Berkshire's Ownership of Occidental Exceeds 20%
Accounting treatment for 20% positions has varied over the years, as we can see from the cases of BNSF, Moody's, DaVita, Kraft Heinz, and American Express
On July 21, I published Buffett's Bet on Occidental Petroleum which provides an overview of Berkshire’s accumulation of Occidental common stock in recent months along with a description of Berkshire’s holdings of Occidental preferred stock and warrants. It looks like $60 per share is about the upper limit that Warren Buffett is willing to pay for Occidental stock, most likely because Berkshire also holds warrants to purchase up to $5 billion of Occidental stock at a price of $59.42 per share.
When Occidental stock declined below $60 on August 4, Mr. Buffett resumed his purchases. In total, 6,681,669 shares were purchased for $390.7 million over three days according to a Form 4 filed with the SEC on August 8. The exhibit below shows the recent purchases along with a running total of shares purchased and the total cost.
The shares purchased from August 4 to 8 were at an average cost of $58.48. The overall position of 188,366,460 shares were purchased at an average cost of $52.80 for a total of just under $10 billion.
Although Mr. Buffett has been buying Occidental stock for months under $60, market participants seem perennially surprised when new purchases are reported. Occidental stock promptly shot up well above $60 on August 9 and this most likely stopped Mr. Buffett’s buying for now.
The exhibit below shows all of Berkshire’s purchases of Occidental common stock grouped by the day of the purchase:
Accounting for 20% Positions: Prior Examples
Berkshire now owns 20.2% of Occidental’s common stock outstanding based on the most recent share count reported by Occidental in its latest 10-Q. As I described in quite a bit of detail in the July article, although there is little economic difference between owning 19.9% of a company and owning 20%, exceeding that threshold can trigger an important change in accounting.
The equity method of accounting is used when a company has a “significant influence” over an investee. What is significant influence? According to the PricewaterhouseCoopers US IFRS & US GAAP guide, significant influence is presumed to exist for investments of 20% of more in common stock.
I won’t repeat the contents of the July article which explained how the equity method of accounting affects the financial statements. For this article, I thought it would be interesting to look back at Berkshire’s history to see how management has dealt with the accounting treatment of investments when the 20% ownership level is exceeded.
Berkshire acquired 48 million shares of Moody’s common stock in 2000 and held its ownership at that level for the next eight years. During those years, Berkshire accounted for its investment in Moody’s as an available-for-sale equity security carried on its books at the quoted market value. However, over a period of several years, Berkshire’s percentage ownership interest in Moody’s steadily increased due to share repurchases by Moody’s. As of December 31, 2008, Berkshire’s interest in Moody’s was 20.4% and the equity method of accounting was adopted.
During the third quarter of 2009, Berkshire sold shares of Moody’s stock brining its ownership interest to under 20%. As a result, Moody’s shares were no longer accounted for under the equity method as of the third quarter of 2009.Berkshire currently owns approximately 13.4% of Moody’s common stock, well below the threshold for equity method accounting.
Burlington Northern Santa Fe
Berkshire began acquiring shares of Burlington Northern Santa Fe (BNSF) in 2006 and accounted for its investment as an available-for-sale security until the third quarter of 2008. In the fourth quarter of 2008, Berkshire acquired additional shares of BNSF which brought its ownership interest to 20.7%. During that quarter, Berkshire began to use the equity method of accounting for BNSF.
On November 9, 2009, Berkshire entered into an agreement to acquire BNSF and the acquisition was completed on February 12, 2010 in a deal involving both cash and the issuance of Berkshire shares. In the case of BNSF, equity method accounting was used starting in 2008 and in 2009 prior to acquisition of the entire company in 2010.
Berkshire began accumulating shares of DaVita in 2011 after Ted Weschler joined Berkshire as an investment manager. Mr. Weschler has a long history with DaVita as discussed in my recent article, DaVita: An Essential Provider of Dialysis Services.
Berkshire’s purchases of DaVita stock did not initially result in a 20% position in the company. However, since DaVita has been a regular repurchaser of its own stock over the years, Berkshire now owns approximately 39.5% of DaVita. In addition, Mr. Weschler personally owns approximately 2.2% of DaVita.
Despite Berkshire’s very significant ownership interest in DaVita, the investment is carried as an available-for-sale security rather than as an equity method investment because agreements between the company limit Berkshire’s influence over DaVita.
In 2013, Berkshire entered into a standstill agreement which prevented Berkshire from increasing its ownership interest beyond 25% through new purchases. On February 9, 2022, the standstill agreement was revised. Berkshire agreed that it would “cause any share of voting stock that it beneficially owns in excess of 40% to be voted in accordance with the recommendation of the Company’s Board of Directors.”
In 2013, Berkshire and 3G Capital acquired the H.J. Heinz Company. Although Berkshire provided the majority of the total financing for the acquisition, Berkshire and 3G were equal partners in the ownership of the common stock of Heinz.As a result, Berkshire began accounting for its 50% investment in the common stock of Heinz using the equity method from the inception of the investment in 2013.
In 2015, Kraft Foods and Heinz agreed to a merger and Berkshire’s ownership interest in the combined company was 27%.Berkshire has maintained its investment in Kraft Heinz ever since and continues to account for it using the equity method.
Notably, Berkshire’s use of the equity method of accounting for Kraft Heinz dampened the effect of very large movements in the price of Kraft Heinz stock. Initially, Kraft Heinz stock soared far above Berkshire’s carrying value in the company. At yearend 2017, Berkshire’s Kraft Heinz investment had market value of $25.3 billion while carrying value was $17.6 billion. But by yearend 2018, Berkshire’s Kraft Heinz common stock had market value of just $14 billion while Berkshire’s carrying value fell to $13.8 billion, which was reduced by a $3 billion charge due to an impairment of Kraft Heinz intangible assets.
Berkshire’s history in Kraft Heinz illustrates how use of the equity method can cause the accounting presentation of Berkshire’s financial statements to differ materially from quoted market values.
Berkshire Hathaway has maintained a position of 151,610,700 shares of American Express for decades. Although the number of shares of this investment has been static for years, the percentage of American Express that it represents has grown due to share repurchases. As of June 30, 2022, Berkshire owned 20.2% of American Express.
Although Berkshire’s ownership interest is now high enough to adopt the equity method for American Express, this will not happen due to an agreement between the companies. Since 1995, Berkshire has agreed to vote a significant percentage of shares based on the recommendation of the American Express board and also has related agreements with the Federal Reserve:
“As of June 30, 2022, we owned 151.6 million shares of American Express Company (“American Express”) common stock representing 20.2% of the American Express outstanding common stock. Since 1995, we have been party to an agreement with American Express whereby we agreed to vote a significant portion of our shares in accordance with the recommendations of the American Express Board of Directors and agreed to passivity commitments to the Board of Governors of the Federal Reserve System, which collectively restrict our ability to exercise significant influence over the operating and financial policies of American Express. Accordingly, we have not applied the equity method of accounting with respect to our investment in American Express and continue to record our investment at fair value.”
As we can see from these examples, breaching the 20% ownership level does not automatically result in adoption of the equity method of accounting. The other factor involves the degree to which Berkshire can influence the management of the investee. In the case of DaVita and American Express, agreements limit Berkshire’s influence to the point where these investments can continue to be held as “available-for-sale” and carried at quoted market values. In the other cases, the equity method was adopted, although in the case of Moody’s Berkshire went back to “available-for-sale” accounting when sales of the stock reduced its interest to under 20%.
In my opinion, in the case of Occidental Petroleum, Berkshire is more likely than not to adopt the equity method starting in the third quarter. If this occurs, Berkshire’s net income will begin to include the company’s proportional interest in Occidental’s net income. Dividends received from Occidental will reduce the carrying value of Berkshire’s investment which will no longer fluctuate with Occidental’s stock quote.
As I wrote last month, the adoption of equity method accounting for Occidental will have a significant impact on Berkshire’s 2022 net income:
According to a recent Wall Street Journal article, analysts expect Occidental to earn about $10 billion in 2022. With an investment of under 20% of the common stock, Berkshire would only report dividends received from Occidental as income. At the current quarterly dividend of $0.13 per share on the common stock, Berkshire would report approximately $94.5 million of dividend income if the investment remains under 20%. However, exceeding 20% would result in Berkshire reporting 20% of Occidental’s expected $10 billion of earnings, or $2 billion.
Economic reality doesn’t change much from 19.9% to 20% but accounting treatment under the equity method can create a dramatic impact. This will be something to examine when Berkshire releases its third quarter results in early November.
Copyright, Disclosures, and Privacy Information
Nothing in this newsletter constitutes investment advice and all content is subject to the copyright and disclaimer policy of The Rational Walk LLC.
Your privacy is taken very seriously. No email addresses or any other subscriber information is ever sold or provided to third parties. If you choose to unsubscribe at any time, you will no longer receive any further communications of any kind.
The Rational Walk is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.
Individuals associated with The Rational Walk own shares of Berkshire Hathaway.