An insight into

Warren Buffetts
Success
A C ASE ST U DY FO C US E D ON TH E 20 05 PARC IFIC
C O RP. AC Q UIS IT ION

Content
Introduction
Valuation of PacifiCorp. and bid assessment: BRKs
approach
The acquisition of MidAmerican Energy
Historical performance of BRK
The Big Four
Conclusion: is Warrant Buffetts model for everyone?

MSc. International Accounting and Finance Cass Business School

Introduction: Quick Facts

Announced on 24th May 2005
$5.1 bn asset + $4.3 bn liability
BRK share price closed up 2.4%, increasing market
capital by $2.55 bn
Value added?

MSc. International Accounting and Finance Cass Business School

Introduction: The Acquisition of

PacifiCorp.
Share price up 2.4%

Share price up 6.28%

Acquired for $9.4bn

MSc. International Accounting and Finance Cass Business School

Introduction Pictures

MSc. International Accounting and Finance Cass Business School

Valuation and Bid Assessment: Valuation

Multiples

Identify peer
group
Identify key
financial
indicator

Peer Group

Calculate
Multiples
Calculate MV equity
and enterprise values
of peer group
Calculate MV equity
and Enterprise value
as multiple of
selected indicators

MSc. International Accounting and Finance Cass Business School

Calculate the mean

and median of
obtained multiples
Multiply firms
financial indicators
values to relevant
multiple to obtain the
value of firm

Estimate
Firm Value

Valuation and Bid Assessment:

Illustration
Peer 1

Peer 2

Peer 3

Peer 4

MV Equity ($)

150,000

250,000

300,000

350,000

Net Income

20,000

40,000

45,000

70,000

MV as Multiple of NI

7.5

6.25

6.67

Mean of Multiple = (7.5+6.25+6.67+5)/4 = 6.335

Net Income of firm in question = $50,000
MV Equity as multiple of NI = 50,000 * 6.335 = $317,750

MSc. International Accounting and Finance Cass Business School

Valuation and Bid Assessment:

Indicators
Net Income: The accounting profit of the firm; does not
reflect real cash flow
EBITDA: The more reliable measure for the real cash flow
EBIT: Useful when depreciation and amortisation is trivial,
e.g. law firms
Revenue: A measure of the total cash inflow of the firm:
not normally useful, only use when no other reliable
measures are available

MSc. International Accounting and Finance Cass Business School

Valuation and Bid Assessment:

Results
Enterprise Value as Multiples of Financial Indicators

MV Equity Valuation

9500

7000

9000

6000

8500

5000

8000

4000

7500

3000

7000

2000

6500

1000

6000

Rev

EBITDA
Median

EBIT

Net Income

EPS

Mean

BRK paid a total of $5.1 bn in asset + $4.3 bn in liability

= $9.4 bn
MSc. International Accounting and Finance Cass Business School

Book Value
Median

Mean

The Acquisition of MidAmerican Energy:

Quick Facts
Mid American Energy: leader in the production of energy
from diversified sources
Located in Des Moines, Iowa; serves 5 million customers
in UK/US
March 2000: major stake of BRK with $1.24 billion
investment in common stock and non-dividend paying
convertible preferred stock
March 2002: further 402 million investment in
convertible stock
MSc. International Accounting and Finance Cass Business School

2/13/15

The Acquisition of MidAmerican Energy:

Valuation
Another common valuation approach: The Free Cash
Flow Valuation
Application to the case:
1) Computation of the FCF accruing to Berkshire from MidAmerican
Energy between 2000 - 2004
2) Discounting of the FCF to the year 2000
3) Investment assessment based on the results

MSc. International Accounting and Finance Cass Business School

2/13/15

The Acquisition of MidAmerican Energy:

Valuation
1) Computation of the FCF accruing to BRK
What is a Free Cash Flow?
Values the companys operations
Does not include financing and non-operating items
Respects: Tax burden from earnings. The Capital Expenditures,
Changes in net working capital

Computation:
FCF = EBIT (1-) + Depreciation - CAPEX - NWC

MSc. International Accounting and Finance Cass Business School

2/13/15

The Acquisition of MidAmerican Energy:

Valuation
1) Computation of the FCF accruing to BRK: Sample
Calculation for 2001
2001
EBIT ( Operating revenue& other sources of
income-Cost of sales and operating expenses )

912.00 $

EBIT(1-): Tax adjusted EBIT, Tax Rate: 40%

547.2

+Depreciation
+Depreciation
-- Change
Change in
in CAPEX
CAPEX (gross
(gross PPE
PPE (2002)-gross
(2002)-gross PPE
PPE
(2001)+
(2001)+ gross
gross Goodwill
Goodwill (2002)-gross
(2002)-gross Goodwill
Goodwill
(2001)
(2001)
-Change
-Change in
in NWC
NWC (( 20%
20% ** Total
Total Assets
Assets 20%
20% Total
Total
Liabilities
Liabilities ))
=
= Free
Free Cash
Cash Flow
Flow

539
539 $
$
1,154.00
1,154.00

MSc. International Accounting and Finance Cass Business School

315.2
315.2
-383.00
-383.00 $
$
2/13/15

The Acquisition of MidAmerican Energy:

Valuation
1) Computation of the FCF accruing to BRK
Year
FCF

2000

2001

2002

2003

2004

2005

-383.00
$

3410.00
$

176.40
$

676.20
$

689.72 $

assuming a growth rate g = 2% after 2004

MSc. International Accounting and Finance Cass Business School

2/13/15

The Acquisition of MidAmerican Energy:

Valuation
2) Discounting of the FCF to the year 2000
Method 1: Calculating the terminal value for year 2004
:
+ 4,374.00 $

MSc. International Accounting and Finance Cass Business School

2/13/15

The Acquisition of MidAmerican Energy:

Valuation
2) Discounting of the FCF to the year 2000
Method 2: Calculating the terminal value for year 2003
: 9,660.00 $
+ 4,374.00 $

MSc. International Accounting and Finance Cass Business School

2/13/15

The Acquisition of MidAmerican Energy:

Valuation
3) Investment assessment based on the results
Calculation of the net gain:
Discounted FCFs ( ) Actual Investment value
$ 4. 374 billion $ 1.24 billion $3.134 billion
profitable investment

MSc. International Accounting and Finance Cass Business School

2/13/15

Historical Performance of BRK

Overall a very strong performance relative to S&P 500
index
Book value share price increased at 21.8% YoY since
1965
However, there are some poor performance worth
noting!

MSc. International Accounting and Finance Cass Business School

MSc. International Accounting and Finance Cass Business School

BRKs Big Four: A 12 Year Review

Big Four of BRK: Cost vs. Market Value as per YE 2004
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%

American Express

Coca-Cola
Cost $mm

MSc. International Accounting and Finance Cass Business School

Gillette
Market Value 2004 $mm

Wells Fargo

Total

Berkshire Hathaway Big 3 Performance vs S&P 500

14

12

BRKs Big Four: A 12 Year Review

10

8
Index
6

0
1/3/1992

1/2/1993

1/2/1995
1/2/1994

1/1/1997
1/2/1996

1/1/1999
1/1/1998

MSc. International Accounting and Finance Cass Business School

1/1/2000

American
Express
Coca Cola
Wells Fargo
Source: Yahoo (2014), Yahoo finance. [Online].
Avaialbe
at: https://uk.finance.yahoo.com

12/31/2000
12/31/2002
12/30/2004
12/31/2001
12/31/2003

S&P 500

Conclusion: Is Buffetts Approach for

Everyone?
Buffetts approach is proven successful
However poor performance during 1999-2001 is
notable!
Conventional Thought
Warren Buffets Wisdom
Risk is the volatility in return

Risk is the absolute loss and

injury

Risk is not avoidable, but can be

hedged

It is not necessary to hedge risk

if you can avoid risk

Therefore need to build a

diversified portfolio!

Therefore you should wait until

you find the elephant

Diversification gives you less risk

Risk can be avoided if you

choose only reliable companies

MSc. International Accounting and Finance Cass Business School

Conclusion: Is Buffetts Approach for

Everyone?
Buffetts approach is not flawless
In certain circumstances, it can function effectively
Berkshire Hathaway

Other institutional investors

Overall long-term objective

(discount cashflow at lower rate)

Managers are reviewed on

quarter or annual basis

Rationality driven motivation

(understanding of fundamental
business reality instead of
accounting reality)

Behaviour is easily driven by the

market, especially when
competitors are making money
(dot.com bubble)

Near perfect alignment of

shareholder/manager interest
(almost 50% of the net worth of
management is attributable to
BRK)

Managers gain commission upon

the completion of an acquisition
regardless of the long term
outcome, which does not
necessarily add value to
shareholders

MSc. International Accounting and Finance Cass Business School

Conclusion: Is Buffetts Approach for

Everyone?
There is no universal method of fortune making
Warren Buffetts saga can only be replicated with many
restrains applied.
It is the methodology, not the result we need to learn:
Fundamental analysis, patience, long-termism and
alignment of stakeholders interest!

MSc. International Accounting and Finance Cass Business School

I am a better investor because I am a

businessman; I am a better businessman because
I am an investor.
- Warren Buffet

MSc. International Accounting and Finance Cass Business School

Thank You very much!

MSc. International Accounting and Finance Cass Business School