approve a proposed $700 billion bailout designed to relieve banks of bad debts.

"Buffett likes to invest when risk is lower, and I think he sees the rescue plan as taking a lot of risk off the table," Millen said.

Buffett, who sits on the board of The Washington Post Co., declined to comment for this story. He told CNBC yesterday, "If I did not think the government was going to act, I would not be doing anything this week."

The rescue plan, if it is approved, could unleash a new wave of buying by investors willing to take battered mortgage securities off the hands of the federal government.

"We and other private-equity firms that have a lot of experience in buying assets and valuing mortgages and securities will probably have teams of people and dedicated funds to buy these securities," said Carlyle's Rubenstein.

David Dupree, chief executive of Halifax Group, another Washington private-equity fund, said he's also getting ready to make investments. But he said he plans to stick to recession-resistant industries such as health-care and homeland-security firms.

"We are going to be extremely patient," Dupree said. Any investment has "got to be a little high and just on the edge of the plate. It's got to be a home run pitch."

The rising cost of credit has fundamentally changed the private-equity business. Instead of borrowing money at relatively low rates, private-equity firms must put up more of their own equity into deals. Carlyle used its cash to cover half of its $2.5 billion purchase of Booz Allen Hamilton's government business earlier this year.

The prospect of putting up more cash has not necessarily dampened investment firms' enthusiasm for fresh opportunities.

"The best private-equity investments generally occur during the bottom of the cycle, and right now we see tremendous opportunities in the market," said Peter Rose, a spokesman for Blackstone Group, a publicly traded private-equity firm. "We think some assets will be priced low, and we are actively seeking those out."

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