Analysis:1 What is the possible meaning of the changes in stock price for Berkshire Hathaway and Scottish Power plc on the day of the acquisition announcement? Specifically, what does the $2.17 billion gain in Berkshire’s market value of equity imply about the intrinsic value of PacificCorp?
2 Based on the multiples for comparable regulated utilities, what is the range of possible values for PacifiCorp? (I am looking for numbers, but they are given in the case).
3 Assess Berkshire’s bid for PacifiCorp. Does it make sense given your answer to #2? Hint: How was has Berkshire Hathaway performed in the aggregate? What about some of its specific investments such as MidAmerican Energy Holdings? Hint: Computations will help to support your answers here
4. How has Berkshire Hathaway performed in the aggregate? According to information divulged in the Berkshire Hathaway 2012 Annual Meeting Notes, in general, all of Berkshire’s companies, with the exception of the residential construction companies had shown good earnings growth in the first quarter of 2011.
Each of Berkshire’s five largest non-insurance companies Burlington Northern Santa FE (BNSF), Iscar, Lubrizol, Marmon Group and MidAmerican Energy delivered record operating earnings in 2011 of more than $9 billion in aggregate. Unless the economy weakens in 2012, Buffett expects each of the “fabulous five” to once again set a record, with aggregate earnings comfortably topping $10 billion.
In the first quarter 10-Q insurance section, Berkshire disclosed how an accounting change for GEICO on deferred policy acquisition costs resulted in a decline in earnings of $250 million although there was no impact on cash flow. GEICO had a terrific first quarter as float grew and the underlying business was better than presented. Buffett feels good about the first quarter and the year.
What about some of Berkshire Hathaway’s specific investments such as MidAmerican Energy Holdings? Some of Berkshire Hathaway’s specific investments such as MidAmerican Energy Holdings Company and BNSF are its two major operations that have important common characteristics distinguishing them for its other businesses. Both have huge investment in very long-lived, regulated assets, with these partially funded by large amounts of long-term debt that is not guaranteed by Berkshire.
Their credit is not needed because each business has earning power that even under terrible conditions amply covers its interest requirements. In last year’s tepid economy, BNSF’s interest coverage (pre-tax earnings/interest, not EBITDA/interest, a commonly-used measure they view as deeply flawed) was 9.6x. Two key factors ensure MidAmerican’s ability to service debt under all circumstances: the company’s recession-resistant earnings, which result from its exclusively offering an essential service and its great diversity of earnings streams, which shield it from being seriously harmed by any single regulatory body.
Every day the two subsidiaries power the American economy in major ways. BNSF carries about 15% (measured by ton-miles) of all inter-city freight, whether is transported by truck, rail, water, air, or pipeline. It moved more ton-miles of goods than anyone else, a fact making BSNF the most important artery in our economy’s circulatory system. MidAmerican’s electric utilities serve regulated retail customers in 10 states.
Only one utility holding company serves more states. In addition, they are the leader in renewables: first, from a standing start nine years ago, it now account for 6% of the country’s wind generation capacity. Second, when it completed three projects now under construction, it will own about 14% of U.S. solar-generated capacity. BSFN will spend about $4 billion on the railroad in 2013, roughly double its depreciation charge and more than any railroad has spent in a single year.
The announcement in 2004 that Berkshire’s wholly owned subsidiary, MidAmerican Energy Holdings Company, would acquire PacifiCorp seemed to indicate that Buffet had found an “elephant.” PacifiCorp was a leading, low-cost energy producer and distributer that served 1.6 million customers in six states in the western United States. Based in Portland, Oregon, PacificCorp generated power through company-owned coal, hydrothermal, renewable wind power, gas-fired combustion, and geothermal facilities.
5. How does Buffett view Intrinsic Value? How is Intrinsic Value estimated?
6. Should Berkshire Hathaway’s shareholders endorse the acquisition of PacifiCorp? The group does need to come to a “final” decision or recommendation with respect to each of these, but I expect that you will present different points of view in your write-up.