Introduction 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. nd 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. 40) 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. ) 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.
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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. ) 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 growth stages, a more appropriate valuation can be obtained. The implied values of PacifiCorp are $9. 23 billion and $9. 076 billion w. r. t. the median and mean multiple of EBITDA (Appendix II, table 4). Titman and Martin (2007, p. 228) indicated that the most popular approach used to estimate a firm’s enterprise value involves the use of a multiple of EBITDA. Therefore, compared to the $9. 4 billion bid for PacifiCorp, it can be concluded that the bid is “fair”. Precedent Acquisition Boeh and Beamish (2007, p. 102) suggested that precedent acquisition is used to value a firm based on other similar acquisitions that have recently occurred. It directs firm to use the most appropriate valuation.
Assessing the $9. 4 billion bid for PacifiCorp can be defined as “fair”. Bruner, Eades and Schill(2010, p. 13) mentioned that the timing of BH’s bid closely followed Duke Energy’s bid to acquire Cinergy for $9 billion. Compare their characteristics (Appendix II, table 5) PacifiCorp and Cinergy deal in the same industry and have similar amount of customers, capital structure and EBITDA. Therefore, it can conclude that they are comparable and the deal between Duke Energy and Cinergy can be used as a reference to value PacifiCorp. Buffett VS Semi-Strong Form Efficient
Semi-strong form efficiency states that security prices adjust rapidly to the release of all public information; that is, current security prices fully reflect all public information (Reilly & Brown, 2009, p. 153). According to BH Inc. , (2009), BH’s has compounded annual gain of 20. 3% while S&P has 9. 3% since 1965 to 2009. This clearly shows that Buffett obtains abnormal return. Regarding semi-strong form, Buffett states that the only way to result in superior returns is by using private information or relying on pure luck (Buffett); supporting Buffett’s idea the market is not in semi-strong form.
Assuming that market is in semi-strong form, the rationale toward Buffett‘s superior performance is that Buffett has accurate market analysis. Market is not efficient to determine undervalued or overvalued assets and capitalize on the inefficiency (Sappideen, 2009). Buffett is one example of superior performance on undervalued stocks. Buffett Investment Philosophy VS Conventional Finance Theory Risk & Diversification Risk is directly related to the difference between price and value. With a smaller dollar difference, the investment is more risky. Buffett employs a margin of safety of 25% (Finkle, 2010) before investing.
Based on his measure of risk, Buffett expects high returns when risk is low – not high average returns when risk is high. Buffett discounts (seemingly risk-less) cash flows at the risk free rate (similar to the certainty equivalent approach) not the risk-adjusted discount rate. As a result, Buffett rejects benefits of portfolio diversification (top down approach to investing). The use of diversification as a means to minimize risk is an extensively promoted concept in the financial industry (Polbennikov, Desclee, & Hyman, 2010; Jorion, 1985); opposite that of which Buffett recommends.
Conventional financial theory dictates that investors are willing to take on higher risk with the prospect of gaining higher returns (Dilmore & Wilson, 1992). Whereas Buffett, expects high returns when risk is low. Leverage Buffett mentioned not to use leverage in investments (Lewis, 1992), but usually firms choose to be highly leveraged due to tax advantages (Opler and Titman, 1994). In cases of mergers, an increase in financial leverage benefits shareholders through tax deductibility of interest payments on corporate debt.
It might also enhance shareholders’ wealth through an expropriation of wealth from bondholders (Ghosh and Jain, 2000). Merging firms increase their financial leverage around mergers and this can signal better acquisitions, which increases the market value (Maloney, McCormick & Mitchell, 1993). Berkshire Hathaway & Goldman Sachs During financial crisis in 2008, BH invested $5 billion in Goldman Sachs Group. During the time, Goldman Sachs was blamed by U. S Securities and Exchange Commission’s for placing its client at stake (McGee & Frye, 2010).
Buffett was sued for civil fraud by regulators and assaulted by Congress for business dealing; without concern for the crisis situation (Patterson, 2010). As a result of investing in Goldman Sachs, Buffett was benefitted and obtained a large return from it. Even though in general, Berkshire’s movements have been ethically sound, Buffett should be aware of unethical behaviours issues that can impact company reputation. Berkshire Hathaway & Petro China In April 2003, BH bought 11% of Petro China (Oster & Cui, 2007); one of the largest oil companies in the world.
BH shareholders fear the issue of genocide between China and Sudan. Consequently, BH sold its stake in 2007 at the cost of losing potential returns (Kostigen, 2007); most prominently because BH became concerned with Petro China’s connection with the Sudanese civil war. Thus action taken by Warren Buffet has influenced large numbers of colleges, universities and states to take action in divesting companies that help fund the genocide in Darfur (Investors against Genocide, 2007). Ethics and Social Responsibility
Even though Buffett has been criticized for using political power for personal gain, Buffett and BH do show evidence of having strong ethical behaviour. Buffett as an active philanthropist has donated 5,000 Class B shares of BH stock, worth approximately $16 million, to an unnamed charitable foundation (Associated Press, 2006). As well in 2006, BH was nominated by Fortune to be one of the twenty most admired companies in America and eighth most admired in the world based on their ethics and social responsibility. (Vogl, F. 2006).
This pledge shows that Buffett’s concern for the society and can reflect that the company is one that maintains the importance of social responsibility. Based on this rationale, it is worthwhile to invest in BH Conclusion In conclusion, comparable company estimates suggest the price bid for PacifiCorp was pretty fair and within the valuation range. Buffett believes that markets are inefficient; opportunities to profit arise from searching undervalued or overvalued assets. Buffett’s tenure consists of not using leverage in investment and merging firms to enlarge market value to outperform the market.
Besides Buffett’s investment records, he’s considered ethically and socially responsible. All in all, it is sensible to invest in Berkshire Hathaway. 15 December 1810) was a writer and critic of 18th-century British children’s literature. Her periodical, The Guardian of Education, helped to define the emerging genre by seriously reviewing children’s literature for the first time; it also provided the first history of children’s literature, establishing a canon of the early landmarks of the genre that scholars still use today.
Trimmer’s most popular children’s book, Fabulous Histories, inspired numerous children’s animal stories and remained in print for over a century. Trimmer was also an active philanthropist. She founded several Sunday schools and charity schools in her parish. To further these educational projects, she wrote textbooks and manuals for women interested in starting their own schools. Trimmer’s efforts inspired other women, such as Hannah More, to establish Sunday school programs and to write for children and the poor.
Trimmer’s works are dedicated to maintaining many aspects of the social and political status quo. As a high church Anglican, she was intent on promoting the Established Church of England and on teaching young children and the poor the doctrines of Christianity. Her writings outlined the benefits of social hierarchy, arguing that each class should remain in its God-given position. Yet, while supporting many of the traditional political and social ideologies of her time, Trimmer questioned others, such as those surrounding gender and the family.