Synopsis and Objectives
Suggested complementary case about investment managers and superior performance: “Bill Miller and Value Trust” (Case 2).
Set in May 2005, this case invites the student to assess Berkshire Hathaway’s bid, through MidAmerican Energy Holdings Company, its wholly owned subsidiary, for the regulated energy-utility PacifiCorp. The task for the student is to perform a simple valuation of PacifiCorp and to consider the reasonableness of Berkshire’s offer. Student analysis readily extends into the investment philosophy and the remarkable record of Berkshire’s chair and CEO, Warren E. Buffett.
The case is an introduction to a finance course or a module on capital markets. The analytical tasks are straightforward and intended to provide a springboard into discussion of the main tenets of modern finance. Thus, the case would be useful for:
• setting themes at the beginning of a finance course, including risk-and-return, economic reality (not accounting reality), the time value of money, and the benefits of alignment of agents and owners
• linking valuation to the behavior of investors in the capital market
• modeling good practice in management and investment using Warren Buffett as an example by returning to the image of Buffett repeatedly during a finance course to ask students what Buffett would likely do in a situation
• characterizing stock prices as equaling the present value of future equity cash flows
• exercising simple equity-valuation skills
While the numerical calculations in the case are simple, novices will find it to be a meaty introduction to a number of important concepts in finance. Ideally, the case could be positioned near the beginning of a course or module, after which it can be reinforced by other cases and exercises. Suggested Questions for Advance Assignment
1. What is the possible meaning of the changes in stock price for Berkshire Hathaway and Scottish Power plc on the day of the acquisition announcement? Specifically, what does the $2.55 billion gain in Berkshire’s market value of equity imply about the intrinsic value of PacifiCorp?
2. Based on the multiples for comparable regulated utilities, what is the range of possible values for PacifiCorp? What questions might you have about this range?
3. Assess the bid for PacifiCorp. How does it compare with the firm’s intrinsic value? As an alternative, the instructor could suggest that students perform a simple discounted cash-flow (DCF) analysis.
4. How well has Berkshire Hathaway performed? How well has it performed in the aggregate? What about its investment in MidAmerican Energy Holdings?
5. What is your assessment of Berkshire’s investments in Buffett’s Big Four: American Express, Coca-Cola, Gillette, and Wells Fargo?
6. From Warren Buffett’s perspective, what is the intrinsic value? Why is it accorded such importance? How is it estimated? What are the alternatives to intrinsic value? Why does Buffett reject them?
7. Critically assess Buffett’s investment philosophy. Be prepared to identify points where you agree and disagree with him.
8. Should Berkshire Hathaway’s shareholders endorse the acquisition of PacifiCorp?
Suggested Supplemental Readings
As the case indicates, there is a growing library of books and articles about Buffett and his investment style. The instructor may choose to assign readings from one or more of the publications listed in Exhibit TN1. Alternatively, it may be appropriate simply to share the list of books with students to illustrate the breadth of scholarship and reportage about the Sage of Omaha, Warren Buffett.
Suggested Teaching Plan
The following questions could be used to motivate a 90-minute discussion of the case:
1.What does the stock market seem to be saying about the acquisition of PacifiCorp by Berkshire Hathaway?...