• Warren Buffett invested an important $3 billion in Dow Chemical at the height of the financial crisis.
  • In return, Berkshire Hathaway received preferred stock with an 8.5% annual dividend.
  • Buffett’s company ultimately made an estimated $3 billion in profits from stock sales and dividends.

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Warren Buffett invested $3 billion in Dow Chemical during the depths of the financial crisis, helping the maker complete a takeover at a time when investors, lenders and companies were running for cover.

Here’s the story of one of Buffett’s standout deals that provided a struggling company with much-needed cash—and a hefty return.

Financial chemistry

Dow agreed to buy Rohm & Haas in July 2008 for nearly $19 billion, including debt, and hired Warren Buffett’s Berkshire Hathaway to help with the financing. The acquisition was part of Dow’s strategy to shift its focus away from commodity chemicals and toward higher-margin specialty chemicals.

Buffett agreed to pay $3 billion in exchange for 3 million shares of Series A convertible preferred stock that paid an 8.5% dividend, or $255 million per year. Preferred stocks often offer higher dividends than common stocks, and holders have priority when it comes to dividend distributions.

Dow had the option, beginning in April 2014, to convert some or all of Berkshire’s preferred stock into common stock at a rate of 24,201 common shares for each preferred share. The maker of chemicals, plastics, agro-scientific products and advanced materials could only do so if its share price exceeds $53.72 in 20 trading days within 30 days.

Side effects

The Dow acquisition turned out to be ill-timed. Lehman Brothers collapsed two months later, leading to a freeze in credit markets, a plunge in asset prices and shock waves that spread through the housing market and the entire U.S. economy.

The chemical giant had planned to cover much of the transaction costs with $9 billion in proceeds from a joint venture with Kuwait’s Petrochemical Industries. However, the state-owned company ended the partnership in December 2008, causing Dow shares to plummet.

“The world collapsed,” Buffett told CNBC in 2017, recalling that Dow had tried in vain to exit its takeover of Rohm and Haas. “We made the deal to buy the stock in April 2009, when the market had already completely collapsed.”

Given the Dow’s slump and its weakened outlook, Buffett paid the equivalent of a dollar for 60 cents, he said.

“We showed up at $3 billion for something that was worth maybe about $1.8 billion at the time,” Buffett noted. “That’s one of the reasons people offer us deals – they know we’ll be there at closing.”

In fact, between 2008 and 2009, Buffett made deals not only with Dow, but also with Goldman Sachs, General Electric, Mars and Swiss Re. He wagered a total of $21.1 billion on these five transactions and ended up securing positions worth a combined $26 billion in 2009, which earned $2.1 billion annually in dividends and interest.

However, the cash-conscious investor sold shares in companies such as 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. He also refrained from capitalizing on some of the tempting opportunities that arose.

“Throughout this entire period, we had these commitments and that stopped me from doing some other things that we could have done at the time – the fact that we had this $3 billion available,” he told CNBC and was referring to the investment by Berkshire Dow.

As for Dow, Buffett’s money and his vote of confidence helped allay fears on Wall Street that the company had received more than it could handle and was headed for bankruptcy.

“The stake 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 he had massively overpaid, but the deal he negotiated was still lucrative.

“These preferred shares offer a lot,” Ahmen said. “For purely financial reasons, I would like to knock him out.”

generate profit

Dow paid Buffett excessive dividends for more than seven years. In December 2016, the company finally converted Berkshire’s preferred shares into 72.6 million shares of common stock, freeing itself from the costly obligation.

Buffett and his team had no interest in owning Dow’s common stock, so they prematurely sold all the shares they were supposed to receive. Dow repurchased the stock on December 30 and Berkshire had exited the position entirely by the end of the next day.

Berkshire made a profit of about $1 billion from the sale of Dow shares, Buffett told CNBC. The company also received a total dividend of over $1.8 billion from its preferred stock. This gave Buffett a pre-tax return of about $3 billion, which is about twice what he invested.

Dow’s then CEO, Andrew Liveris, tipped his hat to Buffett.

“He has done a very good job with this investment, just as he did at Goldman and elsewhere,” he told Reuters. “He was incredibly valuable during the crisis.”

Source : markets.businessinsider.com

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