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Warren Buffett invested a crucial $3 billion in Dow Chemical at the height of the financial crisis.
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In return, Berkshire Hathaway received preferred stock with an annual dividend of 8.5%.
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Buffett’s company ultimately made an estimated $3 billion in profits from stock sales and dividends.
Warren Buffett put $3 billion into Dow Chemical at the height of the financial crisis, helping the manufacturer complete a takeover at a time when investors, lenders and companies were running for cover.
Here’s the story of one of Buffett’s signature deals, which brought an ailing company some much-needed cash – and earned him healthy returns.
Financial chemistry
Dow agreed to buy Rohm and Haas in July 2008 for nearly $19 billion including debt, and brought in Warren Buffett’s Berkshire Hathaway to help with the financing. The acquisition was part of Dow’s strategy to shift its focus from bulk chemicals to higher-margin specialty chemicals.
Buffett agreed to put up $3 billion in exchange for 3 million Series A convertible preferred shares, which pay an 8.5% dividend, or $255 million per year. Preferred stock often offers larger dividends than common stock, and holders have priority when it comes to dividend payments.
Dow had the option as of April 2014 to convert some or all of Berkshire’s preferred stock into common stock, at a ratio of 24.201 common shares for each preferred share. The maker of chemicals, plastics, agricultural products and advanced materials would only be able to do this if its stock price exceeded $53.72 for 20 trading days in a 30-day period.
Opposite reaction
The acquisition of Dow turned out to be poorly timed. Two months later, Lehman Brothers collapsed, causing credit markets to freeze, asset prices to plummet and shock waves to reverberate through the housing market and the broader U.S. economy.
The chemical giant planned to cover much of the deal’s costs with $9 billion in proceeds from a joint venture with Kuwait’s Petrochemical Industries. However, the state-owned company scrapped the partnership in December 2008, causing Dow shares to plummet.
“The world fell apart,” Buffett told CNBC in 2017, recalling Dow trying and failing to pull out of its acquisition of Rohm and Haas. “We closed the deal to buy the stock in April 2009, by which time the market had completely disintegrated.”
Given the collapse of the Dow stocks and the weaker outlook, Buffett had to pay the equivalent of a dollar for 60 cents, he said.
“We came up with $3 billion for something that was worth maybe $1.8 billion at the time,” Buffett said. “That’s one of the reasons people offer us deals: They know we’ll be there at the closing.”
Between 2008 and 2009, Buffett signed deals with not only Dow, but also Goldman Sachs, General Electric, Mars and Swiss Re. He bet a total of $21.1 billion on these five trades, securing positions worth a total of $26 billion at maturity. 2009, which generated $2.1 billion annually in dividends and interest.
However, the money-conscious investor sold shares of companies like Moody’s, Procter & Gamble and Johnson & Johnson to finance the deals and avoid depleting Berkshire’s cash reserves, which fell below $20 billion in April 2009. the tempting opportunities that presented themselves.
“During that whole period we had these commitments and that kept me from doing some of the other things that we could have done at the time – the fact that this $3 billion was going out the door,” he told CNBC, referring to Berkshire’s investment in Dow.
As for Dow, the money and the show of confidence from Buffett helped allay fears on Wall Street that the company had bitten off more than it could chew and could end up in bankruptcy.
“The bet was taken at a time when Dow was really desperate,” Hassan Ahmed, then an analyst at Alembic Global Advisors, told Reuters in 2010.
Buffett may have felt like he paid way too much, but the deal he negotiated was still lucrative.
“Those preference shares yield a lot,” says Ahmen. “Purely on a financial basis I would like to take him out.”
Produce profit
Dow paid super-sized dividends to Buffett for more than seven years. In December 2016, the company finally converted Berkshire’s preferred stock into 72.6 million shares of common stock, freeing itself from the costly liability.
Buffett and his team had no interest in owning Dow common stock, so they sold all the shares they would receive in advance. Dow bought back the shares on December 30, and Berkshire was completely out of position by the end of the next day.
Berkshire made about a billion dollars in profit from selling the Dow shares, Buffett told CNBC. The company also collected more than $1.8 billion in total dividends from its preferred stock. As a result, Buffett earned about $3 billion before taxes, which is roughly double what he invested.
Then-Dow CEO Andrew Liveris tipped his hat to Buffett.
“He did very well with that investment, just as he did at Goldman and elsewhere,” he told Reuters. “He was incredibly valuable during the crisis.”
Read the original article on Business Insider
