Buffett Faces Losing Dow Stake at $255 Million a Year

Warren Buffett may have no choice but to say goodbye to one of the high-yielding investments that he made during the financial crisis.

Dow Chemical Co. shares recently rose past $53.72 at one point for the first time in over nine years. If the company closes above that price for 20 days of trading in a 30 day window, the chemical maker then has the opportunity to convert the $3 billion preferred stake that Buffett owns into common stock.

Swapping the shares would lower the dividend that Dow has been paying Berkshire Hathaway since they asked Buffett to help finance a Rohm & Haas 2009 takeover. During the credit crisis, Warren Buffett and Berkshire Hathaway went on a deal making spending spree, and lent billions of dollars to companies including General Electric and Goldman Sachs group at historically high rates.

“He built the ark before the storm came up,” said Luke Sims, the chairman of Sims Capital Management, says of Buffett. Having lots of cash during a crisis “and staying power gives you many, many opportunities.”

Buffett’s preferred stake is certainly expensive for the chemical company, especially now that interest rates are near their all time lows. The securities themselves have an 8.5% yield, and this entitles Berkshire Hathaway to $255 million each year in dividends. The sovereign wealth of Kuwait also helped finance the purchase of Rohm & Haas, and they hold $1 billion worth of preferred securities.

Creating Value

“Our desire there obviously is for our share price to continue to appreciate and then convert those into common,” said Bill Weideman, Dow’s Chief Financial Officer during the second quarter earnings conference call. “That is the most value creating option.”

Having the ability to convert those preferred shares would be a major milestone for the Dow CEO Andrew Liveris, who has been under serious pressure this year from Dan Loeb, hedge fund manager, in order to boost the share price of the company. While continuing to defend his strategy, the Dow CEO has increased the dividend of the common stock, and announced more buybacks and even expanded a program to divest the underperforming units in the company.

Greater earnings and actions played a major role in the shares rising in price by 21% this year. This is the third best result out of the 16 company Standard & Poor’s 500 Chemicals Index. The company, based out of Midland Michigan, rose by 3% to close at $53.89 in New York once they beat analysts’ estimates on expanding margins.

Low Costs

The natural gas production boom in the United States since the recession began has lowered the Dow ingredient cost which is how they were able to boost profits. Last year alone, net profit was $4.41 billion, and this is up from $336 million not that long ago in 2009.

Dow shares have gained momentum on Loeb’s push as well as investor anticipation of earnings from their new projects, said a UBS securities analyst named John Roberts during a phone interview. Next year, Dow will look to turn more gas into plastics and chemicals on the Gulf Coast of the United States. They also intend to start their $20 billion Sadara joint venture with Saudi Arabian Oil Co.

“People have come to view the dilution from the preferreds as a manageable issue,” said Roberts, based on the prospect of high earnings as well as share buybacks.

The Kuwait Investment Authority and Berkshire Hathaway would be entitled to 96.8 million shares of common stock, according to the terms listed in the most recent annual report of the chemical maker. All in all, that’s roughly 8% of the weighted average outstanding shares.

As part of a $4.5 billion program looking to reduce the impact of preferred share conversions, Dow has currently repurchased 51 million shares for a total of $2.4 billion, we learned from the CFO Weideman.

Wrigley, Mars

For common shares, Berkshire Hathaway’s annual dividend from the chemical maker would come to be about $107 million based on the current payout structure.

Buffett did not respond to requests for comments.

Some of the other Berkshire Hathaway crisis era investments have also wound down. This past October, Mars Inc. repaid $4.4 billion worth of bonds that were held by Berkshire Hathaway. Buffett had these bonds as a way to help the candy company acquire Wm. Wrigley Jr. Co.

During the very same month, Buffett received common equity stakes in GE and Goldman Sachs in order to settle warrants he had received from deals made five years earlier. Berkshire Hathaway had loaned a combined $8 million to these companies during 2008 in order to help them restore market confidence and shore up capital after the collapse of Lehman Brothers. Both General Electric and Goldman Sachs repaid this money at a premium during 2011.

These redemptions caused the coffers at Berkshire Hathaway to swell during a time when fixed income investments have made historical low yields. Buffett’s response to this has been to pursue acquisitions, just like he did last year when purchasing Nevada’s largest utility company.

“His main goal is to buy more operating businesses,” said Sims, whose firm has Berkshire Hathaway stock, based out of Omaha, Nebraska, as one of its largest holdings. “He’ll find plenty of places to put the money to work.”

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