On May 24, 2005, it was announced that Berkshire Hathaway would acquire PacifiCorp. from parent, Scottish Power, for $5.1 billion in cash and $4.3 in liabilities and preferred stock (Bruner, Eades, Schill). After the announcement of the acquisition, the market responded very positively the same day. Berkshire’s stock price had increased by 2.4%, PacifiCorp.’s parent, Scottish Power’s by 6.28% and S&P 500 closed up 0.02%. Berkshire Hathaway’s 2.4% shares increase was equivalent to $2.55 billion. Since this is not consistent with results of other acquisitions of the same order, it must be Warren Buffet’s “cult”-like following that allows this to happen.
Rather than rationally studying the market information of the acquisition, the general public puts their trust in Warren Buffett as an investment guru. Berkshire held many different types of industries in their portfolio, but prior to the acquisition of PacifiCorp., Berkshire did not have significant investment in the energy sector. The now more diversified investment portfolio of Berkshire after the acquisition was expected to provide more stable returns. Often throughout the case study, Buffett’s view on a company’s “intrinsic value” was spotlighted as one of his predominate investing strategies. Book value and the investment outline are the two alternatives to intrinsic value.
Buffett rejects them because these alternatives neither can give clear and accurate information about the expected profit in the investment. A company’s intrinsic value, though, is a company’s value relative to the present value of its discounted future cash flows (Bruner, Eades, Schill). And this is how Buffett evaluates his investments, asking will future cash flows provide an acceptable return on investment.
Problem: The primary problem in the Warren Buffett case study would be whether or not the intrinsic value of PacifiCorp. justifies Berkshire Hathaway’s bid price? Secondary problems presented include how does the PacifiCorp. acquisition stand up against Berkshire’s “elephant only” approach to investing? Thus, whether or not PacifiCorp.’s acquisition would be able to further Berkshire’s already staggering annual growth rate of 24%?
Analysis: Drawing from the financial statements in the text’s exhibits, PacifiCorp.’s annual operating cash flows equaled $1.76 billion. Given this calculation, it would seem as though it would be a relatively short time before Berkshire Hathaway would accumulate enough value on the acquisition for them to receive an expedient return on their investment. “The cost of lost opportunity” is a philosophy of Warren Buffett’s that also applies to this case (Bruner, Eades, Schill). By entering into the energy market with the acquisition of PacifiCorp., the firm can hopefully continue on their incredible growth rate trend. Without it, Berkshire would likely have eventually plateaued.
Recommendation: It is advised that Berkshire Hathaway follow through with the acquisition of PacifiCorp. The firm will continue to cycle large sums of cash flows through their company with this deal, therefore inducing growth and also adding intrinsic value to their firm. The firm also has a lot to gain by entering into the energy market, which already has a stronghold on American interests and adds diversity to their portfolio.