/arren E. Buffett, 2015 On August 10, 2015, Warren E, Buffet, chair and CEO of Berkshire Hathaway Ine. announced that Berkshire Hathaway would acquire the aerospace-parts supplier Preci- sion Castparts Corporation (PCP). In Butt’ largest deal ever, Berkshire would pur= chase all of PCP’s outstanding shares for $235 per share in cash, a 2L% premium over the trading price a day earlier. The bid valued PCP's equity at $32.3 billion! The total transaction Value would be $37.2 billion, including assuming PCP’ outstanding debt— this was what analysts called the “enterprise value.” “I've admired PCPs operation for ‘long time, For good reasons, iti the supplier of choice forthe world’s aerospace in- usr, one of the largest sourees of American exports,"* Buffett said. After the an- rnouncement, Berkshire Hathaway's Class A” shares moved down 1.1% at market open, a loss in market value of $4.05 billion. PCP’s share price jumped 19.2% at the news"; the S&P 500 Composite Index opened up 0.2%. Exhibit 11 illustrates the recent share- price performance for Berkshire Hathaway, PCP, and the S&P 500 Index. Exhibit 1.2 presents recent consolidated financial statements forthe Fim. "Tie diffrence beswoen enterprise vale and equity values the ammount of deb outstanding. On August 10, 2015, PCP’s debt amounted o about 4.9 billionths difrs from the debt indicated in Exhibit 1.9, which was dated March 31, 2018 romi Kilgore, “Warten Buffets $3.72 Billion Buy of Precision Caspar is His Biggest Buyout Eve “Marketwatch, August 10, 2015 p/w markecwatch comstoryhvaren-bufets-372-billion-buy-of precison-csipars-i-hieiggest-buyoutdea-ever 2015-08-10 (acessed Dee. 12,2016). Bach Class A common shire senile to one vote po share Class B common stock possesses dividend nd disuibtion rights equa oone-Fieen-hundredth (1/1500) of such ight of Css A common tock, Each Cass B common shire posesss voting hts equivalent vo onetn-thousandih (10,000) ofthe voting rights of Class A she “the pershare chang in Berkshire Hathaway's Cass A share pice atthe dat ofthe announcement was 1,895. The company hod 811,755 Clas A shares outstanding and 1.247.366, 163 Class B shares oustanding. (Cass B common shares are equivalent to 1/1500 of Cass common shares. ‘the per-share change in PCP share price afer the announcement was $37.28. The stock closed at $193.88 fon August 7, 2015, and opened on August 10, 2015, at $231.16 “This case was prepared by Joke DuBois (MBA "16) and Robert F. Bruner, University Professor, Distinguished Professor of Business Administration, and Dean Emer, a basis for elss discussion rather han to ilustate effective or ineffective handing ofan administrative situation. Copyright © 2017 by the Universi ‘of Virginia Durden School Foundation, Charlotesvills, VA. Allright reserved To order copes, send an ‘mmailo sales @dardenbusinesspblishing com. No par ofthis publication may be reproduced, stored ina Tetrevel syste, used ina spreadsheet, or renamed in any form or by any means—eletronc, mechanical, ‘photocopying, recording or othervise—withou the permission ofthe Darden Schoo! FoundationPart One Seting Some Themes “The acquisition of PCP, Berkshire Hathaway's largest deal ever, renewed public Jinerest in its sponsor, Bufet, In many ways, he was an anomaly. One of the richest individuals in the world (with an estimated net worth of about $66.5 billion according to Forbes), he was also respected and even beloved. Though he had accumulated per- haps the best investment record in history (a compound annual inerease in wealth for Berkshire Hathaway of 21.6% from 1965 to 2014),* Berkshire Hathaway paid him only $100,000 per year to serve as its CEO. While Buffett and other insiders controlled 0.5% of Berkshire Hathaway, he ran the company inthe interests ofall shareholders. “hve will not take eash compensation, resrited stock, or option grants that would make our results superior to [those of Berkshie's investors,” Buffett sai, “I will keep well ever 99% of my net worth in Berkshire. My wife-and I have never sold a share nor do we intend to." Duet, was the subject of numerous laudatory articles and at least eight biogra- pies, yet he remained an intensely private individual. Although acclaimed by many a8 Br intellectual genius, he shunned the company of intellectuals and preferred to affect the manner of a down-home Nebraskan (he lived in Omaha) and a tough-minded inves tor: In contrast othe investment world’s other “stars,” Buffett acknowledged hs invest nent failures hoth quickly and publicly. Although he held an MBA from Columbia University and credited his mentor, Benjamin Graham, with developing the philosophy Ur value based investing that had guided Buffett to his success, he chided business, Schools for the irelevance of their finance and investing theories Nemerous writers sought to distil the essence of Buffett's suocess. What were the key principles that guided Buffet? Could those principles be applied broadly inthe 21 wedrary or were they unique to Buffett and his time? By understanding those principles halyste hoped to illuminate the acquisition of PCP. What were Buffet’ probable m tives in the acquisition? What did Buffets offer say about his valuation of PCP, a how would it compare with valuations for other comparable firms? Would Berkshire’ toquisiion of PCP prove to be a sucess? How would Buffett define success? Berkshire Hathaway Inc. Berkshire Hathaway was incorporated in 1889 as Berkshire Cotton Manufacturing eventually grew to become one of New England's biggest textile producers, accounti for 25% of U.S. cotton-textile production. In 1955, Berkshire Cotton Manufactut merged with Hathaway Manufacturing and began a secular dectine due to inflat technological change, and intensifying competition from foreign rivals. In 1965, Bul and some partners acquired control of Berkshire Hathaway, believing that its fi decline could be reversed. Over the next 20 years, it became apparent that large capital investments woul required for the company to remain competitive, and that even then the financial ret ‘Gn comparison, the aml average toa return on al large stocks from 1965 to the end of 2014 was 9 (See Warren Buffet, ann eter to shareholders, 2014) Warren Buffet, ann eter to shareholders, 2001, Waren Butet has since pled to donate 99% not wort to philanthropic foundations. See hp/givingpledge or.1 Waren E. Buffet, 2015, would be mediocre. Fortunately, the textile group generated enough cash in the early ‘years to permit the firm to purchase two insurance companies headquartered in Omaha: National Indemnity Company and National Fire & Marine Insurance Company. Acqui- sitions of other businesses followed in the 1970s and 1980s; Berkshire Hathaway exited the textile business in 1985. ‘The investment performance of a share in Berkshire Hathaway had astonished most observers. As shown in Exhibit 1.3, a $100 investment in Berkshire Hathaway stock on September 30, 1976, would compound to a value of $305,714 as of July 31, 2015, ap- proximately 39 years later The investment would result in a 305,614% cumulative return, 22.8% when annualized. Over the same period, a $100 investment in the S&P 500 would compound to a value of $1,999 for a cumulative return of 1,899.1% or 8.0% annualized,* In 2014, Berkshire Hathaway's annual report described the firm as “a holding company owning subsidiaries engaged in a number of diverse business activities.” Berkshire Hathaway's portfolio of businesses included: + Insurance: Insurance and reinsurance" of property and casualty risks worldwide ‘and with reinsurance of life, accident, and health risks worldwide in addi (eg., GEICO, General Re). + Railroad: A long-lived asset with heavy regulation and high capital intensity, the company operated one of the largest railroad systems in North America (ie., BNSF). + Utilities and Energy: Generate, transmit, store, distribute, and supply energy through the subsidiary Berkshire Hathaway Energy company. + Manufacturing: Numerous and diverse manufacturing businesses were grouped into three categories: (1) industrial products, (2) building products, and (3) consumer products (e.g., Lubrizol, PCP), > + Service and Retailing: Providers of numerous services, including fractional aircraft- ‘ownership programs, aviation pilot training, electronic-components distribution, and various retailing businesses, including automotive dealerships (e.g., Nets, Nebraska Furniture Mart) + Finance and Financial Products: Manufactured housing and related consumer financing; transportation equipment, manufacturing, and leasing; and furniture leasing (¢-g., Clayton Homes, ULTX, XTRA). Exhibit 1.4 gives a summary of revenues, operating profits, capital expenditures, depreciation, and assets for Berkshire Hathaway's various business segments, The com pany's investment portfolio also included equity interests in numerous publicly traded companies, summarized in Exhibit 1.5. Te annuatizd return ealevlation assumes a 39-year period (sesl time pero is 38 years 10 months) "Bedkshive Hathaway Inc. annul sept, 2008, "Reinsurance was insurmce for insurance companies, away of tasfertng or “ceding” some ofthe Financia Fisk insurance companies assumed in insuring cars, homes, and businesses o another insursnee company, the reinsrer. Insurance Information Institue, “Reins,” November 201, hipJfwiorgfisue-updse! ‘einsucance (accessed Des. 9, 2016Pan One Seting Some Themes Buffett’s Investment Philosophy ‘Warren Buffett was first exposed (o formal training in investing at Columbia Univer- sity, where he studied under Benjamin Graham. A coauthor of the classic text, Security Analysis, Graham developed 2 method of identifying undervalued stocks (that is, stocks whose prices were less than their intrinsic value). This became the cornerstone cof modem value investing. Graham's approach was to focus on the value of assets, such as cash, net working capital, and physical assets. Eventually, Buffett modified that approach to focus also on valuable franchises that were unrecognized by the market, Over the years, Buffett had expounded his philosophy of investing in his chair's letter to shareholders in Berkshire Hathaway's annual report. By 2005, those lengthy Jeters had acquited a broad following because of their wisdom and their humorous, | self-deprecating tone. The letters emphasized the following elements: 1. Economic reality, not accounting reality. Financial statements prepared by accountants conformed to rules that might not adequately represent the economic reality of a business, Buffett wrote: Because ofthe limitations of conventional accounting, consolidated reported earnings may. reveal relatively little about our true economic performance. Charlie Munger, Buffet’s business partner] and T, both as owners and managers, virtually ignore such consolidated ‘numbers... Accounting consequences do not influence our operating or eaptal-allocation process." Accounting reality was conservative, backward looking, and governed by gener- ally accepted accounting principles (GAAP), even though investment decisions should be based on the economic reality of a business. In economic reality, intan= gible assets such as patents, trademarks, special managerial expertise, and reputa- tion might be very valuable, yet, under GAAP, they would be carried at litle or no value. GAAP measured results in terms of net profit, while in economic reali the results of a business were its flows of cash ‘A key feature of Buffett’s approach defined economic reality atthe level of. the business itself, not the market, the economy, or the security—he was a funda: ‘mencal analyst ofthe business. His analysis sought to judge the simplicity of the business, the consistency of its operating history, the atractiveness of its long-t prospects, the quality of management, and the firm’s capacity (o create value. 2. ‘The cost of the lost opportunity. Buffett compared an investment opportunity against the next-best alternative, the lost opportunity. In his business decisions, hhc demonstrated a tendency to frame his choices as either/or decisions rather t yes/no decisions. Thus an important standard of comparison in testing the attrac= tiveness of an acquisition was the potential rate of return from investing in the common stocks of other companies. Buffett held that there was no fundamental difference between buying a business outright and buying a few shares of that bu ress in the equity market. Thus for him, the comparison of an investment agains other returns available in the market was an important benchmark of performan¢ "erkshire Hathaway In. annual report, 2008Case 1 Waren E Buffet, 2015 1 3. Embrace the time value of money. Buffet assessed intrinsic value as the present value of future expected performance: [Al other methods fall short in determining whether] an investor is indeed buying some- thing for what itis worth and is therefore truly operating on the principle of obtaining value for his investments... Irespective of whether a business grows or doesn’t, displays voltil- ity or smoothness in earnings, o carries a high price or low in relation to its curent eamn- ings and book value, the investment shown by the discounted-flows-of-cash calculation to be the cheapest is the one that the investor should purchase. Enlarging on his discussion of intrinsic value, Buffett used an educational example: ‘We define intrinsic value asthe discounted value ofthe cash that canbe taken out of business during its remaining life. Anyone calculating intrinsic value necessarily comes up with a highly subjective figure that wil change both as estimates of future cashflows are revised and as interest rates move. Despite its fuzziness, however, intrinsic value is all important and is the only logical way to evaluate the relative attactiveness of investments and businesses, ‘To see how historical input (book value) and future output (intrinsic value) ean diverge Jet us look at another form of investment, a college education. Think of the education's cost as its “book value.” IF it sto be accurate, the cost should include the earnings that ‘were foregone by the student because he chose college rather than a jab, For this exercise, ‘we will ignore the important non economic benefits ofan education and focus strictly on its economic value, First, we must estimate the earnings that the graduate will receive over his lifetime and sublract from that figure an estimate of what he would have eared had he lacked his education. That gives us an excess eamings figure, which must en be discounted, at an appropriate interest rate, beck to graduation day. The dolar result equals the intrinsic economic value of the education, Some graduates wll find thatthe book vale of their ‘education exceeds its intrnsi value, which means that whoever paid for the education didn’t get his money's worth, In other cases, the intrinsic value of an education will far exceed its book value, a result that proves capital was wisely deployed, In all cases, what is clears that book value is meaningless as an indicator of intrinsic value!” ‘To illustrate the mechanics of this example, consider the hypothetical case presented in Exhibit 1.6. Suppose an individual has the opportunity fo invest {$50 million in a business—this is its cost or book value. This business will throw off cash at the rate of 20% of its investment base each year. Suppose that instead of receiving any dividends, the owner decides to reinvest all cash flow back into the business—at this rate, the book value of the business will grow at 20% per year. Suppose that the investor plans to sell the business for its book value at the tend of the fifth year. Does this investment create value for the individual? One determines this by discounting the future cash flows to the present at a cost of equity of 15%. Suppose that this is the investor's opportunity cost, the required return that could have been earned elsewhere at comparable risk. Dividing the present value of future cash flows (i.e., Bufett’s intrinsic value) by the cost of the "SRerkshise Hathaway ne annual report, 1992. "Berkshite Hathaway In. annual report, 192,Part One Seting Some Themes investment (ic., Buffett's book value) indicates that every dollar invested buys se- curities worth $1.23. Value is created, Consider an opposing case, summarized in Exhibit 1.7, The example is similar in all respects, except for one key difference: the annual retumn on the investment is 10%. ‘The result is that every dollar invested buys securities worth $0.80, Value is destroyed. Comparing the two cases in Exhibits 1.6 and 1.7, te difference in value ere- ation and destruction is driven entirely by the relationship between the expected returns and the discount rate: in the first case, the spread is positive; in the second ‘ease, it is negative. Only inthe instance where expected returns equal the discount rate will book value equal intrinsic value. In short, book value or the investment ‘outlay may not reflect the economic reality. One needs to focus on the prospective rates of return, and how they compare tothe required rate of return, 4, Measure performance by gain in intrinsic value, not accounting profit. Buffett ‘wrote: (Our ong-term economic goal ... is to maximize Berksbire's average annual rate of gi intrinsic business valde ona per-share basis. We do not measure the economic significance or performance of Berkshite by its size; we measure by per-share progress, We are certain, thatthe rae of per-share progress will diminish in the future—a greatly enlarged capital ‘ase will se to that, But we will be disappointed if our rate does not exceed that of the average large American corporation. ‘The gain in inuinsie value could be modeled as the value added by a business above and beyond the charge for the use of capital in that business. The gain in intrinsic value was analogous to the economic-profit and market-value-added ‘measures used by analysts in leading corporations to assess financial performanet TThose measures focus on the ability to earn returns in excess of the cost of capita Set a required return consistent with the risk you bear. Conventional academic and practitioner thinking held that the more risk one took, the more one should get paid. Thus discount rates used in determining intrinsic values should determined by the risk ofthe cash flows being valued. The conventional model f estimating the cost of equity capital was the capital asst pricing model (CAPM), ‘which added a risk premium to the long-term risk-free rate of return, such as the US. Treasury bond yield. In August 2015, a weighted average of Berkshire Hathaway's Cost of equity and debt capital was about 0.8%." Buffet departed from conventional thinking by using the rate of return on long-term (¢., 30-year) US. Treasury bond to discount cash Flows—in August 2015, the yield on the 30-year U.S. Treasury bond was 2.89%. Defending this practice, Buffett argued that he avoided risk, and therefore should use a rskcfree "perkshire Hathaway In. annual por, 2008 "Berkshire Hathway's cost of equity was 9.2%, which reflectd a beta of 0.90, an expected market run (09.90%, and a risk-free rate of 2.89%. The yield on corporate bonds rated AA was 395% —and afc a3 expected marginal ax rate, the cost of debt would be 2.3%, Weights of pita were 16.9% for debt and 83.1% for equity. In contrast tbe beta for PCP was 0.38, Analyst expected that PCP's cash lows would vow indefinitely at about the long-term expected real growth rte of the U.S. economy, 2.5%.Case 1 Warren E, Bute, 2015 ° discount rate. His firm used little debt financing. He focused on companies with predictable and stable earnings. He or his vice chair, Charlie Munger, sat on the boards of directors, where they obtained a candid inside view of the company and ‘could intervene in management decisions if necessary. Buffett once said, “I put a heavy weight on certainty. IF you do that, the whole idea ofa risk factor doesn’t make sense to me. Risk comes from not knowing what you're doing.""° He also wrote: We define risk, using dictionary terms, as “the possibility of loss or injury.” Academics, however, like to define “risk” differently, averting that itis the relative volatility ofa stock (0F a portfolio of stocks—that is, the volatility as compared to that ofa large universe of stocks. Employing databases and statistical skills, these academics eompute with precision the “beta” of a stock—its relative volatility inthe past—and then build arcane investment ‘and capital allocetion theories around this calculation, Intheic hunger fora single statistic ‘to measure risk, however, they forget a fundamental principle: iis better to be approxi ‘mately right than precisely wrong.” 6. Diversify reasonably. Berkshire Hathaway represented a diverse portfolio of business interests. But Buffett disagreed with conventional wisdom that investors should hold a broad portfolio of stocks in order to shed company-specific risk. In his view, investors typically purchased far too many stocks rather than waiting for ‘one exceptional company. Bullet said: Figure businesses out that you understand and concentrate. Diversification is protection against ignorance, but if you don’t feel ignorant, the need for it goes down drastically." 7. Invest based on information, analysis, and self-discipline, not of: emotion or hhunch. Buffett repeatedly emphasized awareness and information as the foundation for investing. He said, “Anyone not aware of the fool in the market probably is the fool in the market” Buffett was fond of repeating a parable told to him by Graham: ‘There was a small private business and one ofthe owners was a man named Market. Every ay, Mr. Market had a new opinion of what the business was worth, andl at that price stood ready fo buy your interest or sell you hs. As excitable ashe was opinionated, Mr, Market presented a constant distraction to is fellow owners. “What does he know?” they would ‘wonder, ashe bid them an extraordinarily high price ora depressingly low one. Actually, the gentleman knew litle or nothing. You may be happy to sll out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But | the rest ofthe time, you wil be wiser to form your own ideas ofthe value of your holdings, based on full reports rom the company about its operation and financial position.” "Sim Rasmussen, “Bue Talks Strategy with Stent" Omak World-Herald, January 2, 1996, 2 Bershize Hathaway ne. anual rept, 193: Ande Kick, OF Penman Vale The Stary of Waren But (Bimingr, AL: AKPE, 1994) 574 "Forbes, October 19,1983; Klptick 574 "Quoetin Mice! Lewis's L's Poter (New York Noto, 1989): 35, esi Hathaway a. repo, 1987. This gutton ws paris rom aes Gras Ming Me Mares (New York: Tes Boos, 1983): 310 Part One Seting Some Themes Buffett used this allegory to illustrate the irrationality of stock prices as com= pared to true intrinsic value. Graham believed that an investor's worst enemy was not the stack market, but oneself. Superior training could not compensate for the absence of the requisite temperament for investing. Over the long term, stock prices should have a strong relationship with the economic progress of the busi- ness, But daily market quotations were heavily influenced by momentary greed or fear and were an unreliable measure of intrinsic value. Buffett said: ‘As far as Tam concemed, the stock market doesn’t exist. Itis there only as a reference to see if anybody is offering to do anything foolish. When we invest in stocks, we invest in businesses. You simply have to behave according to what is rational rather than according 10 whats fashionable." ‘Accordingly, Buffett did not try to “time the market” (Le, trade stocks based ‘on expectations of changes in the market cycle)—his was a strategy of patient, long-term investing. As if in contrast to Mr. Market, Buffett expressed more con- trarian goals: “We simply attempt to be fearful when others are greedy and to be ‘greedy only when others are fearful." Buffett also said, “Lethargy bordering on sloth remains the cornerstone of our investment styl," and “The market, like the Lord, helps those who help themselves. But unlike the Lord, the market does not forgive those who know not what they do.” 8. Look for market inefficiencies. Buffett scorned the academic theory of capital- ‘market efficiency. The efficient-markets hypothesis (EMH) held that publicly known information was rapidly impounded into share prices, and that as a result stock prices were fair in reflecting what was known about the company. Under EMH, there were no bargains to be had, and trying to outperform the market would be futile. “It has been helpful to me to have tens of thousands turned out ‘of business schools that taught that it didn’t do any good to think,” Buffet said. [think it's Fascinating how the ruling orthodoxy ean cause a lot of people to think the e isa, Investing in market whore people believe in efficiency is ike playing bridge wi someone who's been told it doesn’t do any good to look atthe cards.” 9. Align the interests of agents and owners. Explaining his significant ownership interest in Berkshire Hathaway, Buffett said, “I am a better businessman becau Tam an investor. And I am a better investor because I am a businessman." As if to illustrate this sentiment, he said: Ama gta “wish list” will not be filled at shareholder expense, We will not diversify purchasing entre businesses at contol pice ha ignore long-term economic consequ peter Lynch, One Upon Wall Sret (New York: Penguin Books, 1990): 78 geekahie Hathaway In. annual report, 1986. Berkshire Hathaway Ine. annual report, 1990 Berkshire Hathaway Ine. eters to shacholdes, 1977-83. *Kitpavik, 353 %L J. Davis, "Buffet Takes Stock” New York Times, Api 1, 1990 Parkes, October 19,1993; Kilpatrick, 57,Case] Waren E.Butfen,2015 a1 ‘o our shareholders. We will only do with your money what we would do with our own, \weighing fully the values you can obtain by diversifying your own portfolios through direct purchases in the stock marker. For four out of six Berkshire directors, more than 50% of the family net worth was represented by shares in Berkshire Hathaway. The senior managers of Berkshire Hathaway subsidiaries either held shares in the company or were ‘compensated under incentive plans that imitated the potential returns from an equity interest in their business unit, or both” Precision Castparts “In the short run the market is a voting machine but inthe long run iti @ weighing machine.” —Benjamin Graham” ‘The vote was in and the market's reaction to Berkshire Hathaway's acquisition of PCP indicated disapproval. The market ascribed $4.05 billion less value to Berk- shire Hathaway after the announced acquisition than before it, At the same time, the value of PCP jumped more than $5 billion, close to 20% of the market value of the firm. The market seemed to be saying that Buffett and Berkshire had overpaid for the business. Buffett didn’t seem to think so. And despite his age, he didn’t appear to be slowing down. PCP was the largest acquisition in a string of large purchases over the past sev- eral years, including Duracell, Kraft, Heinz, and Burlington Northern Santa Fe, total- ing more than $70 billion in deal value in all. These acquisitions, along with many ‘mote over the years, followed a similar blueprint (Exhibit 1.8). The gist ofthe acquis. tion criteria seemed to be relatively straightforward—Berkshire Hathaway looked for ‘well-run businesses producing consistent results offered at a fair price. As Berkshire ‘Hathaway stated in its press release following the PCP acquisition: PCP fits perfectly into the Berkshire model and will substantially inerease our normalized per-share earning power. Under CEO Mark Donegan, PCP has become the world's premier supplier of aerospace components (most of them destined o be original equipment, though spares are important tothe company as well). Mark's accomplishments remind me of the magic regularly performed by Jacob Harpaz at IMC, our remarkable Israeli manufsctarer of cutting tools, The two men transform very ordinary raw materials into extraordinary products that are used by major manufacturers worldwide. Each isthe da Vinci of his erft PCP’s products, often delivered under multiyear contracts, ae key components in most large sireratt." Owner Related Business Principles,” Berkshire Hathaway annual report, 2004, In Apel 2005, the U.S. Secures and Exchange Commission interviewed BufTetin connection with an Investigation into the insurance giant AIG and its dealings with Berkshire Hathaway's General Reinsurance ‘nit Buffet reported that he hd questioned General Re's CEO about the transactions with AIG, but hat he sever leamed any det as quoted in Berkshire Hathaway Ine, ltr to shareholders, 1993 pce press release, August 10, 2015,2 Part One Setting Some Themes PCP manufactured coniplex metal components and products for very specific a plications, mainly in the critical aerospace and power applications. The components ‘were used in products with highly complex engineering processes, such as large jet- aircraft engines. Its customer base was concentrated and sophisticated, including Gen- eral Electric, Pratt & Whitney, and Rolls-Royce, for whom they had been supplying castings for multiple decades.”™ } Exhibit 1.9 presents PCP's income statement and balance sheet ending March 31, 2013. Exhibit 1.10 provides financials on comparable firms. Exhibit 1.11 provides valuation multiples for comparable firms. ‘The beta of PCP, measured after the acquisi- tion announcement, was 0.38, Conclusion The announcement of Berkshire Hathaway's acquisition of PCP prompted some critical commentary. The Economist magazine wrote, ‘But (Buffet) is far from a model for how capitalism should be transformed. He is a careful largely ethical accumulator of capital invested in traditional businesses, preferably with oligopolistic qualities, whereas what America needs right now is more risk-taking, lower prices, higher invesiment and much more competition. You won't find much at all about these ideas in Mr, Buffets shareholder letters. Conventional thinking held that it would be difficult for Warren Buffet to main his record of 21.6% annual growth" in shareholder wealth. Buffett acknowledged “a fat wallet is the enemy of superior investment results.”"* He stated that it was firm's goal to meet a 15% annual growth rate in intrinsic value, Would the PCP acqui tion serve Berkshire Hathaway's long-term goals? Was the bid price appropriate? He did Berkshire Hathaway's offer measure up against the company's valuation implied the multiples for comparable firms? Did Berkshire Hathaway overpay for PCP? Was ‘market's reaction rational?” Or did Buffett pay a fair price for a great business? If so, what determines a price? What makes a great business? And why would Berkshire Hathaway be inter in buying PCP? Why would PCP be interested in selling itself to Berkshire Hathaws ‘What value did Berkshire Hathaway bring to the equation? PCP annua pot, 2014, the Other Side of Warren Buffet” Economist, August 13,2016 Berkshire Hathaway Ic, leer o shareholders, 2014 Guth Alexander, “Bullet Spends $2bn on Return to His Rots” Tines (London), August 17,1985ase 1 Warren Buffeu,2015 13 I Relative Share Price Performance of Berkshire Hathaway Class A Share, PCP, and the ‘S&P 500 January 1, 2015, to August 13, 2015 75| _ov2015 02/2015 03201 OH2015 «S201 ~—«0BZOIS —O7!ROIS ——OBIROIS PCP = Precion Cstpars: BRKA = Berishre Hthavay Cass shares: SEPS00 = Standard & Poor's $00 Index. source: Google Finance,14 ParvOne Setting Some Themes EXHIBIT 4.2. | Berkshire Hathaway Condensed Const lated Financial Statements, 2011 2012 2013, 2014 Income Statement {tnnlions, except per share data, unless otherwise specified) Revenue $143700 -$162500 $182,200 $194,700 Operating expenses 123,080 434,810 147,770 163,340 Income from operations 20,620 27,680 34430 31,360 Netinterest expense 5310 5,450 5,630 3,250 Income before income tax expense 75.310 22.240 76800 28,110 Income tax expense 4570 020 2,950 7.940 Consolidated net income 310.075 Fases0 © $ 20.170 2014 2012 2013, 2014 Balance Sheet {tv mitions, except per share data, unless otherwise specified) : Assets: 7 ‘Current assets $ 79220 $91,200 © $ 91800 «$107,900 Net property lant and equipment 100,400 108,900 122200 137,200 Deferred tox assets 40540 9,780 8,430 8.430 (ther assets 213,040 229,320 271,270 281,070 Total assets $eo3200 «$437,200 «= $493400 © «534.600 Luabitties & Shareholder Equity: Curren iities $ 34200 $47,290 $ 44470 «$48 510 Deferred tax tabities 47.650 53.670 65870 70.370 Long-term dobt 58.890 50810 65590 71.990 | ‘other long-term abies 93.460 93.830 92970 Tota labiltos 234,200 245,600 268,300 ‘Shareholers' equity 469,000 491,600 224,500 Total ablties and stockholders’ equity $as7.200 $493,400,Case 1 Warren E, Butfeu, 201318 $100,000] $10,000 $1000 100] $10) SOP PPP PE EE EEE S aca [wre 18 Years Annualized | 9.5% | 26% 9 Yoars Annualized | 228% | 80% ‘Note Pei sted as 2015 represents Janvary 1, 2015 toy 31,2015, Dela souce: Yano! Financeom EXHIBIT 4.4 | Business-Segment information for Berksire Hathaway Inc. (dollars in miions) Capital Segment Revenues sir Expenditures Depreciation Total Assets 2014-2018 «201s ~—«2015~—=—«2014~—=—«2015 2014-2015 20142015 Insurance Group $ 45623 $ 45956 $7025 $6287 $ 94 $ 115 $ 69 $ 77 $225,492 $219451 Manufacturing $36,773 $ 36136 $4611 $ 4893 $1324 $1202 $ 943 $ 938 $ 34,509 $ 34141 Serice & Retaling $ 60916 $71,689 $1981 $2222 $ 832 $ 912 $ 620 $ GOS $ 16,722 $ 22,170 Rairo9d $ 23239 $ 21967 $6109 $6775 $5243 $5651 $i.s04 $1,932 $ 62.916 $ 66613 sity and Energy 517618 $ 2H $271 $2ES1 Foss $9876 $2177 $2451 $71,402 74221 Finance & Financial Products $ 6526 $ 6964 $ 1639 $2086 $ 1.137 $2236 $ Gor $ 610 $32,166 $ 37.621 ther $3982 $ 9978 _$ 3569 _$ 8 $- $$ _-_$ 60,714 _$ 99040 Tora 154673 S202 $7010 SISII4 $1518 16082 $6215 $6673 $503999 $552,257 Souce: SEC documentCase 1 Warren. Butfeu, 201317 Major Investees of Berkshire Hathaway (dollars in millions) Percentage of Company ‘Company Owned cost" Market {tn milfons) 610,700 American Express Company 148 $1,287 $14,106 99,000,000 The Coca-Cola Company 92 1.298 16888 513482 _OaVita HealthCare Partners nc. 36 243 1402 430,586 _Doere & Company 45 1.253, 1365 24617939 DIRECTV 49 asa 2134 1962.594 The Goldman Sachs Group, Inc 30 750 2532 6.971.817 International Business Machines Corp. 78 13,187 12349 4,669,778 Moody’s Corporation 1A 248 2364 060,390 Munich Re 18 2,990 4023 “52,477,678 The Procter & Gamble Company 19 336 4983" 22,168930 Sano 7 4721 2032 6.890.565 US. Bancorp 54 3033 4,385 9,387,980 SG Corporation 300 835 n214 61,707,544 Wol-Mor Stores, Ic. 2a 3,798 sais 483,470,853 Wells Fargo & Company a4 grt 26.504 E Others 10,130 Total Common Stocks Carried at Market 355,056 es sates hed by pension funds of Brksie subscales. under contct of sle for ths amount ice Derie Hathevay ne. ler t shareholders, 201418 Par.OneSeting Some Themes EXHIBIT 4.6 | Hypothetical Example of Value Creation Assume: + Fiveyear investment horizon, when you lgudte at "book" or accumulated investment value + Inal investment is $50 milion + No dividends are pad, all cash lows ae reinvested + Return on equity = 20% + Cost of equity= 15% x o 1 2 3 4 5 Investment or book equty| value 50 60 7286104124 Market value or intinsic value) = Present value @ 15% of 124 = $61.65, Market/book = $61,65/50,00 $1.23 Voue created! $1.00 invested becomes $1.23 i market value. Source: Autor analy, EXHIBIT 4.7_1_ Hypothetical Example of Value Destruction Assume: + Fwve.year Investment hotizon, when you liquidate at "book" or accumulated Investment value + Initial nvestmont of $50 mitlon + No dividend ae pal, al cashflows are reinvested + Retuin on equ + Cost of equity = 15% Yeor o 1 2 3 4 5 Investment or book equity value sO 5560778 Market value (or intinsic value) = Present value @ 15% of $2 Market/book = $40.30/5000 Volue destroyect $1.00 invested becomes $0.80 n market vole.Case 1 Waren E.Butfen, 201519 Berkshire Hathaway Acquistion Criteria Get heer from principals or thelr representatives about businesses that meet all ofthe flowing ceria = U‘chases (at least $75 milion of pretax earnings unless the business wil t into one of our existing units) eaming power demonstrated (Future projections are of no interest tous, no ae turnaround situations) s eaming good retums on equity while employing ite or no debt agement in place We can't supply t) businesses (there's lots of technology, we wont understand it) ring price [We don't want to vaste our ime or that of the sella by taking, even preliminaly, about a trans- ln when price Is unknown) larger the compony. the greater wil be our Interest We woul ike to make an acquisition inthe $5 blion bilion range. We ore not interested, however, in rocelving suggestions about purchases we might moe in stock market vill nt engage in unfiendly takeovers. We can promise complete confidentiality and a very fast answec— ly within Five minutes—as to whether we're interested, We prefer to buy fr cash, but wil consider suing 1 We FeceWVe as much in intrinsic business value as we gue, We don't portepate in cuctions, Charlie ond | requenty get approached about acquisitions thet dant come close to meeting our tess: We've Ps thet Ifyou advertise an interest in buying calls, alot of peape wil cal hoping to sel you theit cocker Aline from a country song expresses our feeling about new ventures, turnarounds, or autionke sales: the phone don't ring, you'll know i's me."20 PartOne Setting Some Themes 174.9 12 Months Ending March 34 nec Consolidated net income from continuing operations? $1,433 $1731 : eae a rae {i miions, except per share date, unless otherwise spectec) | ae pee cy ae ass Gieeiaee eee Pension biigation ‘other long-term abitties Total ables Shareholders’ equity? 11413 Total abilties and stockholders’ equity Si586 “Note Fiscal year ends March 31, Period Ist as 2015 eprasents March 31,2044 to Mach 31,2018, Note-The market value of PP’ equly sholy Bele the announcement of he scan by Behe Hathoway wos $31,208 mi excludes equity in unconsosted investments Ercludesnoncontoting insets1" IT 4401 Comparable Firms Price Per Share (otiars in milions) bw. Cash Shares Per Total Total «and. ST LT_—sNet Net Company O/S__ Low ‘High Share Assets Liabiltes Equiv Debt Debt Debt Rev EBITDA EBIT Income Alcoa 1.2167 $ 15.77 $ 1603 $0.12 $3739 $22605 $1.87 $ 83 $8,769 $6,975 $23906 $3556 $2185 $2,043 ust 540 $ 2130 $ 2150 $037 $1387 $ 677 $ 111 $ 46 $ 246 § 181 $ 1,307 $ 193 $ 131 $ 91 Tryssenkrupp 565.9 $ 2064 $ 2085 $0.11 $41547 $38,348 $4,122 $1,071 $6.651 $3,600 $41,304 $2,290 $1,314 $ 210 Allegheny Technologies 1087 $ 3459 $ 3541 $0.72 $6583 $3861 $ 270 $ 18 $1509 $1,257 $4223 $ 283 $ 105 ($3) Carpenter Technology _53.1_$ 6175 $ 6335 $0.72 $ 3058 $1553 $ 120 $ 0 $ 604 $ 484 $ 2173 $ 382 _$ 212 $ 133 Precision Castparts —_ 141.8 $20961 $211.36 $0.12 $19.428 $ 8471 $ 474 $1,093 $3,493 $4,112 $10,005 $2927 $2602 $1,530 Note: Dot values ee mins excep fr share pies and hdends per shoe, whch ara dalla uns, Shares outstanding (O'S) oe sated in miions. ALCOA, NC, engages nights moti engines and manutctong products re uead Worcs nara, sumobiles, commercial uenspottion,packeging. ol and (928 detnse nd instil apcatins USS engages nthe menacing of multinclon fasteners and assembly componenis fo thes business sectors: Atospace, Automotive, and Medial THYSSENKRUPP AG engogesin the production of ste. The Components Technatogy business area affers components othe automotve, constucton and engineering sectors ALLEGHENY TECHNOLOGIES, NC engoges the mentocureo speciaty meterels ond component or alferent cuties, which nde aerospace and defense, ol and ges and chemieal processing, a wet a leu! ener. ‘CARPENTER TECHNOLOGY CORP. engages in devetoning, minuacturing. and dntrbuingcasvorougM and power met sinless seals. operates though Speci Aloys ‘Operatons and Perfomance Engnerea Products Segments.EXHIBIT 4.14. | Valuation of PCP Based on Multiples for Comparable Firms Enterprise Value MV of Equity, ovis ‘as Multiple of 2s Multiple of: Company Mv Enterprise Book Net NetBook tine | Name Equity Value Value | Rev EBITDA BIT Income|Revenue EBITDA ERIT | Income Value 1 [Alcoa $13,637 $23,164 $10599|$23906 $3556 $2,185 §2043| 097% 65Ix 1060x| 668x 129% 2 Just $1332 $1517 $ 709/$ 1307 $ 193 $ 131 $ 81] 11x 7.86x 1156x| 16.36x 1.88% 3 | Thyssenkrupp | 9,460 $12924 $ 3,182 $41304 $2,290 $1,314 § 210| O3tK 564% 984K] 45.05 297% 4 | Aleghery Technologies «| $ 1.804 $ 3193 $ 2598/$ 4223 $ 283 $ 106 ($3)| 076K 11.28% 3009] NM 0.6% 5 | carpenter Technology $1627 $ 2220 _$ 1326|$ 2173 $ 382 $ 212 $ 133| 10% _Satx_1047x| 1225% 1.234 6 | Mecian $1904 $3193 $ 2598|$ 4223 § 362 § 212 $ 133] O97x 6Six 1060x| 1431K 1.29% Mean $5572 $ 8603 _$ 3683|$14583 $1,341 $ 790 $ 493] ae 742 1451x| 2008 161% Precision Castpars '$10929 | $10005 $2927 $2,602 $1530 ‘| 8 | implied Value - Median’ $9,705 $19.055 $27.581|$21,894 $14,098 9 | Implied Vaiue- Mean’ $3408 $21,718 $37,755|$30,722 $17,596 Data Sours: Facto. "The calculation ofthe pled values for PCP based onthe median of he peer es mses aks he producto he median vel of the mutes of comparable fms ine 8) ne ‘ats times te relevant bese fevence, ETDA, ERT, rot nome, of Bock vale) fer PCP. The same method i sed forthe alculton of the pled vlve based onthe ‘average or meon ofthe peer ims’ utils fine 9}. For instance the pled ale based onthe median util of EBT ($37,795 milion) is derive by muting 14.5 Ge mean BIT mute fr he comparable tks} tes $2,602 rion (he EBT af PCP,