Henry Stupp, Colin Riley
Case Study Warren E. Buffett, 2005 Executive Summary Background / Problems
Warren Buffett, The CEO of Berkshire Hathaway, historically delivers to his shareholders noteworthy excess returns, however, with how massive this firm has become, it is becoming increasingly more difficult to deliver similar results. In his annual letter to his shareholders,
Buffett explains that his “elephant” strategy is the only way for Berkshire to make sufficient gains in their net worth. With the slow start of making any multibillion dollar acquisitions,
Berkshire saw an accumulating cash balance and the S&P 500 outperform it, they were losing money, and they were not meeting their goal of a 15% annual increase in intrinsic value.
Berkshire hoped that by MidAmerican’s (a 76% owned subsidiary) acquisition of PacifiCorp, a regulated energy utility company and hopeful “elephant”, they will earn enough money to keep their shareholders satisfied. Assumptions
Enterprise value and constant growth models are reflective of how the market works to assess investment opportunities
Buffett’s history of success make it reasonable and useful to use his model for analysis (10 year treasury yield, intrinsic return)
Because of the accumulation of cash and no elephants, this project is the chief value creation project being undertaken by Berkshire
PacifiCorp’s comparables provide useful benchmarks with which to compare the company
Quarterly revenues, expenses, expenditures, etc. are proportional to ¼ of the annual amounts
We recommend that Warren Buffet shift his target acquisitions from “elephants” of $5bn or larger to include more investment opportunities. This will return other investment possibilities like Geico and the ones which propelled Berkshire to success. If Warren Buffett truly wants to see robust, exceptional growth for his investors, he must abandon his desperate
“allornothing” strategy as time has shown that it has not paid off. If Buffett is disturbed by the fact that his massive, welldiversified company does not make the return percentages that it used to, then his best course of action would be to transform his flagship from a cash cow to a leaner, nimbler enterprise. Divestiture from Berkshire’s holdings (on the part of Buffett himself or the company’s business divisions) might allow him to see more of the fruits of his investing decisions, instead of towing investors along for his white whale (or white elephant) hunt. Narrative Analysis
We used the multiples analysis data, as it seemed normally distributedOnly Cinergy
Corporation stands as out as the leader of these firms, the mean and medians are only separated by $300 million, showing that there is very little impact from the outlying numbers coming from Cinergy. This analysis implied that MidAmerican slightly overpaid for PacifiCorp.
Free Cash Flow and Enterprise Value
We built the forecast assuming five quarters of supernormal growth (to reflect the acquisition timeline) and constant growth after that. We then used the free cash flow at the horizon and constant growth model to estimate the enterprise value at that time. We then assumed that this enterprise value would be capitalized into Berkshire’s and reflect the increase in intrinsic value of the firm. We used these assumptions to build a model which would integrate the performance of PacifiCorp with the enterprise value of Berkshire Hathaway’s Class A stock.
The purpose of this is to do sensitivity analysis to see what type of change would achieve
Buffett’s espoused goals.
The Problem with Elephants
Although PacifiCorp seems like a very healthy business overall, the single acquisition of this company is not going to solve the primary problems