Buffett's Net bet on Amazon junk may yield treasure

OMAHA, Neb. — Billionaire investor Warren Buffett praised Amazon.com in July for its decision to account for stock options as an expense, saying it took "particular courage" and would be "recognized and remembered."

A week later, Buffett bought $98.3 million of the company's junk bonds.

Geico, the auto-insurance unit of Buffett's Berkshire Hathaway, stands to make a $16.4 million profit on the investment in high-risk, high-yield debt if Seattle-based Amazon, the world's largest Web merchant, repurchases the 10 percent senior notes next month, as some analysts predict.

That would be an almost 17 percent return for an investor who avoided Internet investments during the 1990s tech boom.

If Buffett hits his payday, he will have demonstrated — again — his ability to make money at a time when he considers stocks overpriced. Berkshire boosted its junk-bond holdings sixfold in 2002 to $8.3 billion, buying securities in industries that the billionaire had previously shunned, including telecommunications.

"It just proves again that Buffett is usually one step ahead of everyone else," said Jake Dollarhide, a money manager at Fredric E. Russell Investment Management, which owns about 700 Berkshire shares.

Geico, whose portfolio is controlled by Louis Simpson, bought 109,239 of the 10 percent discount notes for $900 per $1,000 face amount, according to a filing with the National Association of Insurance Commissioners, which monitors insurers' financial reports and solvency.

The bonds are redeemable next month at $1,050 each, which means Geico's return would be 22 percent on an annualized basis.

The bonds were sold in 1998 with no interest to be paid for five years. Amazon already has redeemed $266 million of the notes.

By calling the remaining $264 million, Amazon would eliminate the $26.4 million of annual interest costs it must start paying in November.

Amazon.com had $1.3 billion of cash and marketable securities at the end of last year and may repurchase the notes when they are callable on May 1, analysts said.

"It's probably in Amazon's best interest to redeem the debt because of the low-interest-rate environment," said Stephen Ardizzoni, who helps to manage $500 million of high-yield bonds at SMH Capital Advisors and previously owned Amazon bonds.

Buffett also bought $60.1 million of Amazon.com's 6 7/8 percent convertible bonds in August, making Berkshire the second-largest holder of the issue behind Capital Research and Management, according to Bloomberg data.

Buffett, who says he uses Amazon to buy books, sent Amazon President and Chief Executive Officer Jeffrey Bezos a letter in late July praising the company's decision on stock options. Buffett has championed expensing of options, saying it will boost investor confidence.

"It took particular courage on your part, and that will be recognized and remembered," Buffett wrote in a July 24, 2002, letter to Bezos that was obtained by Bloomberg News. "If I could show my appreciation by stepping up my book orders, I would. But you're already getting all of my business."

Buffett has previously purchased debt of a company whose CEO he admired. In 1987 he bought $700 million of convertible debt of Salomon. Buffett said, at the time, he was impressed by the integrity and ability of Salomon's John Gutfreund.

Buffett's investment in Amazon.com debt is a rare move into the Internet arena for him. He has stayed away from technology stocks, saying they were too high priced and that he didn't understand the Web well enough.

"The number of failures will far outweigh the number of successes" among Web companies, Buffett said in April 2000. Six months later, he said that Internet stock values show that "the ability to monetize shareholder ignorance has probably never been exceeded."

Buffett's disdain for unprofitable technology companies led him to look elsewhere for investments. In his 2000 letter to Berkshire shareholders, he wrote: "We have embraced the 21st century by entering such cutting-edge industries as brick, carpet and paint. Try to control your excitement."