Case 1 Buffet
- 1. Tracy Kelly 1/22/2015 Case 1 Warren E Buffett, 2005 This case focuses on the purchase of PacifiCorp, a low-cost energy product and distributor in the Western United States. Warren Buffet, a CEO for Berkshire Hathaway, Inc was known for investing in low-cost corporations and turning them into multi-billion dollar companies. MidAmerica Energy Holdings Company is a subsidiary of Berkshire Hathaway Inc; it is that corporation that will be acquiring PacifiCorp. Warren Buffet is known for his investing strategies, he studied at Columbia University under the professor Benjamin Graham who’s known for the development method of identifying undervalued stock. Buffet’s primary focus is to maximize the wealth of his shareholders. Berkshire Hathaway Inc currently holds a diverse portfolio of corporations in which they are either subsidiaries, or Berkshire Hathaway has a hefty amount of shares. Berkshire Hathaway was originally incorporated in 1889 as a cotton manufacturing company which grew to be New England’s biggest textile producer. In 1955 a merger took place with Berkshire and Hathaway, that merger was in crisis due to economic changes in the area of technology, inflation and social behavior. In 1965 Buffett and some partners acquired control of Berkshire Hathaway; this was the first of many, searches for “elephants”, an attractive acquisition opportunity. Warren Buffett was accustomed to record earnings of 25% as an annual growth rate in intrinsic value; with the acquisition of PacifiCorp he would have to settle for smaller earnings of 15% instead. Berkshire Hathaway was a holding company of diversified portfolio; they were engaged in Insurance, Apparel, Building products, Finance and financial products, Flight services, Retail, Grocery distribution and Carpet and floor coverings. Buffet had a strategy; a philosophy in which he expounded upon in his investments. 1. Economic reality, not accounting reality. Warren Buffet first element focuses more on the heart of the business and the factors that are important to keep it successful but these factors are not used on a financial statement. Economy plays a strong part in the life cycle of the business; it sometimes help determine if a business will remain successful or fail. For instance, the automobile industry. At one point in time everyone wanted to own a 6 to 8 cylinder truck. The prices of the trucks were affordable, maintenance was of average cost and gas prices were less than $2 a gallon. Then, there was a shift in the economy; businesses were failing, people were losing their jobs, investments were declining, war on terrorism which caused conflict with Iran (the country in which we received our oil) and caused an increase in gas prices. With such a shift in the economy 6 to 8 cylinder trucks were no longer a desire for consumers. Therefore the sales were
- 2. effected which caused a shift in the auto industry. In this scenario, the business was greatly affected by the economy and until disaster began a financial statement could not predict the recession that occurred. Warren Buffet philosophy is similar; he is looking at various aspects of the economy as a deciding factor. Companies like Apple has a reputation, therefore when they announce a new product the number of pre-sales are enormous because the name Apple has a reputation. A reputation that does not require people to research nor study; instead Apple’s reputation and marketing technique has turned each of their products into a consumer need. A consumer that feels as though they have a need will fulfill that need. Another great point in Warren Buffets first philosophical point is that great managerial skills can make a good business a great business. There are strategic managers that focus strictly on how to outdo the last success of their business. These managers use techniques such as marketing, SWOT analysis, external factor evaluations, internal factor evaluations, surveys, comparison of similar businesses, etc to create a growth plan. Strategic managers also use financial data to assist in the planning. 2. The cost of the lost opportunity. Warren Buffet tends to way his options on every decision he make. Comparing the options available that he felt are more beneficial. Warren Buffet has chosen to acquire some businesses which have allowed him to manage the company, be the core decider for changes and get a closer look at the rate of return along with other financials. Warren Buffet has also invested in business which allows him to have a voice in some of the decisions made. Both instances allow for control but the comparison of the decision will identify the greater opportunity of the two. 3. Value creation: time is money. Don’t waste time on unproductive things. What you sacrifice today should be multiplied / surplus tomorrow. Buffet and Berkshire waited several years before identifying the next attractive acquisition opportunity. That opportunity was PacifiCorp. 4. Measure Performance by gain in intrinsic value, not accounting profit. In this philosophical statement Warren Buffet is expressing how he depends on a variety of analytical techniques to identify the true value of a company. These techniques consist of identifying the target market, the hierarchy of the business and the powers that be, the business model and or mission of the organization. This philosophy also looks at the ratios, financial statement analysis and stock price. 5. Risk and discount rates. Buffet used almost no debt financing and avoided risk. Buffet is very confident in his planning for his business. Buffet feels, “risk comes from not knowing what you’re doing”. Buffet knows what he’s doing, in 1977 Berkshire Hathaway share was priced at $102; on May 24, 2005 the closing price on Class A shares reached $85,500. This is a testament to how well Buffet invest in a corporation.
- 3. 6. Diversification. Warren Buffet doesn’t feel that his holding company is diversified for risk management reasons. Instead his diversification is built on companies in which he has a strong knowledge base on how to manage and grow them. Success is not based upon risk but understanding the aspects of a business. Using the facts and data to the ability of the investor. The fact that Berkshire Hathaway has an Acquisition Criteria tells you that they are aware of exactly what it is they are looking for in a business. 7. Investing behavior should be driven by information, analysis and self-discipline, not by emotion or “hunch.” Research; be informed about the value of your company based upon key factors. 8. Alignment of agents and owners. With greater than half the directors having 50% of their family net worth invested in Berkshire Hathaway is saying that there are people, other investors that have confidence in the decisions being made. I believe this is why the shareholders will support PacifiCorp because Buffet has made it clear that there will be returns, not as great as returns of other acquisitions in the past but it is still a great investment. Buffet has taken into consideration every component of the industry, how to invest and when to invest. Because of Buffet’s success there are individuals that trust his decision as a manager and as an investor. The stock price changed for both Berkshire Hathaway and Scottish Power due to the announcement of MidAmerica Energy Holdings Company acquiring PacifiCorp. The increase in stock price for both companies is common when a successful investor with a great track record is acquiring a business. History speaks for itself, Warren Buffet has the best investment record in history, he is known for increasing wealth for shareholders. There are times when acquisitions occur the takeover company usually purchase higher than what market value is stating. When the market has identified this, it feels as if there is a hidden value that gives reason to raise the stock price. The bid for PacifiCorp is $5.1 billion in cash and $4.3 billion in liabilities and preferred stock. The reason for the cash transaction is to avoid contingency payments; it also eliminates others from trying to compete in the bid through ways of finance. Cash transactions are least risky because it gives affirmation to the markets value. The liability transactions that are assumed through the acquisition appear to be limited to the contractual agreement. This means that the un-agreed upon liabilities are still the responsibility of Scottish Power. See the attached Discounted Cash Flow Analysis to analyze the market value of PacifiCorp and what the projected earnings will be for the company. To forecast the cash flow management would have to consider a variety of factors; the current market of the company, if they are expanding or contracting and how they are performing. Once this is determined new factors would be identified such as; will there be new ways due to technology of producing or
- 4. offering more energy, will there be an immediate price change and what does the future of the economy predict. In the Big Four Investment; American Express Company, The Coca-Cola Company, The Gilette Company and Wells Fargo & Company Berkshire invested $3.83 billion through transactions between May 1988 and October 2003. During that time the Berkshire Hathaway Class A stock was on a steady climb. This was due 20 years after Buffet acquired control of Berkshire Hathaway and it became apparent that large capital investments would be necessary to gain competitive control and grown the financial returns. In conclusion PacifiCorp’s acquisition will meet Buffet’s goal in the long term. Short term there will be a lot of strategic planning to gain a competitive advantage and grow the revenue. The bid price was appropriate because the forecasted revenue shows a larger cash value. Therefore the sacrificial cost today to invest would respond with great returns in the future. Berkshires offer of cash was a no brainer; it showed what the current market value of the investment was. There was no risk of leasing payments or opening the door for other competitors to bid on the acquisition. Cash is a low risk offer that shows strength and buying power. The increase in share price for Berkshire Hathaway at the announcement was due to the intrinsic value of the company. Buffet has a reputation of 25% growth over previous acquisitions, the upfront offer was above what the current market price quoted, Buffet is known for searching for attractive acquisition opportunities and because Buffet is known for valuable management as well as investments the price increased.