MGT520: Financial Analysis of Warren Buffett's PacifiCorp Investment

This report provides an in-depth analysis of Warren Buffett's proposed investment in PacifiCorp, examining whether the acquisition constitutes a sound financial decision. The case study delves into the financial performance of PacifiCorp, calculating the return on equity and comparing it to Hathaway Berkshire's required return. It explores the bid price, comparing it to comparable companies using various valuation multiples, with a focus on EBITDA as the most relevant metric. The report also discusses the factors influencing the increase in share price and concludes that the current acquisition valuation is appropriate, while acknowledging that the ultimate success of the acquisition requires consideration of broader economic factors. The report uses the principles of value-based investment strategy and the doctrines of Warren Buffet and Charlie Munger.

MGT520 FINANCIAL
MANAGEMENT CASES
WARREN E. BUFFET, 2005

TABLE OF CONTENT:
Executive Summary..................................................................2
Introduction.............................................................................2
Deep Analysis...........................................................................2
Bid price...................................................................................4
Increase in Share price.............................................................4
Conclusion................................................................................5

Executive Summary
The report has been written to discuss whether the proposed investment in the PacifiCorp is actually
an elephant and whether the proposed payment is worth. The said matter has been deeply resolved in
the later part of the report.
Introduction
The case study relates to one of the richest person in the world Mr. Warren E. Buffet who through his
company Hathaway Berkshire has taught many the spirit and strategy of investing. The present report
deals with acquisition of PacifiCorp by MidAmerican Energy Company Holdings Limited, subsidiary
of Hathaway Berkshire, from the parent company Scottish Power Plc for $ 5.1 billion in cash and 4.3
Billion dollar of preferred stock. The said deal was the second largest in his career. Mr. Buffet is a
man of principles and follows value based investment strategy guided by Benjamin Graham. Further,
the case study elaborates the doctrine of Mr. Warren E. Buffet along with his companion Mr. Charlie
Munger.
The case study concludes with certain unchartered answers and the report deals to unravel the
mysteries presented in the report.
Deep Analysis
The report presents that the company of Mr. Buffet has returned a compounded growth of 24% on
year on year basis for the period 1965 to 2004. Further, whether the company can continue to earn
such a high return post such huge funds available in the company and with limited opportunities in
external market.
The PacifiCorp financial shows a net income of $ 248.1 Million and 251.7 $ on the sales of 3194.5 $
Million and 3048.8 $ million. The return for both the years is approx..8% on sales and the
computation of return on equity is presented as under:
Sl. No Particulars Equity Net Profit Return on Equity
1 2004 3071.9 248.1 8.08%
2 2005 3320 251.7 7.58%
Assumption: Investment is represented by Equity

On perusal of the above table, it can be inferred that return on equity or shareholders is 8% roughly
for both the years which is lower than the required threshold for the Hathaway which seeks a
minimum return of 15% on the investment value. Thus, on a prima facie facts it can be stated that the
said acquisition shall not result in the significant value addition and may not be a elephant. However,
it shall be too early to comment on the same as one needs to consider the other factor before
commenting on the prospects. The factor that needs to be considered has been detailed here-in-below:
(a) Synergy earnings;
(b) Additional Management Expertise;
(c) Market Expectation as increase is in profit is not a true indicator of return on investment;
(d) Economic reality is different from accounting reality;
(e) Capacity to create value
Further, observing the past years, the company in the past years have provided a significant return on
equity to the shareholders which is a significant factor for considering the long term value of the
company.
In addition the return on equity earned by MidAmerican Energy Holding Co of Hathaway Berkshire
for the past years has been presented as below:
Sl No Year Equity Net Profit Return on Equity
1 2000 1495 81 5%
2 2001 1576 143 9%
3 2002 1708 397 23%
4 2003 2294 443 19%
5 2004 2771 538 19%
Loss from discontinues operation has not been considered being an extraordinary item
2004 2005
7.30%
7.40%
7.50%
7.60%
7.70%
7.80%
7.90%
8.00%
8.10%
8.20%
Return Equity

On perusal of the above table, it can be inferred that return on equity or shareholders is significantly
higher compared to PacifiCorp. Thus, from fundamental perspective acquisition is not attractive.
However, Mr. Buffet Valuation technique shall make the investment attraction.
Bid price
The bid price for the said acquisition is roughly $ 9.4 Billion with a break up of cash and preferred
stock. For judging whether the said acquisition is at fair price or not, one needs to look at the value of
potentially comparable company as the company is not trading on stock exchange. The comparable
company are as under:
(a) Alliant Energy Corp;
(b) Cinergy Corp;
(c) Instar;
(d) SCANA Corp;
(e) Wisconsin Energy Corp.
On the basis of the said companies, the market value based on various multiples has been determined
as under:
Sl. No
Revenu
e EBIT EBITDA
Net
Income EPS
Book
Value
Implied value
Mean Basis 6252 8775 9023 7596 4277 5904
Median Basis 6584 9289 9076 7553 4308 5678
Actual
Payment 9400 9400 9400 9400 9400 9400
% Above
Mean Basis 50.35% 7.12% 4.18% 23.75% 119.78% 59.21%
Median Basis 42.77% 1.19% 3.57% 24.45% 118.20% 65.55%
2000 2001 2002 2003 2004
0%
5%
10%
15%
20%
25%
Return on Equity

On perusal of the above, it can be inferred that the actual payment is much above the implied value of
the company as computed from comparable which are listed on recognised stock exchanges.
However, among the comparable presented, the true representative of valuation shall be EBITDA as it
presents a true valuation of enterprise value on account of following rationale:
(a) It does not take tax into account as tax may be different from different enterprises;
(b) Depreciation rate shall be different for different enterprises. Hence, the said factor shall be
ignored for analysis;
(c) Further, some companies may be debt free so in order to provide proper comparison interest shall
be ignored.
Thus, on the basis of above, it can be concluded that EBITDA is a proper comparable. Also based on
EBITDA it can be seen that valuation of company is near about perfect. Hence, it can be concluded
that the payment made for acquiring the company is correct.
Increase in Share price
The possible reason for increase in share price shall be positive anticipation of the announcement in
the market on account of corporate image of the company and the past results of the company. The
announcements has been anticipated as an elephant in the market by the investors. Further, the
investors have viewed synergy in the acquisition. Thus, increase in share price is predominantly due
to positive expectation in the market.
Conclusion
The current acquisition valuation is correct. However, whether the said acquisition shall be an
elephant is something which needs to be pondered upon and cannot be commented just by looking at
fundamentals rather the economic activity needs to be considered.