Warren Buffett’s Occidental death spiral deal

Warren Buffett wouldn’t stoop to a borderline-legal financing technique associated with penny-stock financiers.

Berkshire Hathaway CEO Warren Buffett Picture: AFP

Warren Buffett wouldn’t stoop to a borderline-legal financing technique associated with penny-stock financiers.

Yet, while it was never his ­intention, Berkshire Hathaway might wind up with a chunk of discounted shares in Occidental Petroleum in a pattern similar to so-called death-spiral financing. The technique involves a company that is unable to raise public equity directly and instead issues debt privately to an outside source; the debt becomes convertible into stock for a fixed dollar amount rather than a fixed number of shares. The share price declines in anticipation of dilution, giving the financier much of the company.

Last year, Occidental found itself in a bidding war with much-larger Chevron for Anadarko Petroleum. To win and to avoid having its own shareholders vote to approve it, Occidental paid for much of the $US37bn purchase with $US10bn in preferred stock bearing an 8 per cent coupon issued to Berkshire. While perpetual and not convertible, dividends can be paid in common stock at a 10 per cent discount. A year ago, when Occidental’s bidding war was heating up, its market value was $US50bn. Now its $US12bn ($19.5bn), it has slashed its dividend and capital expenditures and its debt prices signal distress.

A logical but painful way of staying afloat is to pay Buffett in shares at next week’s dividend declaration. Occidental can do so at 90 per cent of the volume-weighted average price of Occidental’s shares for 10 days after the declaration. At today’s price, paying the next four quarterly dividends in discounted stock would give Berkshire 7.3 per cent of the company.

Occidental also could axe its remaining common dividend and defer quarterly payments on the preferred shares, but then it would owe Berkshire dividends on the unpaid amount that compound ad infinitum. Even Buffett wasn’t oracular enough to see this year’s coronavirus-­induced oil-price collapse, and if there were a market price for his preferred stock then it would trade below par value. But he was smart enough to throw Occidental a costly lifeline.

The ideal outcome for Berkshire would be for Occidental to remain on the ropes long enough to give the conglomerate a chunk of a once-great oil company at a bargain price.