Warren Buffett's Berkshire Hathaway (NYSE: BRK-A)(NYSE: BRK-B) owns about 30.8% of USG (NYSE: USG), which is best known for making wallboard (drywall). Berkshire Hathaway, USG's largest shareholder, has found itself part of a company that's not as eager to sell itself to an interested buyer.
Neither Buffett nor Berkshire have gotten involved in the deal talks, at least not publicly, but Berkshire Hathaway has made it clear that it will publicly support the acquirer in exchange for an $87 million "fee."
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What's going on?
Here's the quick backstory, as detailed in a regulatory filing. A company called Gebr Knauf (I'll refer to it as "Knauf" from now on) wants to acquire USG, a publicly traded company, and Berkshire is its largest shareholder.
On March 15, Knauf sent a letter to USG in which it proposed buying the company for $42 per share. The latter declined to sell at that price, saying it was insufficient. That's standard fare as far as mergers and acquisitions go. The would-be buyer makes a proposal, and the would-be seller says "yes," "no," or "maybe if you pay more."
But this ordinary M&A stuff apparently gets tricky when Buffett and Berkshire are involved as major shareholders in the target company. On March 23, eight days after Knauf offered $42 per share to acquire USG, Buffett and an unnamed Berkshire executive called Knauf with an interesting proposal.
Over the phone, Berkshire offered to sell Knauf an option that would give it the right to acquire all of Berkshire's USG shares for at least $42 each, assuming it could get all the other USG shareholders to agree to sell on the same terms within roughly six months' time. For this option to buy its 30.8% stake in USG, Knauf would have to pay Berkshire a premium of $2 for every share of USG that Berkshire owned, or approximately $87 million in all.
How this could play out
Berkshire has many ways to profit from this stock option proposal. There are only three likely outcomes from Berkshire's pitch to Knauf:
- Knauf pays Berkshire $2 per share for each option, but ultimately fails to reach an agreement to acquire USG within six months for any number of reasons. Berkshire keeps the $87 million option premium as profit.
- Knauf pays Berkshire $2 per share for each option and reaches an agreement to pay $42 or more per share to acquire USG within six months. Berkshire cashes out of its USG stake when the acquisition closes, but it receives a small portion of the price ($2 per share) up front.
- Knauf says "no thanks" to Berkshire and continues to negotiate with USG. Having passed on the options from Berkshire, Knauf risks having to pay a substantially higher price to acquire USG later or missing out on the acquisition altogether.
It's worth pointing out that Berkshire wasn't offering Knauf an ordinary call option, which gives the owner the right to buy stock at a predetermined price. The options would give Knauf the right to acquire Berkshire's USG shares at the same price it ultimately agreed to pay for the whole company.
Thus, if Knauf agreed to acquire USG for $50 per share, it would have to pay Berkshire $48 per share ($50 less the $2 option premium it already paid) to buy its USG stock. Berkshire's proposal didn't risk giving up any upside if Knauf bid more than $42 per share for USG, which makes these options very different from a typical call option.
Berkshire is really throwing its weight around, making it clear that it wants to see a hard offer of at least $42 per share to be a motivated seller, option deal or not.
The Berkshire premium
Buffett often extracts a premium when his firm makes a big investment, but to try to extract a special deal when selling a stake in a company is really extraordinary.
When Berkshire invested $5 billion in Bank of America during the European debt crisis, for instance, Berkshire got a really juicy deal on which it made a fortune. Bank of America got the capital injection it needed, but more importantly, it also scored some credibility from having an investing legend bet billions on its success at a time when bank stocks were almost universally hated.
This USG ordeal is kind of similar, except Buffett is looking to get a premium from a buyer rather than a seller. Knauf could have purchased the options from Berkshire, and then taken the contract to every other USG shareholder, laying the case that if Buffett will sell his stake for $42 per share, then every other shareholder should sell, too. I mean, it is a pretty good pitch. If the greatest investor of all time will sell his stake in USG for $42 per share, then maybe mere mortals should be happy with that price, too.
Cynically, Berkshire was essentially offering to sell Knauf a piece of paper that implicitly said, "We think Knauf is paying full price (if not more) for USG, so you should take the money" signed by Warren Buffett himself. (Berkshire already has too much cash, so it probably isn't inclined to sell any of its holdings unless a buyer is willing to overpay.)
Having Buffett on Knauf's side may help get a deal done quickly, less expensively, or both. Or maybe not. No one can say for sure. But Buffett & Co. wanted to get paid either way, to the tune of $87 million in option premium, for Knauf to be able to count Berkshire in its corner.
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