Berkshire Hathaway, Inc.

 

Please see disclaimer at bottom of this document

 

 

April 5, 2006    MidAmerican Energy Holding (MEHC)  More Notes

 

1.    When reading about the debt, one has to understand that Berkshire does not guarantee that debt.  The following is a quote from the annual report.

 

        " At MidAmerican, we have substantial debt, but it is that company’s obligation only. Though it
will appear on our consolidated balance sheet, Berkshire does not guarantee it.

Even so, this debt is unquestionably secure because it is serviced by MidAmerican’s diversified
stream of highly-stable utility earnings. If there were to be some bolt from the blue that hurt one
of MidAmerican’s utility properties, earnings from the others would still be more than ample to
cover all debt requirements. Moreover, MidAmerican retains all of its earnings, an equitybuilding
practice that is rare in the utility field.

From a risk standpoint, it is far safer to have earnings from ten diverse and uncorrelated utility
operations that cover interest charges by, say, a 2:1 ratio than it is to have far greater coverage
provided by a single utility. A catastrophic event can render a single utility insolvent – witness
what Katrina did to the local electric utility in New Orleans – no matter how conservative its debt
policy. A geographical disaster – say, an earthquake in a Western state – can’t have the same
effect on MidAmerican. And even a worrier like Charlie can’t think of an event that would
systemically decrease utility earnings in any major way. Because of MidAmerican’s everwidening
diversity of regulated earnings, it will always utilize major amounts of debt."

 

2.    The annual report also discussed the debt in this fashion, "Specifically, MidAmerican’s debt is currently not guaranteed by Berkshire. However, Berkshire has made a commitment until February 28, 2011 that would allow MidAmerican to request up to $3.5 billion of capital to pay its debt obligations or to provide funding to its regulated subsidiaries."

 

 

 

April 4, 2006    MidAmerican Energy Holding (MEHC)  Notes from 10-K and misc. notes

 

This is how Berkshire describes MEHC:  "MidAmerican owns a combined electric and natural gas utility company in the United States, two interstate natural gas pipeline companies in the United States, two electricity distribution companies in the United Kingdom, a diversified portfolio of domestic and international electric power projects and the second largest residential real estate brokerage firm in the United States."

 

 

1.    www.utilityforecaster.com  is a subscription based newsletter covering the Utility Industry.  I like to use it in a manner similar to Value Line.  It is a source I go to for our utility investing.  It is merely one of many sources.  The best source of information is typically the SEC filings.  The following is text from the April issue. 

 

"Berkshire Hathaway will complete the purchase of PacifiCorp from Scottish Power in barely nine months.  The speed is bound to whet Warren Buffett’s appetite for more deals.

One he might be eyeing is Xcel Energy, which serves 3.3 million electric and 1.8 million natural gas customers in 10 states. It also owns 15.8 gigawatts of low-cost generating capacity, two-thirds of which is stable-priced coal, nuclear and hydro. Recent successful rate cases prove management has repaired once-frayed regulatory relations as it reduces debt and operating risk. Trading at just 1.38 times book value, Xcel is a buy up to 19 for a takeover offer in the low to mid-20s.

The other big acquirer in the power patch is Britain’s National Grid, which has built a wires and pipes empire serving 3.1 million US customers. Grid faces a horrific regulatory environment in Labour ruled Britain, with allowed returns for its wires and pipes of just 6.25 percent. In contrast, its New York investments earn a 10.6 percent return on equity."

 

 

 

2.    Some metrics:

 

 

 

 

 

 

 

3.    Reading the financials, I certainly get concerned.  Debt loads seem high, and this is before Pacificorp.  Current ratio is less than 1.  Keep in mind that a negative current ratio in Utility industry is not terribly uncommon.  I am not sure if debt load is from a build-out of plant. 

 

4.    Miscellaneous Notes:      Berkshire Hathaway owns 88% of MEHC (not publicly traded).

        a.     Closed its $5.1B acquisition of PacifCorp. Berkshire paid for this purchase in cash. bought from Scottish Power.

        b.     MEHC was looking for $3.25b in funding. They decided to reduce the amount to $1.7B. The note was a 30 year note, priced at 130bp over treasuries (5 pts wider than originally discussed).

        c.     I think even at $1.7B, this was the largest 30 year bond deal, ever.

        d.    Why did they bring down the amount? Perhaps because so few are familiar with MEHC, not followed, not researched. Berkshire known to be shrewd in financing. Buyers and street might realize Berkshires shrewdness and not want to be on other side of transaction.

        e.    MEHC has $16.4B of debt, of which 4.5b is senior and 1.4 is subordinated.


                From NGI's Daily Gas Price Index:

Coming off 2005 utility results in which net earnings tripled to more than half-a-billion-dollars, Berkshire Hathaway's growth-hungry MidAmerican Energy Holdings Co. is looking at a two-fold jump in its electric utility customer base to more than 2.4 million, revenues of more than $3 billion and a total portfolio of utility energy assets exceeding $14 billion. These are the numbers Berkshire's billionaire founder and CEO Warren Buffett spelled out in a letter to shareholders posted on the parent conglomerate's website earlier this month.

Even without PacifiCorp in last year's results, Buffett said the U.S. utility operations, along with Kern River interstate natural gas pipeline operations, pulled in nearly $600 million of income before corporate interest and taxes. Kern River contributed $309 million out of the $1.16 billion before interest/taxes.

With the repeal last year of the Public Utility Holding Company Act (PUHCA), Buffett noted that Berkshire earlier this year converted its 80% ownership of MidAmerican from preferred to common shares of stock. The utility operations continue to be what he called a "four-party ownership" among Berkshire, Walter Scott and the utility holding company's CEO and president, respectively, Dave Sokol and Greg Abel. The foursome has to be in agreement before MidAmerican will pursue an acquisition or business strategy, Buffett said.

"Five years of working with Dave, Greg and Walter have underscored my original belief -- Berkshire couldn't have better partners," Buffett wrote in his shareholder letter.

Buffett told his shareholders he doesn't expect "outsized profits" from the regulated utility business, but it offers "fair returns" on large investments, and he made it clear the company is looking to acquire more utilities beyond last year's PacifiCorp purchase, which closed last Tuesday.

MidAmerican's varied assets include United Kingdom-based utilities, Yorkshire Electricity and Northern Electric, which showed $308 million in earnings before interest and taxes last year, compared to $326 million in 2004; its Iowa-based utility operations, which earned $288 million before interest/taxes in 2005, compared with $268 million the previous year; Kern River Pipeline, which brought in profits before interest and taxes of $309 million last year, compared to $288 million in 2004; and even the nation's second largest real estate brokerage firm, HomeServices of America, which had earnings before interest and taxes of $148 million last year, compared with $130 million for the previous year.



        f.    ebitda expected of 3.3B (35% from PacifiCorp). this covers pro-forma interest expense by 2.5X.

        g.    capex expected to be 1B + for next 5 years.

        h.    Berkshire AAA rated, does not guarantee MEHC debt, yet Berkshire did sink in $3.5B and a 5 year equity commitment. through 2/8/11.


        i.     Buffett did say in recent annual report that he plans on buying more Utilities.

        j.     Here is what Standard and Poors had to say...

Separately, Standard & Poor's Ratings Services announced last Wednesday that it raised PacifiCorp's rating to "A-1" from "A-2" to reflect the completion of MidAmerican's purchase of the Portland, OR-based utility from ScottishPower. The higher rating reflects S&P's conclusion that the "utility's short-term rating benefits from the explicit and implicit support that MidAmerican receives from its parent company, Berkshire Hathaway."

S&P credit analyst Anne Selting said there is specific support in the form of a $3.5 billion equity commitment agreement between Berkshire and MidAmerican Energy Holdings Co. "It could be called upon to support the liquidity requirements of MidAmerican's regulated subsidiaries, including PacifiCorp," Selting said.

"In addition, S&P believes that due to Berkshire's increased ownership interest in MidAmerican and its strategic focus on utility investments, it has incentives to treat PacifiCorp and MidAmerican's other regulated investments, as core to consolidated Berkshire Hathaway operations," she said.

As a further post-sale step Wednesday, S&P said it withdrew the credit ratings of PacifiCorp Holdings Inc. at the company's request. The unit is a wholly owned subsidiary of ScottishPower and has no debt outstanding, S&P said.

PacifiCorp Holdings had been the guarantor of obligations entered into by ScottishPower merchant energy company, PPM Energy Inc., which the UK-based company still owns in the United States. PPM is one of the nation's largest developers of merchant wind energy and natural gas storage projects.

    k.    The daily telegraph explained the sale as follows

SCOTTISH Power has become the latest FTSE 100 company to plug a hole in its final salary pension scheme by ploughing pounds 200m into its fund.

The Glasgow-based utility disclosed the plan as it completed the $9.4bn ( pounds 5.1bn) sale of its troubled former US subsidiary PacifiCorp to Warren Buffett's MidAmerican Energy Holdings.

The sale of PacifiCorp has generated pounds 2.5bn of spare cash, most of which should be handed back to the company's shareholders by early June.

However, Scottish Power revealed that it had decided to divert some of the cash into its final salary pension scheme, which is showing a deficit of around pounds 170m. The scheme is due to be closed to new members from April 6.

Philip Bowman, Scottish Power's chief executive who is due to give more details on his strategy for the company in late May at the full year results, said he was delighted that the deal had been completed ahead of schedule.

The cash handback will include a B-share option which could minimise the tax bill for smaller investors. He said: "The sale will allow the group to concentrate on developing continuing businesses. It is appropriate to make that return after having taken into account the review of financing, the ability to invest in opportunities within the group to deliver attractive returns and the need to make additional payments to our group pension schemes.'

Scottish Power shares rose 3 to 587½p. Analysts have suggested that the sale clears the way for an auction of Scottish Power, with Scottish & Southern Energy and Germany's E.on leading the pack of possible bidders.

According to analysts at US investment bank Merrill Lynch, the door is open for "a merger of equals' between the two Scottish companies because E.on is distracted by its ?29bn ( pounds 20bn) hostile bid for Spain's Endesa.

In a note, they said: "Scottish & Southern and Scottish Power have a significant opportunity to forge a merger of equals that would place the combined group solidly within Europe's top 10.'

A combination of the two companies would have 24pc of the UK energy market, still some way behind market leader Centrica with 37pc, although local monopolies in some regions of the UK could trouble the regulator.

"Other suitors may appear for one or both companies. However, European power is changing rapidly and neither company can ignore the implications,' Merrill said.


        l.    Barrons last week mentioned that head of MEHC might one day be on the docket to replace Warren at Berkshire

Who is that Berkshire manager? Our best guess is that it's David Sokol, 49, the chief executive of MidAmerican Energy, Berkshire's utility arm and the largest single earnings contributor to Berkshire after its insurance operations. While relatively young, Sokol has significant experience as a CEO, has demonstrated deal-making skills and appears to possess the ambition and ego needed to fill Buffett's enormous shoes. And since Berkshire is likely to do additional utility acquisitions beyond the pending $5 billion purchase of the Oregon electric company PacifiCorp, Sokol's experience in the field would be a boon.

It probably doesn't hurt that Sokol was raised in Buffett's hometown, Omaha, and went to the University of Nebraska. He works in Omaha, giving him easy access to the boss. Sokol was the wunderkind who ran a public company, Ogden Projects, when he was in his 20s. In 1991 he took the helm at California Energy, merged it with MidAmerican, an Iowa utility, and then sold MidAmerican to Berkshire in 2000. He elicits consistent praise from Buffett, who called Sokol and MidAmerican's president, Greg Abel, "terrific managers" in the annual letter.

We first tipped Sokol for the chief's post in our cover story "Buffett's Legacy," on April 26, 2004. Like our current assessment, it was based on discussions with investors who closely follow Berkshire, and on our coverage of the company for the past seven years. We have no inside knowledge; Buffett and Sokol have declined to comment. Meanwhile, Buffett deflected attention by noting that he feels "terrific." Given his good health, he could be at the helm at least another five years. He relishes the job, and most Berkshire holders want to see him running the show for as long as he can.

While many feel that Buffett, whose 32% stake in Berkshire is worth $45 billion, is irreplaceable, Berkshire
 

 

 

 

March 31, 2006    Wesco Notes from 10-K

 

1. Net income was 294,579. Yet, if you eliminated the realized capital gains, the gain would be as follows:

 

 

 

 

The $9.51 of adjusted eps shows nice growth from 2004 eps of 6.66. Sure seems like a good year.

Dividends and interest income increased by 19,948. I wonder how much of that is reoccurring. How much will it increase with rise in short term rates? If not reoccurring, then might want to reduce from Net Income After Taxes



2. I love the conservatism in the letter and in the financials (except for a condo in this market? ) I kid on the condo , small potatoes, so what's the difference. I like the allocation to safety, until opportunity appears.

"All that now remains outside Wes-FIC but within Wesco as a consequence of Wesco's former involvement with Mutual Savings, Wesco's long-held savings and loan subsidiary, is a small real estate subsidiary, MS Property Company, that holds tag ends of appreciated real estate assets consisting mainly of the nine-story commercial  building in downtown Pasadena, where Wesco is headquartered. Adjacent to that building is a parcel of land on which we have begun to build a multi-story luxury condominium building. We are also seeking city approval of our plans to build another multi-story luxury condominium building on a vacant parcel of land in the next block."

3. Insurance premiums going down. that seems cool where Charlie I guess is trimming risk, and letting business pass by, just like the old days.

4. " Business and human quality in place at Wesco continues to be not nearly as good, all factors considered, as that in place at Berkshire Hathaway."

"All that said, we make no attempt to appraise relative attractiveness for investment of Wesco versus Berkshire Hathaway stock at present stock-market quotations."

" Wesco's consolidated balance sheet reflects total assets of $2.7 billion as of yearend 2005. Of that amount, more than $1 billion has been invested in cash equivalents and fixed-maturity investments since early in 2003. Unless those funds can be attractively reinvested in acquisitions, equity securities or other long-term instruments of the type that have been responsible for the long-term growth of Wesco's shareholders' equity, future returns on shareholders' equity will probably be less than those of the past. Due to the current size of Wesco and its parent, Berkshire Hathaway, Wesco's opportunities for growing shareholders' equity are unlikely to be as attractive as in the past."

 

 

 

 

 

 

 

 

 

 

March 13, 2006    Gathering more data, asking more questions

 

 

 

1.    I am trying to determine look-through earnings for Berkshire.  I suspect the analysis done on March 3 (below), was too conservative in projection of earnings.  I will try to rehash that over time.  Here is a  real quick run through.

 

 

        The 10-K uses a different approach in calculating "Total Normalized Earnings."  This is prepared on "Consolidated Statement of Changes in Shareholders' Equity and Comprehensive Income."  The calculation works similar to mine above, but basically takes Net Operating Earnings and subtracts "other comprehensive income."  Based on my infancy with this industry, and Berkshires common thread of clarity and proper presentation, I would gather that their presented figure is correct.  See table below:

 

 

 

 

2.    Shares outstanding as of March 8, 2006 are 1,540,950.  This was listed in Form DEF 14A

 

3.    Interesting table of insider holdings.  This is not a complete table, but notice how Charles Munger does not own that many shares.  I am curious why Charles owns such few shares.  Easy enough to research, but really not important.

 

 

1.    "  All of Berkshire’s major insurance subsidiaries are rated AAA by Standard & Poor’s Corporation, the highest Financial Strength Rating assigned by Standard & Poor’s, and nearly all are rated A++ (superior) by A.M. Best with respect to their financial condition and operating performance."

 

2.    General Re owns approximately 91% of Cologne Re as of December 31, 2005.

 

3.    Geico is the nations 4th largest auto insurer.

 

4.    " In May 2005, General Re terminated the consulting services of its former Chief Executive Officer, Ronald Ferguson, after Mr. Ferguson invoked the Fifth Amendment in response to questions from the SEC and DOJ relating to their investigations. In June 2005, John Houldsworth, the former Chief Executive Officer of Cologne Reinsurance Company (Dublin) Limited (“CRD”), a subsidiary of General Re, pleaded guilty to a federal criminal charge of conspiring with others to misstate certain AIG financial statements and entered into a partial settlement agreement with the SEC with respect to such matters. Mr. Houldsworth, who had been on administrative leave, was terminated following this announcement. In June 2005, Richard Napier, a former Senior Vice President of General Re who had served as an account representative for the AIG account, also pleaded guilty to a federal criminal charge of conspiring with others to misstate certain AIG financial statements and entered into a partial settlement agreement with the SEC with respect to such matters. General Re terminated Mr. Napier following the announcement of these actions."

 

5.    "Berkshire’s preferred strategy is to hold equity investments for very long periods of time. Thus, Berkshire’s management is not troubled by short term equity price volatility with respect to its investments provided that the underlying business, economic and management characteristics of the investees remain favorable. Berkshire strives to maintain above average levels of shareholder capital to provide a margin of safety against short-term equity price volatility."

 

Notes on Annual Statement of General Re from NAIC (www.naic.org)

 

Selected Data

1.  

 

 

Selected Five-Year Historical Data

 

 

March 3, 2006    Some back of the envelope analysis.

 

 

The following is some back of the envelope valuation work for Berkshire.  Berkshire seems to be impossible to do real valuation analysis.  The business model is based on insurance, float and a  collection of investments.  The flow through of all these parts, because of accounting rules, do not necessarily flow through consistently into the financial statements.  That is the primary reason that Warren Buffett suggests using "look-through earnings."  With that said, I am trying to ascertain a margin of safety in our investment.  I made a variety of vague assumptions.  There could be errors galore in my assumptions, the theories of assumptions, the applications of the assumptions and in the spreadsheets I used.  Please do not use this in making your investment decisions.  I have tried to be conservative in the assumptions used.