Case Study

Warren Buffett
“Our shareholders can buy the S&P through an index fund at very low
cost. Unless we achieve gains in per-share intrinsic value in the future
that outdo the S&P, Charlie and I will be adding nothing to what you can
accomplish on your own.“

– Warren Buffett’s Letters to the Shareholders (2004).

Executive Summary

“The energy sector has long interested us, and this is a right fit” - On March 14,
2000, Berkshire Hathaway took a major interest (76% economic interest) in
MidAmerican Energy Holdings, initiating Berkshire’s move into the utilities sector. On
May 24, 2005, Berkshire then extended its presence in the utilities sectors by
announing the acquisition of Pacficorp (100% economic interest).

The following material presents an analysis of Berkshire’s investments in

MidAmerican Energy holdings, and subsequently, its investment in the acquisition of
Pacficorp. Furthermore, this analysis also provides:

 Historical performance of Berkshire Hathaway.

 Strategic overlook on Berkshire’s other investments (Coca-Cola, Gilette,
AmEx and Wells Fargo);
 An assessment of DCF and Multiples valuation techniques;
 A valuation opinion on Pacificorp and MidAmerican;
 Bid assessment for Pacificorp’s Acquisition;
 Buffett’s investment philosophy
Agenda

1. Berkshire Hathaway
An Assessment of Berkshire Hathaway’s Historial Performance
Berkshire’s Big 4 Analysis – Gilette, Coca-Cola, Wells Fargo and AmEx

2. Berkshire’s Investments in the Energy Sector:

An investment Analysis of Berkshire’s Acquisition of MidAmerican
Pacificorp – Valuation Opinion (DCF & Multiples)
Pacificorp – Berkshire’s Bid Assessment vs. Valuation Opinion
MidAmerican Acquires Pacificorp – Market Reaction & Expectations

3. An Evaluation of Warren Buffett’s Investment Philosophy

1 Berkshire Hathaway

An Assessment of Berkshire Hathaway’s Historial Performance

Berkshire’s Big 4 Analysis: Gilette, Coca-Cola, Wells Fargo and AmEx

Berkshire Hathaway
Berkshire Hathaway’s Business Strategy
1960s – Insurance and Cigar butts
- 1967 saw Berkshire Hathaway acquire National Indemnity Insurance and National Fire and Marine Insurance
Company.
- Insurance companies form a key part of the Berkshire Hathaway’s success through ‘floats’.
- ‘Floats’ are created as a result of the time delay between collecting premiums and paying out claims.

Buffett’s mentor, Ben Graham was known as the ‘father of value investing’, i.e. buying securities that appear under-
priced by some form of fundamental analysis (e.g. share price < book value). This then enables a one-time return
between the gap between the price and the closing value.

1970s and beyond – Doubling down on Insurance and a shift in mindset

- Since the 60s, Berkshire has continued to expand its operations in the insurance market e.g. merging with
General Re (1998) and acquiring Geico (1996).
- Furthermore, we know that Charlie Munger has a big influence on Buffett’s life and is believed to have change
Buffett’s view on investing to look toward a more long-term investing mindset.
- In 1972, Berkshire Hathaway acquired of See’s Candies, an American manufacturer and distributor of candy.
This acquisition Buffett reaffirm that long term investing was the way to go.
- See’s was only earning approximately $4 mil pre tax and utilizing $8 mil of net tangible assets, yet the
owners wanted $30 mil for the business. In the end Buffett was willing to pay $25 mil which is still a
massive premium over tangible assets. Why?
- Did it pay off? In 2007 profits stood at $82mil per annum (20x) and this only required $32mil worth of
reinvestment into Sees.
Berkshire Hathaway
So how can we measure Berkshire’s performance?
Can we just look at their income statement figures? No – because BRK is not a simple manufacturing
company:
Whilst BH owns many other businesses, it also owns minority stakes in many others including some of the largest
organizations on the S&P 500 e.g. Coca-Cola. If Coca-Cola share price increases by $10, Berkshire Hathaway would
score a $4 billion gain on its investment – but how is this captured on BRK’s financial statements?

Book Value
100.0% Book value vs S&P500 (1960-2005) BRK.a BV/share 
Return on S&P 500*

50.0%

0.0%

-50.0%
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Book Value
Book value vs S&P500 (2006-2018) BRK.a BV/share ∆% 
Return on S&P 500*
50.0%

0.0%

-50.0%
2006 2008 2010 2012 2014 2016 2018

*Including Dividends
Berkshire Hathaway
Comparing the Compound Annual Growth Rate (CAGR) between periods…

CAGR (%) BRK CAGR (%) S&P ∆ BRK vs. S&P

Period
Class "A"* 500 500

1965 - 2004 24.2% 9.99% 14%

2007 - 2017 7.7% 8.5% -1%

2007 - 2009 -16.3% -10.7% -6%

We observe that the CAGR for BRK between 1965 and 2014 had astonishing performance, even
when compared to the S&P 500.
However, compared to the last 10 financial years performance has been less stellar…
Berkshire Hathaway
Exploring potential reasons for recent ‘poor’ performance

 Diversified Portfolio: How diversified Berkshire’s portfolio is meaning it mirrors the economy and
broader market more, and so it is becoming harder to ‘beat the market’.

 Percentage Changes: Measurements of percentage changes may provide misleading results. In 1980,
at the peak of its outperformance of the S&P 500, Berkshire’s market cap was $420 million; today, it is
$516 billion. A return that would have doubled the company’s value in 1980 adds just 0.08% to its worth
now.

 ‘Gems’ in the market: The task of identifying undervalued companies gets increasingly difficult with
scale, too. Berkshire already owns part or all of more than 100 companies. There are only so many
undervalued companies out there!

 Private firms on portfolio: Warren Buffett suggests the reason for the decline in its annual growth rate
is an understatement in the value of its private businesses, which can't be priced daily like its stock
holdings and represents a far greater percentage of total assets than a decade or two ago.

 Ownership vs. minority holdings: A change in strategy has meant a movement toward wholly owning
businesses rather than a minority interest.
 Since 2004, BH has made 21 acquisitions1. Combined with the fact that as at August 2018, Apple,
Wells Fargo, Bank of America, Coca-Cola and American Express make up around 70% of
Berkshire Hathaway’s portfolio.

1. Bureau van Dijk – Zephyr query
Berkshire Hathaway’s ‘Big 4’
Berkshire’s Big 4 Analysis (I)

Share Own. End Value Beg. Value

Company Yr of Purchase Ownership Share Own. CAGR Period (Years)
(mi) (USDmi) (USDmi)

1988 8.3% 200.0 16% 16% 8,328 1,299 12.50

1989 9.7% 96.0 14% 17% 4,299 600 12.50

1990 3.3% 56.4 13% 18% 3,508 463 12.50

1987 12.1% 151.6 17% 15% 8,546 1,470 12.50

Total n.a. n.a. n.a. 60% 16.07% 24,681 3,832 12.50

End value = Beg value (1+CAGR)12.5

Consolidated CAGR End Value (USDmi) Beg. Value (USDmi) Period (Yrs)
Portfolio CAGR 12.1% 37,717 9,056 12.50
Berkshire Hathaway’s ‘Big 4’
Berkshire’s Big 4 Analysis (II)

Assumptions
• BRK’s 4 investments saw a 16.1%
Years 12.5 12.5-YR CAGR growth, showing to
have been good investments when
Discount Rate 9.0% compared to S&P gains over the
same period.
Purchase Price Market Value
Buffett's Big 4
(USD mi) (USD mi) • The PV of the 2004 MV of BRK’s Big
4 investments in 1992 is USD 8.4bn;
1,299 2,836

• The PV of the PP of BRK’s Big 4

600 1,464
investments is USD 3.8bi.
463 1,195
• BRK’s 4 investments have seen a
2.2x increase in MV between the
1,470 2,910
assumed 12.5yr average
investment holding period.
PV of Market Value 3,832 8,405

PV of Market Value
2.19x
/ Purchase Price
Berkshire Hathaway’s ‘Big 4’
Why These Four?

• These brand names are household names both globally and even more so in America. This
provides what is termed an ‘economic moat’ i.e. enables long-term profits, growth even in a highly
competitive market and a buffer of protection.

• For example: Buffett first purchased AmEx in 1964, right after their share price halved as a result
of the ‘salad oil scandal’.
 Buffett saw this as a one-off event and that AmEx’s core business, good management and
moat would prevail. Over the next 10 years, AmEx’s share price increased tenfold.

• After Wells Fargo’s recent scandals, Buffett also sees this as a one-off event – similar to
American Express back in the 60s.
 Buffett has gone on record to say, “I see no reason to think that Wells Fargo going forward, is
anything other than a large bank that had an episode…”
2 Berkshire’s Investments in the Energy Sector

- Analysis of Bershire’s investment in MidAmerican in 2000

- Analysis of Bershire’s acquisition of Pacificorp in 2005

“It's far better to buy a wonderful company at a fair price than a fair
company at a wonderful price.”

- Warren Buffett’s Letters to Shareholders (1989)

Analysis of BRK’s MidAmerican Acquisition
Discount Period 0 1 2 3 4
FCFF – MidAmerican (USDmi)
EBIT
2000 2001
912
2002
1,281
2003
1,627
2004
1,699
Key Figures
Income Tax Rate (%) 40% 40% 40% 40%
EBIAT
D&A
547
539
769
530
976
603
1,019
638
WACC
Operating CF 1,086 1,299 1,579 1,657 @ 9.0%
PPE 6,537 10,285 11,181 11,607
Net Capital Spending
Total Assets
-1,188
11,681 12,626
-3,748
18,435
-896
19,145
-426
19,904
TV Growth
PPE (Gross) 5,349 6,537 10,285 11,181 11,607 @ 2.0%
Goodwill (Gross) 3,673 3,639 4,258 4,306 4,307
Current Assets 2,659 2,450 3,892 3,658 3,990
Total Liabilities 10,105 10,918 16,141 16,374 16,933
Total Debt 6,951 7,618 12,014 11,874 12,006 PV of TV
Current Liabilities
Net Working Capital (NWC)
3,154 3,300
-495 -850
4,127
-235
4,500
-842
4,927
-937
@ USD 13.7bn
Changes in NWC -355 615 -607 -95
FCFF 253 -3,064 1,290 1,326
Terminal Value 19,328 PV of FFCFs
@ -USD 195mi
PV of USD=1 @ 2000 1.00 0.92 0.84 0.77 0.71

PV of CF's n.a. 232 -2,579 996 940

13,692
NPV (Yr. 2000)
@ USD13.3bn
NPV 13,281
Analysis of BRK’s MidAmerican Acquisition

MidAmerican Energy Holdings Indicative Valuation & BRK Return

2000 2001 2002 2003 2004 Perp.
FCFF (USD mi) 253 -3,064 1,290 1,326
Terminal Value (USD mi) 19,328
PV of USD=1 1.00 0.92 0.84 0.77 0.71 0.71
BRK Econ. Interest 76.0% 83.7% 83.7% 83.7% 83.7%
BRK Econ. Interest FCF MidAm 192 -2,565 1,080 1,110 16,177
PMT for Shares by BRK -1,578
PV of FCFF -1,578 177 -2,159 834 786 11,460

Investment NPV 9,520 NPV of BRK’s investment in MidAmerican

(post-share purchase in 2000 & 2002)

2000 2001 2002 2003 2004 + Perp.

Cash Outflow (PV of share Purchase) -1,578 0 0 0 0
Cash Inflow 0 192 -2,565 1,080 17,287
Net Cash In/Outflow -1,578 192 -2,565 1,080 17,287
MidAmerican BRK Investment IRR 68.6%

For IRR analysis, we calculate the cash (in)/outflow to BRK. Key CF outflow is the PV (YR-2000) of
share purchases in 2000 & 2002. CF Inflows are the FCFF of MidAmerican x BRK Economic
Interest – Rendering an IRR of 68.6%.
Pacificorp Valuation Opinion
Valuation methodology used to value PacifiCorp
For the valuation opinion issued on Pacificorp, we utilized a weighted average based on DCF (30%)
and peer company multiples (70%). We rely more on the multiple method in this situation because
Pacificorp is a private firm with limited available information to make reliable FCF forecast.
Method Advantages
 Valuation based on CF generation, discounted by
a rate that reflects the business’ risk;
 Fundamentalist analysis based on short, medium
Discounted and long-term company projections;
Cash Flow
 Operational assumptions based on historical
(DCF)
performance, management and market forecasts;
30%
 Requires deep understanding of the operation and
relevant factors sensitive to the company;
 Allows adjustments for non-recurring items.
 Evaluates based on comparable listed companies;
 Allows intuitive assessment of the company. We
Peer utilized EV/EBITDA for better comparison (EBITDA
Multiples can be readily prepared, and mitigates D&A
70% accounting policies);
 Disregards particularities of each company/non-
recurring items.
Valuation Considerations
Internal/External Drivers Analysis:
 DCF allows for a company-specific assessment,
analysing its expected future cash flows – in line with
Berkshire Hathaway’s preferred methodology of
businesses based on future CF’s;
Bottom-Up Approach:
 Clear identification of key value drivers driving the
business’ FCF’s.
Market Thermometer:
 Using multiples provides an average benchmark for the
sector, for comparable companies (size, market
segment, average EBITDA, geography);
 Given that it is based on historical looking figures, it is
important to “hedge” one’s valuation by also
considering DCF.
 Pre-crisis multiples potentially reflecting high valuation
multiples.
PacifiCorp DCF Valuation – Key Assumptions
Assumption # Comments

Weighted average cost of capital between the

WACC 9% p.a.
cost of debt and the cost of equity.

7.0% (2006 + 2007) We estimate CAPEX financing via the usage

Yearly CAPEX Growth 65% debt, with an average debt maturity of 20
2.0% (perpetuity) years.

2.0% p.a. (for projected period 2006-2012) We assume constant growth of 2.0% p.a.,
Revenue Growth aligned with last 20-yr historical US GDP
2.0% p.a. (for terminal value calculation) growth – high correlation with energy firms.

Based largely on the average for generation,

Average D&A Time 20 Years (for existing and new assets)
transmission and distribution assets.

Model does not assume sale

CAPEX Residual Value 0
of residual asset

Dividend Payments Model assumes no dividend payments

GP margin 73.5% at maturity

Operational Optimization
OPEX margin 31% at maturity

Projections in USD in real basis. Model assumes valuation

Currency & Base Date
base date on 31/03/2006 (PacifiCorp FY end)

365 days convention

Working Capital Assumptions
AR 40 days / Inventory 60 days / AP 120 days / Other 50 days.
Pacificorp Valuation – DCF (USD mi)
Projected Free Cash Flow
Project Year # 0 1 2 3 4 5 6
FCFF (Nominal Values) Year 2006 2007 2008 2009 2010 2011 2012 Perp.
Net Revenues USD mi 3,110 3,172 3,235 3,300 3,366 3,433 3,502
(-) COGSS USD mi -871 -888 -874 -891 -892 -910 -928
(-) SG&A USD mi -1,026 -1,047 -1,035 -1,056 -1,043 -1,064 -1,086
(-) D&A USD mi 750 800 853 885 919 954 973
(=) EBITDA USD mi 1,213 1,237 1,327 1,353 1,431 1,459 1,488
EBITDA Margin % 39% 39% 41% 41% 43% 43% 43%
(-) D&A USD mi -750 -800 -853 -885 -919 -954 -973
(=) EBIT USD mi 462 437 473 468 511 505 516
Corporate Income Tax Rate % 40% 40% 40% 40% 40% 40% 40%
(=) EBIAT USD mi 277 262 284 281 307 303 310
(-) Investiments USD mi -991 -1,060 -648 -674 -701 -365 -372
(+) D&A USD mi 750 800 853 885 919 954 973
(+/-) Changes in Working Capital USD mi 158 -2 -12 -2 -7 -2 -2
(=) FCFF USD mi 195 -0 477 489 517 890 908 0
Annual Discount Rate % 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0%
PV of 1 USD USD 1.00 0.92 0.84 0.77 0.71 0.65 0.60 0.60
Cash Flows Present Value USD mi 195 -0 401 378 367 579 541 0
Terminal Value USD mi 13,225
TV PV USD mi 0 0 0 0 0 0 0 7,886

7-YR EBITDA Revenue TV Pacificorp

43% @ maturity @ maturity Present Value NPV

1,358 mi 3,502 mi 7,866 mi 10,347mi

 Pacificorp Valuation - Multiples
Selected Peer Multiples Valuation
Average Peer Multiples (x)1:
EV/Revenue EV/EBIT EV/EBITDA EV/Net Income

Med: 2.05x Med: 13.37x Med: 8.25x Med: 30.18x

Mean: 2.16x Mean: 14.15x Mean: 8.30x Mean: 30.01x
Pacificorp FY05 Key Figures (USD mi):
Revenue EBIT EBITDA Net Income

3,049 656 1,093 256

Pacificorp FY05 Multiples Valuation (USD mi):
EV/Revenue EV/EBIT EV/EBITDA EV/Net Income

Med: 6,252 Med: 8,775 Med: 9,023 Med: 7,596

Mean: 6,584 Mean: 9,289 Mean: 9,076 Mean: 7,553
PacifiCorp Bid Assessment
Enterprise Value Analysis (USD mi)

PacifiCorp Valuation - Enterprise Value

$9,289 $9,400

$6,252

Lowest EV (Revenue) Highest EV (EBIT) Amount Paid

PacifiCorp Bid Assessment
Equity Value Analysis (on EPS and BV basis) showing diverging results…

MV Equity as Multiple of EPS

$5,100

$4,277 $4,308

Median Mean Amount Paid (Cash)

MV Equity as Multiple of Book Value

$5,904
$5,678
$5,100

Mean Median Amount Paid (Cash)

Market Expectations for PacifiCorp Acquisition
BRK.a Share A • On announcement of BRK’s acquisition of PacifiCorp from Scottish Power, its
Class A share price increased 2.4% (+USD 2.55bi MV). Scottish Power also
Price Increase •
saw a daily MV increase of ~GBP 13.0bn (+6.28).
The share increase potentially shows market expectation of value accretion to
(May 24, 2005)
BRK, who made its 2nd largest ever investment in the Utilities/Energy sector.
• Alternatively, short-term stock price swings may reflect investor and speculative
sentiments – poor indicator of future earnings quality.
• Positive BRK MV impact - deal may be interpreted as accretive to BRK:
+2.55bi in BRK.a MV / PacifiCorp Shares = USD 8.15/share
• Deal Cash Payment:
 PP for 100% PacifiCorp: USD 9.4bn
o Debt assumption @ USD 4.3bn
o Cash @ USD 5.1bn:

+2.4%  PacifiCorp Shares outstanding: 312.8mi

 5.1bn / 312.8mi = USD 16.3/share paid to Scottish Power

BRK Scales • Scaling investments in utilities meant accessing a sector with:

 Capital Intensive Projects;
Utilities  Steady & predictable long-term cash flows (Utilities Beta = 0.29);
 High barriers to entry;
 Significant growth opportunities (increase in energy demand/capita in
Presence PacifiCorp region of operation);
 Long-term energy contracts = Long term capital deployment
• Large investment ticket is “the enemy of superior returns”. 24% p.a. returns
are will be difficult - 10-15% p.a. is more realistic. Return aligned with
average energy sector yearly ROE of 10% in the U.S.
3 An Evaluation of Warren Buffet’s Investment Philosophy
Buffett’s Investment Philosophy
Advantages / Limitations Comments

• Economic reality is a broader way and includes intangible

assets, such as trademarks, special managerial expertise and
1. •Agree – Decisions that affect company future
reputation of the business.
Economic reality, not performance should not be solely anchored on
accounting reality accounting parameters.
• Not basing investment decisions on accounting policies.
• Intangible assets cannot be quantified but are valuable.

2. • Considering the real cost of an investment as being what

•Agree – It is a logical to weigh alternatives when
The cost of lost you give up (i.e., other project/opportunities) to earn the
making an investment decision.
opportunity potential return on the current project.

• Buffett defines intrinsic value as the discounted value of the •Agree that it is the most complete method as it
3. cash that can be taken out of a business during its remaining provides estimates of future cash flows.
Value creation: life.
•However discount rates are subjective, and therefore
time is money should be applied together with other valuation
• Book value does not necessarily reflect economic reality. methods (DCF, DDM etc.)

• Measuring business performance by intrinsic value on a per-

4. share progress. Increases in profit levels does not always •Agree Buffett measures company’s performance by
Measure performance increase intrinsic value. per share basis.
by the gain in intrinsic •But it is also important to consider that the
values, not accounting • Although accounting profit ignores the cost of capital and shareholders are the main investors in the business,
profit market risk, it is also necessary because it enables better they need to understand the accounting records.
comparability between other firms.

Agree Partially Agree Disagree

Buffett’s Investment Philosophy
Advantages / Limitations Comments

•Buffett uses risk-free rate to discount cash flows and

focuses on companies with predictable and stable •Partly agree with his choice for rate of return, however
5. earnings. all investments have a degree of risk, and return should
Risk and discount rates •The unpredictable risk, e.g. natural disasters, political be factored according to that level of risk (subjective to
events. different investors).
•“the greater risk the greater return”.

•Investors should be waiting for one exceptional company

• Agree with investing a company you considerably
rather have a broad portfolio.
6. understand, but diversification is still a useful tool for
Diversification some investors who don’t have the resources to make
•Investors should act like the owner of the business.
entirely informed decisions about a given investment.
Understanding the operating fundamentals.

7. •Do not “time the market’.

Investing behavior •Does not believe in capital market efficiency. The stock
• Agree that making investment decisions by doing proper
should be driven by prices do not accurately reflect the intrinsic value of the
research on information about the company.
information, analysis business.
and self-discipline •Rational long-term investment approach.

8. •Management should have most of their wealth in

• Agree - A firm’s management and shareholders should
Alignment of agents company stock so as to serve the shareholders better in
have aligned interests as to minimize the agency problem.
and owners. decision making.

Agree Partially Agree Disagree

4 Takeaways

‐ Berkshire Hathaway’s performance has been outstanding compared to the 
S&P during 1965‐2004.

‐ Buffett’s investment in the Big Four generates a long‐term return that exceeds 
the average return of a portfolio of all large stocks.

‐ Pacificorp is a private firm that does not pay dividends and has limited 
information to make reliable forecast assumptions  Multiple valuation is 
preferred to discounted cash flow approach.

‐ Buffett’s investment philosophy: know his 8 principles