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Berkshire investment in Occidental is unusual for the normally 'friendly' Buffett

Key Points
  • Berkshire Hathaway's deal to put cash into Occidental Petroleum is a big assist in its effort to buy Anadarko, but it is also an unusual entry by Warren Buffett's firm into a competitive takeover battle.
  • Buffett has said he does not want to do hostile tenders, but his firm would be helping to bankroll the Anadarko bid with an investment that is contingent on completion of the deal.
  • Occidental has topped a bid by Chevron for Anadarko and is in talks with Anadarko, though its board for now is supporting the Chevron bid.
Warren Buffett, Chairman and CEO of Berkshire Hathaway.
David A. Grogan | CNBC

Berkshire Hathaway's deal to put cash into Occidental Petroleum is classic Warren Buffett, but it is also unusual in that Berkshire is assisting what could be viewed as a hostile takeover bid, something it has mostly shied away from in the past.

Berkshire and its chairman and CEO, Buffett, have veered away from using Berkshire's vast cash resources to do hostile deals. Two years ago, Kraft Heinz, which was backed by Buffett and private equity firm 3G, withdrew from an uninvited bid for Unilever because of Buffett's aversion to hostile deals.

In this case, Berkshire will invest $10 billion in Occidental in exchange for 100,000 shares of cumulative perpetual preferred stock, contingent on Occidental's successful acquisition of Anadarko. The deal also includes warrants to buy 80 million shares of Occidental common stock.

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"The hostile component, the bidding component is a little strange. Berkshire has said in the past they don't participate in auctions," KBW analyst Meyer Shields said. Shields said Berkshire did join Validus Holdings in trying to disrupt Allied World Assurance's bid for Transatlantic in 2011, but it didn't win.

"Berkshire Hathaway has a ton of cash and they've shown they don't find that valuations have been terribly compelling. There's been reluctance to buy stuff that's out there. ... It's 10% or less of its current cash, so why not?" Shields said.

No 'appetite for unfriendly deals'

By buying into a possible combined Occidental and Anadarko, Berkshire is making a big bet on U.S. shale. Both companies have holdings in the Permian Basin. Occidental has bid $38 billion in stock and cash for Anadarko, topping an earlier bid by Chevron. Anadarko has entered negotiations with Occidental, but its board so far still supports the Chevron deal.

Buffett told shareholders just last year that Berkshire doesn't have an appetite for unfriendly deals. "Well, we will not make hostile tenders ourselves. I do not believe that there's anything fundamentally wrong with the idea. I mean, if you take the Fortune 500 companies, I'm sure that all 500 are not managed by the best, or in some cases even the friendliest to investor managements in the world," he said.

Buffett also said he doesn't think it's "evil or anything to conduct a hostile offer for a company. It's just we won't do it, and we don't want to get into that," he said. Buffett said he prefers to be liked by the managements of companies he invests in because the managers will continue to run their companies. Berkshire has taken a few rare positions against managements, including one when it withheld its vote for a Coca-Cola compensation plan that Buffett viewed as excessive.

Shields said the investment in Occidental may be viewed as less hostile now that it's in talks with Anadarko, but it is still a competitive bidding situation. In essence, Berkshire would be acting as a banker of sorts for the combined company, not actually a party to the bidding. Still, its financial support has strengthened Occidental's stock and cash bid.

Analysts have expected Chevron to return with another bid for Anadarko, even one that undercut Occidental on price, but on Tuesday its stock bounced, signaling that the market viewed Occidental as now having the upper hand. Occidental, before the promise of Berkshire cash, was seen as a weaker bidder, both because its stock was a less attractive currency than Chevron's and because its deal was contingent on asset sales. The company would also be more levered as a result.

So far, Chevron is sticking with its deal. "We believe our signed agreement with Anadarko provides the best value and the most certainty to Anadarko's shareholders," the company said.

Shields said Berkshire, which has its own large energy portfolio, might even be considering a role in the sale of Anadarko assets, which could include Anadarko's deepwater and liquefied natural gas holdings. Berkshire's holdings include MidAmerican Energy, which has diverse energy assets like pipelines, electric transmission and wind energy investments.

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The funding for Occidental is just a warmup to some very big acquisition by Berkshire. Buffett said recently on CNBC that a big one recently got away, and he was very close to making a very large acquisition in the fourth quarter but the deal fell apart.

"Berkshire has $90+bn of cash available for acquisitions to supplement organic growth, which we would expect to be immediately accretive to EPS. Mr. Buffett recently said the company was contemplating a large acquisition which did not come to fruition. We don't know what type of company it was, but this means Berkshire remains open to large deals," wrote Barclays analyst Jay Gelb recently.

Shields also said the big deal could be in any industry, and Buffett is not necessarily signaling a large energy buy. "That could be almost anything. It could be energy but when we're talking about over 100 billion in cash and they're putting $15 billion into this deal. That leaves a lot of dry powder for other things," he said.

Berkshire's interest in Occidental is not unusual for Buffett. Going back to the financial crisis, he put cash into companies like Goldman Sachs and GE, though for very different reasons.

"There haven't been dozens and dozens of these deals," Shields said. "Berkshire was able to lend money at very attractive terms ... from that standpoint it's not that unusual. Obviously, you have to be of the size of Berkshire to have these opportunities available."

The fact that the Occidental investment includes preferred stock makes it particularly attractive since it provides Berkshire with a coupon without the exposure of common stock volatility, Shield said. The preferred stock will accrue dividends at 8% per year, and it is redeemable in 10 years at a redemption price equal to 105% of the liquidation preference and any accumulated and unpaid dividends. Dividends can be paid in cash or Occidental common stock.

Berkshire also would receive warrants to buy up to 80 million shares of Occidental common stock at a price of $62.50 per share. Occidental was trading Tuesday at $59, off about 1.8%.