Caso 1- Warren E Buffett 2005(1)

CASE 1

WARREN E. BUFFETT, 2005

Synopsis and Objectives

Set in May 2005, this case invites the student to assess Berkshire Hathaway’s bid, throuh MidA!erican Enery Ho"dins Co!#any, its who""y owned subsidiary, $or the reu"ated enery%uti"ity &aci$iCor#' (he task $or the student is to #er$or! a si!#"e va"uation o$ &aci$iCor# and to consider the reasonab"eness o$ Berkshire’s o$$er' Student ana"ysis readi"y e)tends into the invest!ent #hi"oso#hy and the re!arkab"e record o$ Berkshire’s chair and CE*, +arren E' Bu$$ett' (he case is an introduction to a $inance course or a !odu"e on ca#ita" !arkets' (he ana"ytica" tasks are straiht$orward and intended to #rovide a s#rinboard into discussion o$ the !ain tenets o$ !odern $inance' (hus, the case wou"d be use$u" $or  setting themes at the beinnin o$ a $inance course, inc"udin risk%and%return, econo!ic rea"ity -not accountin rea"ity., the ti!e va"ue o$ !oney, and the bene$its o$ a"in!ent o$  aents and owners •

 o$ investors in the ca#ita" !arket linking valuation to the behavior  o$ modeling good practice  in !anae!ent and invest!ent usin +arren Bu$$ett as an e)a!#"e by returnin to the i!ae o$ Bu$$ett re#eated"y durin a $inance course to ask  students what Bu$$ett wou"d "ike"y do in a situation

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characterizing stock prices as e/ua"in the #resent va"ue o$ $uture e/uity cash $"ows

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exercising simple equity-valuation skills

Questions

1' +hat is the the #ossib"e #ossib"e !eanin !eanin o$ the chanes chanes in stock stock #rice $or $or Berkshir Berkshiree Hathaway and Scottish &ower #"c on the day o$ the ac/uisition announce!ent S#eci$ica""y, what does the 2'55 bi""ion ain in Berkshire’s !arket va"ue o$ e/uity i!#"y about the intrinsic va"ue o$ &aci$iCor# 2' Based Based on the !u"ti# !u"ti#"es "es $or co!#ar co!#arab" ab"ee reu"at reu"ated ed uti"itie uti"ities, s, what is the rane o$ #ossib"e #ossib"e va"ues $or &aci$iCor# +hat /uestions !iht you have about this rane ' Assess Assess the bid $or &aci$iCor &aci$iCor#' #' How does it co!#are co!#are with the the $ir!’s $ir!’s intrinsi intrinsicc va"ue

3

Case 1 +arren E' Bu$$et, 2005

3' How we"" has Berkshire Hathaway #er$or!ed How we"" has it #er$or!ed in the areate +hat about its invest!ent in MidA!erican Enery Ho"dins 5' +hat is your assess!ent o$ Berkshire’s invest!ents in Bu$$ett’s Bi 4our A!erican E)#ress, Coca%Co"a, i""ette, and +e""s 4aro 6' 4ro! +arren Bu$$ett’s #ers#ective, what is the intrinsic va"ue +hy is it accorded such i!#ortance How is it esti!ated +hat are the a"ternatives to intrinsic va"ue +hy does Bu$$ett re7ect the! 8' Critica""y assess Bu$$ett’s invest!ent #hi"oso#hy' Be #re#ared to identi$y #oints where you aree and disaree with hi!' 9' Shou"d Berkshire Hathaway’s shareho"ders endorse the ac/uisition o$ &aci$iCor#

1' What does the stock market seem to be saying about the acquisition of PacifiCorp by  Berkshire Hathaay! (his o#enin o$$ers the o##ortunity to deve"o# the notion that stock #rices are the #resent va"ue o$ e)#ected cash $"ows' Moreover, it dea"s with the i!!ediate o#enin #rob"e! o$  the case the !arket’s res#onse to the &aci$iCor# announce!ent' 4ina""y, it shou"d he"# to !otivate a discussion o$ Bu$$ett’s invest!ent #hi"oso#hy' 2'  Based on your on analysis" hat do you think PacifiCorp as orth on its on before its acquisition by Berkshire! (his /uestion e)#ands u#on the o#enin /uestion and he"#s dee#en the !ystery about the ac/uisition:the bid #rice see!s to be a $air"y $u""%#rice o$$er $or &aci$iCor#' ' Well" maybe Buffett is overpaying#does he have a record of overpaying in the past! Here, the discussion shou"d shi$t to an ana"ysis o$ Berkshire’s enera" record, its e)#erience with MidA!erican, and its e)#eriences buyin e/uity #ositions in the Bi 4our' (he enera" conc"usion wi"" be that Bu$$ett has done very we"" as an investor and as the !anaer o$ Berkshire' 3'  Here are the ma$or elements of Buffett%s philosophy& What do those elements mean! 'o  you agree ith them! *n a sideboard, one cou"d "ist the !a7or to#ic headins iven in the case' (he ai! here shou"d be to discuss the intuition behind each #oint why Bu$$ett ho"ds those views and what they i!#"y $or his work' ;$ the students a"ready have been e)#osed to the !a7or  under#innins o$ !odern $inance, this se!ent o$ the discussion wou"d take the $or! o$ a /uick review' 4or novices, this se!ent wou"d warrant s"ower deve"o#!ent' 5'  (et%s return to the basic issue& )s the PacifiCorp acquisition a good or bad deal! Why! (his /uestion returns the discussion to the o#enin and ai!s to rationa"i #rovides $inancia" data $or the co!#arab"e $ir!s, and case E)hibit 10 #resents i!#"ied va"uations $or &aci$iCor# usin averaes and !edians o$  those $ir!s’ !u"ti#"es' Table 1 #resents a su!!ary o$ the rane o$ va"uations #rovided in the case (ab"e 1' Su!!ary o$ &aci$iCor# va"uation esti!ates' nterprise Value as !ultiple of 

!V "uity as !ultiple of#

8

$ev%

6,252 6,593

&IT

9,885 >,29>

&IT'A

>,02 >,086

(et Income

8,5>6 8,55

Case 1 +arren E' Bu$$et, 2005

PS

&oo) Value

3,288 3,09

5,>03 5,689

Because the case states that it wou"d take 12 to 19 !onths $or the dea" to ac/uire &aci$iCor# to c"ose, the instructor !ay wish to so"icit a #resent va"ue $or Berkshire Hathaway’s o$$er $or the e/uity #ortion o$ &aci$iCor#' An a##ro#riate discount rate !ay be derived usin the ca#ita" asset #ricin !ode" -CA&M.' 4ootnote 1 in the case e)#"ains that the yie"d on the 0% year 'S' (reasury bond was 5'86 and that Berkshire’s beta was 0'85, and the case states that the "on%run !arket return was 10'5' So Berkshire’s cost o$ e/uity !ay be esti!ated as >'2' sin this rate to discount Berkshire’s 5'1 bi""ion o$$er over 12 or 19 !onths, we et a #resent va"ue o$ about 3'8 bi""ion' Berkshire’s o$$er $or &aci$iCor# was, there$ore, rouh"y in "ine with the rane o$ #eer  $ir! va"uations' (his does not e)#"ain why the !arket reacted so #ositive"y to the news o$ the ac/uisition' ;t is #ossib"e that the investors #erceived #otentia" syneries between &aci$iCor# and MidA!erican, but in the hih"y reu"ated and reiona""y $ocused e"ectric%uti"ity business, such syneristic bene$its !ay be weak' +as there #erha#s so!ethin in Bu$$ett’s record as an investor  that "ed to the !arket’s res#onse &uffett*s record @iscussio n /uestions

(he case a$$ords three o##ortunities to ana"y65 to 1>>5' ;n co!#arison, wea"th creation $or  "are $ir!s averaed 10'5 #er year over the sa!e #eriod' (he $irst chart in the case he"#s students visua"i>8' owenstein, Doer' Buffett0 *he ,aking of an merican Capitalist ' -Main Street Books., 1>>6' Morio, Ayano' Warren Buffett0 n )llustrated Biography of the World%s ,ost 1uccessful )nvestor ' -ew Iork John +i"ey  Sons., 2003' *’ouh"in, Ja!es' *he 6eal Warren Buffett0 ,anaging Capital" (eading People' -ondon  icho"as Brea"ey &ub"ishin., 200' Deyno"ds, Si!on' *houghts of Chairman Buffett0 *hirty 7ears of .nconventional Wisdom from the 1age of 4maha' -ew Iork Co""ins., 1>>9' Stee"e, Jay' Warren Buffett0 ,aster of the ,arket ' -ew Iork Har#er &a#erbacks., 1>>>' (rain, John' *he ,idas *ouch0 *he 1trategies *hat Have ,ade Warren Buffett merica%s  Preeminent )nvestor ' De#rint ed' -ew Iork Har#erCo""ins., 1>99'

1

Case 1 +arren E' Bu$$et, 2005

E)hibit (2 -A$$( % &.//TT0 ,2

E)a!#"e o$ Co!#"eted ;DD Ana"ysis $or Berkshire Hathaway’s ;nvest!ent in MidA!erican - in !i""ions e)ce#t #er%share $iures.

Period Operatin5 $evenue and Other Income % Cost o$ sa"es and o#eratin e)#enses % @e#reciation and a!orti2'0  50'0

,3 8 90143%  ,>1'0  60'0

8  

,4 907,7% 3,>0'0 69'0

8 

61,% 63'9

8 10,:1%  512'3

8 

109,7% 650'9

8 

10966% 68>'6

Profit After Ta+  @e#reciation and a!orti