Warren E. Buffett, the chairperson of Berkshire Hathaway (BH), is the world’s greatest investor of the current era. From 1965 to 2007, BH has compounded annual gain of 20.3% while S&P has 9.3% (Berkshire Hathaway Inc., 2009). Most investors get normal returns and believe the market is in semi strong form. However Buffett believes the market is inefficient and acts on his own investment philosophy. This report will analysis BH’s acquisition of PacifiCorp, evaluate Buffett’s performance against EMH and discuss his ethical standards. Berkshire Hathaway Ltd. VS Scottish Power Plc.
After the acquisition was announced, BH Ltd. and Scottish Power Plc. both experienced price ran up. Reilly and Brown (2009) state that, the acquired firm’s stock price usually increases; resulting from the premium offered by the acquiring firm, whereas stock price in the acquiring firm usually decreases as the concern of overpaid. However, the deal between BH and Scottish Power was a different case. BH and PacifiCorp share price increased by 2.4% and 6.28% on the announcement day, it indicated that most investors and markets recognized the bid of PacifiCorp was fair and believed that acquiring PacifiCorp was a good investment that could benefit BH. Malatesta and Thompson (1985, p.249) stated that an acquisition program is desirable and profitable for active acquirers and successive acquisition attempts associated with positive announcement effects. Therefore, as an active acquirer, BH could benefit from the successful acquisition of PacifiCorp and have positive share price performance.
In addition, the share price performance of PacifiCorp proved the existence of its intrinsic value and Buffett made a right decision in recognizing the fact. Jennings and Mazzeo (1991, p. 140) suggested that the acquisition process is usually associated with significant unexpected stock returns and bidder would only make an offer to the target when the value of target is less than the market price. Therefore, Buffett’s calculation of PacifiCorp’s value must have supported this notion. Although the share price performance might be an affect of Warren Buffett’s fame, it was sufficient enough to reflect the exactly value created by the deal between BH Ltd. and Scottish Power Plc. Valuation for PacifiCorp
Bruner, Eades and Schill(2010, p.3) stated that MidAmerican Energy Holdings, Buffett’s utility company, acquired PacifiCorp from its parent, Scottish Power Plc, for $5.1 billion in cash and $4.3 billion in liabilities and preferred stock. The bid for PacifiCorp can be proved as “fair” through three methods, including discounted cash flow, intrinsic value, comparable and precedent acquisition. Present Value of Operating Free Cash Flows
DCF method can be viewed as the conceptual basis for most relative valuation criteria (Titman and Martin 2007, p.215) However, the growth rate was unknown in this case. In order to use the model, the growth rate was assumed to equal to the growth rate of 2004 to 2005 which was 0.0145. In five years investment horizon, NPV of $5.1 billion’s bid is negative if the growth rate equal to 0.0145 (Appendix I; table 1 and table 2). If the growth rate is equal or larger than 0.594, the $5.1 billion bid would have positive NPV. Therefore, it can be concluded that in five years, the bid for PacifiCorp is “fair” if the net income of PacifiCorp can increase by 59.4% or more Intrinsic Value
Bruner, Eades and Schill (2010, p.7) indicated that Buffett believes intrinsic value is effective in evaluating the relative attractiveness of investment. (Appendix II, table 3)The $5.1 billion bid for PacifiCorp could be defined as “fair” since every dollar to acquire PacifiCorp becomes $1.22 in the 10 year investment horizon. Comparable
Boeh and Beamish (2007, p.102) stated that it is common to revalue a firm based on the trading multiples of a group of similar firms. By looking at the direct competitors who have comparable sizes and...