Berkshire Hathaway Inc. is a famous company which also involves in many different business segments. It was originally operated as a cotton manufacturing company. In 1965, Warren Buffet declared to take over it and he became the chairman and CEO of Berkshire Hathaway. Since then, this company started to be well known by the world.
Market value implication On May 24, 2005, Buffet announced that MidAmerican Energy Holding Company, a subsidiary of Berkshire Hathaway would acquire PacifiCorp which is an electric utility company. He decided to use $5.1 billion in cash and $4.3 billion in liabilities and preferred stock to acquire it. According to the data, on the day of announcement, Berkshire Hathaway’s Class A shares closed up 2.4% for the day and reached $2,010 per share, for a gain in market value of $2.55 billion. It implies that market showed a promising attitude towards this acquisition.
Since Buffet is a well-known and successful investor, people will trust his decision in investment. They believed this acquisition would generate more profits for them. Scottish Power’s share price jumped 6.28% and It implies that people also consider PacifiCorp could be more profitable and provide better service to citizens under the acquisition by MidAmerican. The intrinsic value of PacifiCorp could be calculated as $24.51 per share. The calculation process is shown in Table 1, Compared with the competitors like other energy firms, PacifiCorp’s intrinsic value is reasonable.
Analysis of PacifiCorp value
The case also uses valuation multiples to figure out the value for PacifiCorp in a quick way and presents detailed information in Exhibit 10. To see in a direct way, we list the ranges of possible values in Table 2. Compared with the purchase price of $9.4 billion offered by MidAmerican, the market value of equity part of PacifiCorp is much smaller; what makes Buffett decided such attractive price? Does he definitely sure this acquisition can bring stable income for the shareholders, although there will be great restrictions in controlling utility industry?
In order to analyze the bid for PacifiCorp in a more accurate way, we would like to present the intrinsic value, as Buffett once said in his letter, “Intrinsic value is the only logical way to evaluate the relative attractiveness of investments and businesses.” Form the information and footnotes provided by the case, we know that the deal will last for 12 to 18 months, and the future cash flow will be $5.1 billion in cash; for the discount rate we use CAPM as basic for calculation, footnote 13 indicates the risk-free rate of return equals to 5.76% and the beta equals to 0.75, in the last, we find out the average market return of stocks is 10.5% according to footnote 3. Combined with these data, the intrinsic values for PacifiCorp are shown in Table 3. As the outcome shows, the intrinsic value of PacifiCorp is much smaller than the bid as well. Berkshire Hathaway’s performance
Now we would like to analyses Berkshire Hathaway’s performance from three aspects.
From the case we know Berkshire Hathaway started in textile industry in 1889. From 1970s, it acquired insurance companies and began to step into other industries.
The financial data provided in the case also show good performance of Berkshire Hathaway. The first chart in the case shows a strong increasing of its stock price. We can see that in 1977, the stock price of both Berkshire Hathaway “class A” and S&P 500 composite index are nearly $100. However, Berkshire Hathaway “class A” attained nearly $85,500 in 2005 while the S&P is about $1,194. It’s quite a big margin between these two.
MidAmerican Energy Holding Company
Berkshire Hathaway took a major stake in MidAmerican Energy Holdings in 2000. We can see from the exhibit 6 of the case, the net earnings of MidAmerican Energy Holdings had increased 76% in 2001 and 165% in 2002. We also found the statistic that the earnings per share of MidAmerican Energy
Holdings were increased from $2.6 in 2000 to $20 in 2012. From this aspect, we can conclude that the investment in MidAmerican Energy Holdings performs well.
“Big Four” is the investments of Berkshire which contains American Express, Coca-Cola, Gillette and Wells Fargo. As the data provided in exhibit 3 of the case, we could calculate the compound annual growth rate to measure the performance of “Big Four”. At first we pick up the cost and market value of these four. We get the ending value of “Big Four is $24,681 and the beginning value is $3,830. With the number of 12.5 years, we get the annual growth rate of the “Big Four” is 16.07% which is larger than 10.5%, the annual average total return on all large stocks at that period. Through this we could find that the performance of “Big Four” is quite good. (The formula of compound annual growth rate is show in Table 4.
Buffett’s investment philosophy
Berkshire Hathaway’s shareholders would be willing to endorse this acquisition. Acquiring an electric utility company will diversify the whole investment basket of Berkshire Hathaway. From the advantage of diversification, it lowers the overall risk of portfolio. What’s more, PacifiCorp is a leading, low-cost energy producer in the western United States. According to Exhibit 9, the net income of PacifiCorp is high among the competitors. MidAmerican would get stable revenue from this acquisition. However, according to the Berkshire Hathaway’s earnings before taxes figure in 2004, which is $7.44 billion, we cannot ignore that the $9.4 billion is not a small amount. Spending such great amount involves high risk taking. But high return comes from high risk so we hold the conclusion that the shareholders would be willing to endorse the acquisition.
The process of calculating the intrinsic value of PacifiCorp: A gain in market value of Berkshire Hathaway is $2.55 billion. Buffet is willing to pay $5.1 billion cash to PacifiCorp. The number of share outstanding in PacifiCorp is 312.18 million. ($2.55+$5.1 billion) /312.18 million =$24.51 per share