Berkshire Hathaway to Sell Bond
Investors Must Keep Paying For

NEW YORK -- Convertible investors have purchased zero-coupon bonds, so why not negative-coupon convertibles?

That's the question being put forth by Berkshire Hathaway Inc., which through bookrunner Goldman Sachs is bringing the first known convertible bond that actually makes investors pay to own it.

The $250 million deal, expected to price Wednesday, consists of five-year notes, called "Squarz." The deal also has a $37.5 million overallotment.

Like most convertibles, the hybrid securities are made up of both a bond and a warrant to purchase the company's stock. But these securities have two-way cash flows, with the result being that investor "installment payments" on the warrants will top coupon payments by between 0.5% and 1.0% -- thus the negative coupon.

"The holder pays between 50 and 100 basis points to the issuer in return for a solid bond floor with a serial put," said Ravi Arcot, director of the independent convertible research firm Kynex.

In other words, investors are asked to pay extra for the triple-A rating held by Warren Buffett's investment holding company, as well as the right to put, or sell back, the bonds to the company on a yearly basis.

With such little risk, the securities become a potentially ideal arbitrage instrument for the hedge funds that dominate the convertible market. Hedge funds typically play off the volatility in a company's stock by buying a convertible and shorting the stock.

"I don't see how outright investors are going to buy this," said Mr. Arcot. "Hedge funds will short the stock and try to make money trading the stock."

Price talk on the offering suggests an attractive, low conversion premium of between 12% and 15%. However, volatility on Berkshire's stock may be too low to benefit much from an arbitrage strategy, market participants say.

"It's priced as a volatility play, but it's not that attractive to us," said a hedge-fund manager who doesn't plan to participate in the deal, complaining that the premium should be even lower. "The stock just isn't that volatile to justify the price."

Mr. Arcot agrees, estimating that 90-day volatility on the stock is around 15% to 17%, while volatility would have to be closer to 25% to become truly attractive.

"They're marketing it as an investment-grade credit with a volatile stock, but Berkshire isn't that volatile," said Mr. Arcot, adding, "We'll have to wait and see what investors do."

Write to Tom Barkley at tom.barkley@dowjones.com¹

Updated May 22, 2002