How to sell preferred stock
Warren Buffett explains the rationale behind issuing preferred stock
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the second item of business of this
meeting is to consider the
recommendation for directors to amend
the company certificate of incorporation
the proposed amendment would add a
provision to the certificate of
incorporation authorizing the board of
directors to issue up to 1 million
shares of preferred stock in one or more
series with such preferences limitations
and relative rights as the board of
directors may determine now we discussed
this some in the in the annual report
but I would say and we'll find out the
exact number but I think we probably had
11 or 12 maybe 12 thousand or so shares
voted against the proposal I think we
had a couple thousand shares that I
abstained and since there really is no
downside to the proposal that indicated
to me that that I had not done a very
adequate job of explaining the logic of
authorizing the preferred so I'd like to
discuss that for a minute now and I'd
also like anybody that would like to ask
questions about it they can do so now we
can talk about it later too but if you'd
like to do it before the vote that'd be
fine the authorization is just that it's
an authorization it's it's it's not a
command issue shares it's not a
directive it simply gives the directors
of the company the ability in a
situation or it makes sense for the
company to issue preferred shares to do
so now when we acquire businesses and
I'll tell you about one when we're we're
through with this in a few minutes when
we acquire businesses sometimes the the
seller of the business wants cash
sometimes they would like common stock
and it's certainly possible as one
potential seller did last year that they
wanted in that case a convertible
preferred stock now from our standpoint
as long as the value of the
consideration that we give equates we
really don't care
aside from a question of tax basis we
might obtain but we in in in other
economic respects we don't care what
form of consideration we use because we
will
the value of cash versus a straight
preferred versus a convertible preferred
versus common stock whatever it may be
so if the worry is that we will do
something dumb in issuing the preferred
stock you should that's a perfectly
valid worry but you should worry just as
much we'll do something and dumb in
terms of using cash or the common stock
I mean it's if we're going to if we're
if we're going to do something
unintelligent we can do it with a
variety of instruments and we will not
get more licentious in our behavior
anything but simply because we have they
preferred stock and the preferred stock
I preferred you in this stock may offer
sellers of a business the chance to do a
tax free exchange with us and they may
not want common stock because they may
have an ownership situation where they
don't want to run the risks of common
stock ownership and that's why our
preferred is flexible as to terms
because we could give those people a
straight preferred with a coupon that
made it worth par at the time we issued
it and then they would know what their
income would be for the next ten years
and and that may be of paramount
interest to them we could issue them an
adjustable rate preferred which as money
market conditions change would also
change its coupon and then they would be
sure of a constant principal value for
the rest of their lifetimes and one or
both of those factors could be more
important to one seller or another so
that we simply have more forms of
currency available to make acquisitions
if we have the ability to issue various
forms of preferred because a preferred
stock if it's properly structured allows
for the possibility of a tax-free
transaction with with it with the seller
and that's that's important to many
sellers now in the end many sellers will
prefer cash just as in the past and
probably most of the sellers that don't
want cash will want common stock but we
will have a preferred stock
woman we're only authoring authorizing a
million shares because under Delaware
law there's an annual I think there's an
annual fee I know there's an initial fee
and I think there's an annual fee that
relates to the amount of shares
authorized so if we authorized a hundred
million shares it would we would be
paying at larger annual fee which is
something mr. Munger wouldn't let me do
so what we will do if we issue this we
will issue undoubtedly will oh we will
issue some sub shares so that the number
of shares for taxation purposes is
relatively limited but that we will
issue sub shares to make it easier to
make change essentially in the market we
may issue if the occasion demands we may
issue convertible prefer but that
convertible preferred would not be worth
any more at the time we issue it than a
straight preferred we would adjust in
terms of the coupon and the conversion
price and so on so we we can equate
various forms of currency to fit the
desires of the seller of the business
and this is this is simply one more tool
to do it there's no downside like I say
unless unless we do something stupid and
if we do something stupid with us we
would do something stupid
cash or whatever so it we probably
should have done this some time ago but
we we never had a case of of a seller
wanting that form of currency before and
so it just and and we always thought we
could get it authorized promptly but
there's no reason to lose a couple of
months if a transaction is pending to
call a meeting to get this on the books
so it's simply one more tool and if
there are any if there's anybody that
has any questions or comments on the
preferred like I say you can't hold them
till later but I'd be glad to have them
before we have the boat do we have any
yeah there's a question over there and
if you'll do wait just a second we'll
get a microphone to you
when you ask questions now or later if
you'll give your name and and and and
where you live I'd appreciate it
hi my name is dr. Lawrence Worcester I'm
from New York my question is this if you
want to buy a business and the people
who know business want cash you have to
have cash cash that you know this kind
of cash we're familiar with it yeah
but it's it strikes me that the
preferred isn't really cash it's it's
fiat currency that is its currency that
we can create that's true it's just like
it's like common stock in that respect
it is the it is a form it's an alternate
form of currency and but it is it is
just that in terms of common stock for
example assuming we had enough
authorised we have an unlimited ability
to create currency no if we created at
the wrong price that dilutes the value
of the old currency but go ahead on
until we vote in the affirmative which
I'm sure that this group will probably
do because of their confidence in you
but until we vote in the affirmative it
doesn't exist that is correct well you
were that that would be true
incidentally with common stock if we had
no more authorized common stock out than
we had issued we have I think a million
and a half authorized but let's assume
that we dish udall that we had
authorized until Morrow was authorized
by the shareholders there would it would
not be available to be issued but if
more were authorized by the shareholders
then isn't it true that the value of the
shareholders holding would be diluted
only only if we receive less in value
than we give that's the key to it I mean
if we issue two hundred million dollars
worth of preferred and we receive a
business that's only worth a hundred and
fifty million there's no question you're
worse off than before so are we
incidentally but but we're all we're
soft the and that's true if we give cash
that's worth more for a business than
the business is worth if we give two
hundred million of cash for a business
that's worth 150 million we are worth
soft we may not have issued a share of
stock but we have diluted the value of
your stock if we do that as long as we
get value received in terms of whether
with cash common stock or preferred
stock then you are not diluted in terms
of value it's an important point that
and I and obviously a number of
companies as as you may have Charlie and
I have commented about in reports and
elsewhere a number of companies in our
append
have issued common stock particularly
which has a value greater than what they
receive and when they do that they are
running what I what John Medellin of the
Wachovia called the chain letter in
Reverse and and that's cost American
shareholders a lot of money I don't
think it'll cost them any money at
Berkshire but it's a perfectly valid
worry for shareholders to have because a
management can build an empire but just
by issuing these little pieces of paper
which which they feel don't cost them
anything that I think Charlie had one
story about that in the past I didn't
want to comment on that Charlotte no
names basis of course there was a
particular bank where one of the
officers wanting stock options pointed
out to the management that they could
issue all these shares and it didn't
cost anything
imagine hiring a manager who thinks that
way and paying the money to behave like
Judas at your various and your very
midst we have we have had conversations
with managers where they tell us how
fortunate they feel because the stock is
down and they can issue options cheaper
now if they were issuing those to the
third parties you know I'm not sure I'm
not sure whether they have exactly the
same attitude but we have no feeling
that that we're getting richer when we
issue shares we we have a feeling we're
getting richer when we get at least as
much value in a business as the shares
are worth that we issue and we don't
intend to issue them under any other
circumstances but it's a perfectly valid
valid worry the second part of the
question is that obviously with
preferred issue you have a situation
where the Carmen's shareholder is moves
to the back of the line as it were why
should the Carmen shareholder in this
room want to step to the back of the
line if he's at the front of the line
now well it but it's also true if we buy
a business for cash and let's say we
borrow the money the bank that we borrow
the money from will come ahead at the
common shareholder there's no there's no
question anytime you move you engage in
transactions that involve the capital
structure you are changing the potential
for each part of the capital structure
if you issue a lot of common and you've
got some debt outstanding you've
generally improved the position of the
debt and the question really becomes
whether you think that the position of
the common shareholder is improved by
issuing either preferred stock or
perhaps borrowing a lot of money to make
an acquisition I mean with a couple of
times in the history of Berkshire we've
borrowed money to to buy something if to
buy a business and when we do that we
are placing a bank or an insurance
company or whomever ahead of the
position of the common shareholder we
did that when we issued some some debt a
few years back and and there's a
question of weighing whether the common
shareholders are going to be better off
by by borrowing money but borrowing
money is not necessarily at all harmful
to the shareholders although certainly
if it's carried to excess it is and the
preferred is a form of quasi borrowed
money that does rank ahead of Michigan
the common shareholder but then at the
same time we're adding a business which
we think is going to benefit the sheriff
shareholder if we issue that so that's
the trade-off
