Investors who are fed up with Berkshire Hathaway's (NYSE: BRK-A) (NYSE: BRK-B) ever-increasing cash stockpile just got a reason to smile.
Berkshire Hathaway is making a $10 billion investment in oil company Occidental Petroleum (NYSE: OXY) to help the company acquire Anadarko Petroleum (NYSE: APC). This is the largest investment Berkshire Hathaway has made in some time. However, this isn't just a common stock investment, so here's a rundown of what investors need to know.
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Some details on this investment offer
In exchange for the $10 billion, Berkshire is going to receive preferred stock that pays an annual dividend of 8%. So Berkshire is set to receive $800 million in annual income from the investment.
In addition, Berkshire will have warrants to buy as many as 80 million shares of Occidental for $62.50 per share. Some simple math tells us that this essentially gives Buffett the option to convert half ($5 billion) of his investment into common stock at this predetermined price.
The investment is contingent on the completion of Occidental's proposed acquisition of Anadarko. Occidental recently topped Chevron's (NYSE: CVX) bid for Anadarko by offering $38 billion for the company — a $5 billion premium to Chevron's offer. Anadarko is still considering Occidental's offer while its agreement with Chevron is in place. It's also possible that Chevron could choose to increase its $33 billion bid.
In many ways, this investment is right up Berkshire's alley. The company has no shortage of energy-related investments, both in its stock portfolio and in its collection of wholly owned subsidiaries. And the investment structure where Berkshire receives a combination of preferred stock and warrants isn't anything new.
What makes this investment rare is that Buffett seldom gets anywhere near bidding wars. Just a couple years ago, Buffett immediately walked away from a major utility acquisition when he was outbid.
This sounds eerily similar to another Buffett investment
Warren Buffett has used the preferred stock and warrant structure in making deals before. In fact, that's exactly how Bank of America (NYSE: BAC) became one of the largest positions in Berkshire's stock portfolio.
In the wake of the financial crisis, Buffett decided to invest $5 billion in Bank of America. This investment was for preferred stock that paid Berkshire a 6% annual dividend, and also came with warrants to buy 700 million shares of the bank for $7.14 each.
The deal turned out to be one of Buffett's most successful investments of all time. As of this writing, Bank of America trades for about $31 per share, more than four times the exercise price of Buffett's warrants.
While I'm not saying that Occidental's stock price is going to quadruple in the next few years, the point is that Buffett is a master dealmaker. Just as in the case of Bank of America, even if the common stock doesn't go anywhere, Buffett locked in a nice income stream no matter what, and some serious upside potential if things go well.
Finally! A significant investment for Berkshire
To be clear, this investment isn't finalized yet. Occidental's acquisition of Anadarko is far from a sure thing, and if it doesn't go through, this investment opportunity will almost certainly disappear.
Even so, Berkshire Hathaway shareholders should interpret this as good news. The company managed to find a place to invest a significant amount of money at a strong guaranteed return, with potential for even more upside in the future.
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Matthew Frankel, CFP owns shares of Bank of America and Berkshire Hathaway (B shares). The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.