Warren Buffett Case Study

Background

In 1965, Warren E. Buffet and his partners acquired control of Berkshire Hathaway, believing they could reverse the financial decline. Over the next 20 years, the textile group generated enough cash to purchase two insurance companies and acquired several others over the next decade, leading to their exit of the textile industry in 1985. From 1977 to May 24, 2005 Hathaway’s share price rose from $102 to $85,500 per share.

Buffet is known worldwide as a financial genius and gives credit to his college professor, Professor Benjamin Graham, at Columbia University for laying the foundation of value investing for him. On May 25, 2005, Buffet announced that Berkshire Hathaway’s subsidiary, MidAmerican Energy Holding Company, would acquire PacifiCorp, an electric utility company, for $5.1 billion in cash and $4.3 billion in liabilities and preferred stock.

This was the second largest deal of his career. Buffet had previously been looking for an extremely large investment in the utility industry of between $10 and $15 billion since he wanted to put to better use the $43 billion cash balance on hand earning minimal returns. At this point in time only these extremely large investments would have a significant enough increase in net worth to be worthwhile. At the time of announcement Berkshire Hathaway’s Class A shares closed up 2.4% with a market value gain of $2.17 billion. On the other side, Scottish Power plc (parent of PacifiCorp) closed up 6.28%.

Analysis/Assumption

  • Purchase Value: $5.1 billion cash; $4.3 billion liabilities and preferred stock
  • Target annual growth rate of intrinsic value: 15%
  • ROE of PacifiCorp: 7.46%
  • PacifiCorp Average Enterprise Value from Multiples: $8.015 billion oCompetitor’s Average Enterprise Value: $7.955 billion
  • PacifiCorp Average Market Value from Multiples: $5.042 billion oCompetitor’s Average Market Value: $4.551 billion

Recommendation

PacifiCorp is an excellent investment for Buffet and Berkshire Hathaway. According to their acquisition criteria released in the 2004 annual report PacifiCorp meets at least 5 of the 6 principles needed. They are considered a large purchase with pretax earnings at $656 million and have positive earnings growth over the last two years (only two years of data available).

PacifiCorp already has management in place with steady growth meaning it would be simple for Berkshire Hathaway to take over without large amounts of restructuring. In addition to the beneficial, qualitative factors of PacifiCorp, the company’s fundamentals prove the company will be a successful investment. Referring to Exhibit 10 in the case, looking at its relative enterprise valuation based on operating measures (e.g., revenues, operating profit, and net income), it yields an average enterprise value of $8.015 billion, which is higher than its primary competitors.

Also, when comparing PacifiCorp’s average relative valuation of expected market value it yields $5.042 billion, better than the firm’s primary competitors’ average of $4.551 billion by 11 basis points. Buffet has a knack for selecting underperforming companies and turning them around to industry leaders, and this company fits into his portfolio of typically “boring,” yet profitable companies.