DOW Dow Inc

By David Benoit and Nicole Friedman 

Dow Chemical Co. finally gained the right to convert $4 billion of preferred stock into common shares, ridding the company of an expensive burden and depriving Warren Buffett of another lucrative crisis-era investment.

A recent rally in Dow stock on Thursday triggered a clause allowing the chemical giant to convert the shares. That will enable the company to start keeping $255 million it has been sending to Mr. Buffet's Berkshire Hathaway Inc. every year, and another $85 million owed to Kuwait's sovereign-wealth fund, which owns $1 billion of the shares.

The Midland, Mich., company plans to call for the conversions immediately, and should complete them over the next week or so, people familiar with the matter said. They will hand Berkshire roughly 6% of Dow's common stock, while Kuwait gets about 2%. It isn't clear what the investors will do with the new shares, but Mr. Buffett has indicated he's a seller.

Dow would have to pay out about $180 million a year in ordinary dividends on the common stock, but investors and analysts have been waiting eagerly for the conversion as the move is expected to free up capital for other uses.

Dow sold the stakes in 2009 to help pay for its purchase of Rohm & Haas Co., a roughly $15 billion deal struck in the summer of 2008 that was aimed at expanding the company's presence in high-margin specialty chemicals. The deal soured when sales took a hit from the financial crisis and the debt it added proved burdensome. Dow had agreed to pay Mr. Buffett and the Kuwait Investment Authority 8.5% interest, or a total of $340 million annually. That's yielded Berkshire more than $1.5 billion -- or as Mr. Buffett likes to say, $8 a second.

From 2008 to 2011, Berkshire shelled out roughly $25 billion for preferred securities of Dow, Bank of America Corp., General Electric Co., Goldman Sachs Group Inc., insurer Swiss Re and gum maker Wm. Wrigley Jr. Co. In exchange for generous terms, the famed investor would lend critical support for a company or a deal it was trying to pull off. At the end of 2009, Berkshire held preferred shares in five companies that paid an aggregate $2.1 billion a year in dividends and interest.

"Berkshire was in effect, on the corporate side, the lender of last resort in 08-09," said David Kass, a finance professor at the University of Maryland's Robert H. Smith School of Business and a Berkshire shareholder. "It certainly worked out well for Berkshire."

It isn't hard to see why companies are eager to shed such investments while Mr. Buffett is eager to hold on to them.

Swiss Re, GE and Goldman redeemed their preferred stock in 2010 and 2011, and Mars Inc. earlier this year bought Berkshire's stake in Wrigley, which Mr. Buffett had helped the candy maker buy in 2008. Berkshire still holds preferred stock of Bank of America, a $5 billion investment that came in 2011 as the bank grappled with continued fallout from the financial crisis. Berkshire also holds preferred stock in Burger King parent Restaurant Brands International Inc., which it helped with financing the buyout of coffee chain Tim Hortons Inc. in 2014.

Mr. Buffett has called the redemption of preferred shares "decidedly negative."

Dow was able to force the conversion starting in April 2014 as long as its stock closed above $53.72 in 20 of 30 trading days. While the stock occasionally breached the figure, as it did last December and this August, it never did so for long enough.

One Yale Law School professor studied the pattern and concluded there was less than a one-in-a-thousand chance the stock's failure to trip the trigger was random.

Dow itself has suspected someone was shorting the stock at around $53 and keeping it from breaching the trigger level for long enough, people familiar with the matter have said.

Under the original agreement, Berkshire was only forbidden from engaging in short selling or hedging its preferred stake until April 2014. Mr. Buffett has declined to comment on whether he or his deputies were shorting Dow stock.

The company has said it had no evidence or knowledge Berkshire was doing so.

Dow's earnings and margins have been improving and last year it struck a landmark deal with rival DuPont Co. that would combine the two and then break them into three new companies if regulators approve.

Amid that and the powerful rally that followed the presidential election, Dow stock has now finally stayed above the threshold for 20 days. Dow stock closed Thursday at $58.35, up just over 1% and at an all-time closing high.

"Converting just in time for the holidays!" Wells Fargo analyst Frank Mitsch wrote in a report this week, boosting his view on Dow stock's worth to $66-$68. "We conclude that the conversion creates material value through cash flow generation and opportunities for investing or buying back shares."

The conversion will make Berkshire Dow's second-largest common-stock holder behind index-fund giant Vanguard Group. But that may not be the case for long.

"Would I rather own Dow...than any other stock?" Mr. Buffett said on CNBC in February. "If that were the case then I would have been buying it already."

Write to David Benoit at david.benoit@wsj.com and Nicole Friedman at nicole.friedman@wsj.com

(END) Dow Jones Newswires

December 15, 2016 16:31 ET (21:31 GMT)

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