BNSF and MidAmerican

[jay21]

I feel as if I do not understand these businesses that well.  I understand that they are capital intensive businesses that are expected to earn good rates of returns on the capital deployed.  Does anyone know what exactly the return characteristics are?  Also, is there anything "special" about these companies that makes them different from their competitors?

[rmitz]

I feel as if I do not understand these businesses that well.  I understand that they are capital intensive businesses that are expected to earn good rates of returns on the capital deployed.  Does anyone know what exactly the return characteristics are?  Also, is there anything "special" about these companies that makes them different from their competitors?

 

They don't really have competitors.  Being heavily regulated, and in Midamerican's case, a utility, means you don't really have to compete in the same ways.  The railroads have parts of the country where they don't really operate as a matter of history.  Now this does not describe the entirety of their businesses but I believe it's a large enough chunk, and really was the core of the thesis.

[matjone]

I'm far from an expert on railroads but I've read security analysis and Graham had some stuff in there about them.

 

I think I remember reading that Buffett figured BNSF would benefit because they have more rails going out west than other railroads, and he believes there will be above average growth in freight traffic there due to population growth in the west and growth in trade with China.  I can't remember if it was Buffett that said this in a letter or if it was someone else in an article or blog.  Seems reasonable though.

 

Costs per ton-mile go down as the amount of freight on each trainload goes up.  So, if BNSF is already running a train from LA to new orleans today, and there is no one else with the same route, and 10 years from now there is 50% more freight that needs to be moved on the same route, you are getting 50% more revenue, before counting whatever price increases you are allowed. And maintenance on the track and fuel costs don't go up as fast as revenues do.

[twacowfca]

I feel as if I do not understand these businesses that well.  I understand that they are capital intensive businesses that are expected to earn good rates of returns on the capital deployed.  Does anyone know what exactly the return characteristics are?  Also, is there anything "special" about these companies that makes them different from their competitors?

 

They don't really have competitors.  Being heavily regulated, and in Midamerican's case, a utility, means you don't really have to compete in the same ways.  The railroads have parts of the country where they don't really operate as a matter of history.  Now this does not describe the entirety of their businesses but I believe it's a large enough chunk, and really was the core of the thesis.

 

 

BNSF is the easier of the two to understand.  The railroad industry has been very poor for returns on capital for most of its history.  However, about 10 years ago, Bill Gates and Cascade noticed that things had changed, especially for Railroads with long routes that were more economical for moving stuff over long distances than trucks.  Railroads like BNSF still have lots of potential capex for investment, but that capex now returns more than their cost of capital.  BNSF can borrow cheaply to finance a lot of their capex, especially under BRK 's wing.  They are also able to pay large dividends to the holding company in addition to their capex.

 

BNSF doesn't have a direct competitor, it would be way too costly for another railroad to encroach on their territory.  Trucks are not as economical an alternative over most of their routes.  BNSF connects the west coast to the Midwest.  The expansion of the Panama canal should not impact them as much as other railroads.

 

Mid American isn't such a good investment in my opinion, although they do relatively well in an industry that is tough.

[redskin]

"Mid American isn't such a good investment in my opinion, although they do relatively well in an industry that is tough."

 

Berkshire bought Midamerican for $34/share and now values it at $250/share.  Approximately 16% annual return.

 

I thought Buffett's comments regarding Midamerican at the annual meeting were interesting.  He believes they may have the opportunity to invest $100 billion over the next 10 years in Midamerican.

[mikazo]

BNSF doesn't have a direct competitor

 

I'd say Union Pacific is a pretty big competitor: http://pacificbiomassexport.com/wp-content/uploads/2011/06/USA_UP-BNSF.jpg

[jay21]

"Mid American isn't such a good investment in my opinion, although they do relatively well in an industry that is tough."

 

Berkshire bought Midamerican for $34/share and now values it at $250/share.  Approximately 16% annual return.

 

I thought Buffett's comments regarding Midamerican at the annual meeting were interesting.  He believes they may have the opportunity to invest $100 billion over the next 10 years in Midamerican.

 

How did he talk about the valuation?  Was it strictly FCF growth of 16%?

 

What will the $100b in investments earn though?  I guess my problem is I do not understand the return characteristics of a utility company.  If you are expecting a 10% return from these investments, I am not that enthused because then you will need a growth in float to get great returns.  If these companies earn a teens return, that's great.

 

Does anyone have a link to a good article describing the shift in capital returns that twacowfca was describing?

[twacowfca]

"Mid American isn't such a good investment in my opinion, although they do relatively well in an industry that is tough."

 

Berkshire bought Midamerican for $34/share and now values it at $250/share.  Approximately 16% annual return.

 

I thought Buffett's comments regarding Midamerican at the annual meeting were interesting.  He believes they may have the opportunity to invest $100 billion over the next 10 years in Midamerican.

 

How did he talk about the valuation?  Was it strictly FCF growth of 16%?

 

What will the $100b in investments earn though?  I guess my problem is I do not understand the return characteristics of a utility company.  If you are expecting a 10% return from these investments, I am not that enthused because then you will need a growth in float to get great returns.  If these companies earn a teens return, that's great.

 

Does anyone have a link to a good article describing the shift in capital returns that twacowfca was describing?

 

WEB's hurdle rate for BRK's subsidiaries has been 15%, and the Mid American investment has compounded at about that rate.  However,  the original investment in Mid Am was made at a bargain price, and the current rate environment for utilities is not good.  At some point in time, Mid Am may have the opportunity to pick up more assets at a bargain price.  Even so, it may be difficult to get a 15% return going forward or even a double digit return. 

 

Plus, everything in Mid Am is dead money for the Holdco to redeploy at extremely attractive rates of return opportunistically in the future in other ways that will certainly pop up.  Thus, Mid American's opportunities are limited to reinvesting in a subpar industry.  This is similar to Net Jets situation, but Net Jets capital and future earnings is much easier to redeploy.  There is an active market for business jets.

[thepupil]

Is it wrong to think of these two capital intensive regulated businesses as alternatives to fixed income? Berkshire still keeps its float in cash and fixed income but much of that can quickly be invested in a new acquisition. Do not these businesses provide dependable steady above fixed income returns and allow Berkshire to keep a shorter duration fixed income portfolio vs that of other insurance companies?

 

Yes I'd love all of Berkshire's investments to earn very high returns but when you compare the return on these businesses vs fixed income which comprises the vast majority of large insurance co's portfolios, their presence makes more sense.

 

 

[compoundinglife]

Not sure how or if this could play out regulation wise. But at the time of the BNSF purchase I was trying to think of non-obvious or off the wall reasons why BRK would want to buy them. Clearly there is the fixed income like nature of this company but what is the kicker? Only thing I could think was that in the future there might be some synergy between BRK's utility companies and BNSF. For example if there is a way to efficiently move power over long distances, maybe Mid Am. can utilize the rail roads tracks or land around the tracks to do so?

 

[Palantir]

I'd like to know more about this as well. I felt the acquisition of BNSF was done at an extremely rich valuation. What FCF growth was WEB assuming for that?

 

 

Also the interest in investing in "capital intensive" businesses I don't get either. I understand BRK generates a lot of cash, and they need to deploy it....but why this? If a firm is capital intensive, doesn't that also imply it will have low return? Or should we expect that Buffet is planning on leveraging a low return business with the float?

[mikazo]

I felt the acquisition of BNSF was done at an extremely rich valuation.

 

Agreed. I did valuations on all of the major publicly-traded railway stocks in North America, and found that all of them were over-valued. Is there some other considerations to take into account besides FCF when valuing a railroad, or is the industry just at the top of a cycle?

[jay21]

There was a good write-up on the VIC site that gave me more comfort over BNSF:

 

Summary

Burlington Northern Santa Fe is the second largest Class I railroad servicing the Western half of the United States.  The Company operates a railway system of approximately 32,000 miles of track over which it transports coal, consumer products, agricultural products and industrial products.  At the current price, you are paying $1.35 million per mile of track that costs $2 million in materials and labor to build but excluding the real estate which is inestimable.  While the shares appear reasonably priced today, there are some significant hidden assets and, over time, the pricing power the company enjoys should allow it to generate above average returns on capital.

 

Brief History of Industry

In 1980, the Staggers Act was signed that largely deregulated the railroad industry since the passage of the 1887 Interstate Commerce Act.  Not surprisingly, the industry underwent significant consolidation over the next 20 years bringing the number of class I railroads (a railroad company with over $320 million revenues) from 30 businesses to seven today.  In the United States, Burlington and Union Pacific effectively hold a duopoly over the western half of the country, while CSX and Norfolk Southern hold a duopoly over the eastern half of the United States.

 

Since 1980, the number of rail employees has been cut by over 50%, the miles of track by 40%, the number of freight cars in service by 25% and at the same time, the number of revenue ton miles operated by the rails has doubled.  In 2004, demand started to outweigh the reduced supply of the railroad industry and the Rail companies finally gained pricing power of their customers.

 

Business Description

A railroad company generates cash by charging customers such as utilities or trucking companies a fee per ton of load carried and uses cash to pay expenses of labor (mostly unionized), fuel, equipment rents, depreciation/replacement of railcars and track, and transportation services such as ramping and drayage.

 

Burlington generates about 36.5% of revenue from transporting intermodal containers both domestically and internationally.  “Intermodal” is better thought of as multimodal.  Burlington enters into 1-5 year contracts with shippers or truckers to transport containers primarily from ports to centralized trucking distribution centers where the containers are then moved to the end customer by a company such as JB Hunt or Schneider.  About 8% of  the 36.5% of consumer products is related to automotive, and that 8% primarily relates to imports, not the Big Three, leaving Burlington the least leveraged to the U.S. auto industry.

 

Burlington also transports a significant amount of coal.  BNI generates approximately 20% of revenue moving coal from coal mines to utilities, who are the customers of this business.  Coal contracts are typically 10 years in length and the utility owns the cars which transport the coal.  Burlington operates primarily in the Powder River Basin of Wyoming and Montana.  For those not familiar, Powder River Basin (PRB) coal is the lowest sulfur coal.  Coal-fired plants currently generate approximately 50% of the electricity in the United States.  Because of the government enacted caps on sulfur emissions from coal-fired plants, PRB coal has become the cheapest to burn per mmbtu of energy created given its sulfur (and heat content) vis a vis Central and Northern Appalachia coal and others.  Burlington currently competes with UNP in the southern PRB region and does not appear to compete with anyone in the northern half of the PRB.

 

The agricultural products segment generates approximately 17% of revenue for Burlington and consists of the transportation of corn, wheat, fertilizer and soy beans.  BNI benefits from 1) a rail network concentrated in the regions where most crops are harvested 2) exposure to the western ports for grain export and 3) the often written about growth in ethanol which is produced primarily in the western region of the United States.

 

Finally, BNI generates about 24% of revenue from the transport of industrial products.  Of this 24%, revenue is comprised of building products (33%), construction products (32%), petroleum and chemical products (27%) and food and beverage (8%).

 

Valuation

Though Burlington currently trades at 16.0x GAAP earnings, GAAP needs to be adjusted to get a true picture of owners’ earnings.  First, maintenance capital expenditures runs at about 140% of stated deprecation and amortization.  Second, Burlington enjoys a tax rate that is significantly lower than the 35% Federal + state tax because of the accelerated depreciation on the rail stock.  As long as BNI remains in the rail industry, this deferred tax liability is in effect deferred to infinity and so the tax rate averages about 25% versus 38%.  Adjusting for these items, BNI trades at approximately 16.5x tax-adjusted free cash flow.  A 6% free cash flow yield doesn’t seem worthy of the $5,000 prize, but it is what’s beneath the track surface that makes this a very interesting investment.

 

First, is the “hidden asset” in the form of below market contracts.  Coal contracts are typically 10 years in length and since we are 3 years post the time during which they enjoyed pricing power, there are 6-7 years worth of coal contracts signed at a time when 1) supply exceeded demand and 2) UNP and BNI were engaged in price wars.  Management estimates that these contracts are about 30% below market if re-signed today.  Applying decently conservative estimates to the coal revenue streams, a full repricing will add approximately 20% of fully-taxed free cash flow to the current earnings streams.  While this is relatively well known in the industry, another “hidden asset” lays in the fuel provisions in the contracts.  Prior to 2004, many of the contracts did not contain the fuel pass thru that are included today.  Diesel averaged around 65 cents per gallon versus the LTM $2.03 per gallon paid.  Assuming simply a ‘mark to market’ of gas prices in historical contracts, BNI will add another 17.5% of fully-taxed (38%) free cash flow to current earnings.  Over a 6 year time frame, repricings should add approximately 6% per year to a holder’s total return bringing us to 12% prior to any growth in GDP+inflation plus the earnings growth resulting from owning a non-replaceable asset that acts as a tax on commerce.

 

In addition the coal contracts, I think there lays significant hidden value in the intermodal business.  Because I cannot find segment level numbers, consider simply that rails is a $50 billion per year industry.  Trucking is a $600 billion per year industry.  Now rails will never move things from Wal-mart’s distribution center to their stores, however there is significant upside as gas prices have increased for rails to take market share from the trucks in the medium hauls.  Currently, the rule of thumb is less than 500 mile per haul goes to truck.  However, implicit in that rule is a gas price which has tripled over the past years as we saw in the coal contracts.  As gas prices increase, the “market” for intermodal actually increases exponentially.  And so we are up to 6% cash yield + 6% from repricing plus GDP + inflation + outsized growth in intermodal business given its cost advantage over trucks.

 

And finally, to get a sense of the true upside in earnings power, I think a look at the replacement cost of this asset is far more useful.  At the current price, you are effectively paying $1.35 million per mile of track.  There are three costs to recreating a railroad: 1) cost of labor, 2) cost of material, 3) the “right of way” or real estate underneath the track.  The cost of #1 and #2 today are approximately $2 million per mile or approximately 48% higher than you are paying for BNI.  The cost of #3 is inestimable.  Buffett often talks about a moat by illustrating the money it would cost to recreate Coca-Cola.  This is better.  You actually can recreate Coca-cola, you would just earn a miserable return on your capital that was required to do so.  You can NOT recreate Burlington with any amount of money.  Right of way was given away to railroads during the 1800’s to incent construction to develop the western half of the United States and to increase commerce.  That will never happen again as long as we live (and beyond).  You can absolutely buy the “right of way” in the middle of Nevada for probably a few thousand dollars per mile, but your track will never connect to the Port of Los Angeles and so it’s useless.

 

A useful comp to consider is the situation with D,M&E who tried to build a new 262 mile track to haul coal in the Powder River Basin in Wyoming.  The project was slated to cost $6 billion which equates to $22.9 million per mile.  The Company was seeking a federally-subsidized loan for $2.3 billion, so assuming that was actually zero cost, at $3.7 billion, that cost to build is approximately $14.1 million per mile versus the $1.35 million you are buying BNI for today.

 

Final Word

Everyone knows Buffett has been buying; the other important buyer is the Company itself.  In 2004, the Company generated $782 million from cash flow from operations less investing.  Of this, it spent $376 million repurchasing stock and $231 million in dividends.  In 2005, the numbers were $586 of cash generated, $789 million spent buying back stock and $267 million on dividends.  In 2006, BNI generated $1.022 billion in cash flow from operations less investing, and spent $1.040 returning cash to shareholders.  Since 1997, the Company has repurchased over 160 million shares compared with 358 million fully diluted outstanding today.  Even with these repurchases, the Company remains significantly underlevered today, particularly when you consider that the deferred tax liability on the balance sheet ($8.4 billion of $22.7 billion of total liabilities) will never have to be repaid.

 

When the recession fully rears its ugly head and the world realizes that Burlington’s volumes don’t drop off considerably given the high percentages associated with grains and coal, the multiple expansion will be nicely amplified by the repurchases.

[twacowfca]

Not sure how or if this could play out regulation wise. But at the time of the BNSF purchase I was trying to think of non-obvious or off the wall reasons why BRK would want to buy them. Clearly there is the fixed income like nature of this company but what is the kicker? Only thing I could think was that in the future there might be some synergy between BRK's utility companies and BNSF. For example if there is a way to efficiently move power over long distances, maybe Mid Am. can utilize the rail roads tracks or land around the tracks to do so?

 

I do think that it ticked WEB off that there was no good alternative to the high rates BNSF got to haul coal to utilities or corrosive ethanol that could not be transported via pipelines.

[redskin]

"Mid American isn't such a good investment in my opinion, although they do relatively well in an industry that is tough."

 

Berkshire bought Midamerican for $34/share and now values it at $250/share.  Approximately 16% annual return.

 

I thought Buffett's comments regarding Midamerican at the annual meeting were interesting.  He believes they may have the opportunity to invest $100 billion over the next 10 years in Midamerican.

 

How did he talk about the valuation?  Was it strictly FCF growth of 16%?

 

What will the $100b in investments earn though?  I guess my problem is I do not understand the return characteristics of a utility company.  If you are expecting a 10% return from these investments, I am not that enthused because then you will need a growth in float to get great returns.  If these companies earn a teens return, that's great.

 

Does anyone have a link to a good article describing the shift in capital returns that twacowfca was describing?

 

This is Buffett's discussion of the Mid American valuation in the 2007 annual letter...

 

'We agreed to purchase 35,464,337 shares of MidAmerican at $35.05 per share in 1999, a year in

which its per-share earnings were $2.59. Why the odd figure of $35.05? I originally decided the business

was worth $35.00 per share to Berkshire. Now, I’m a “one-price” guy (remember See’s?) and for several

days the investment bankers representing MidAmerican had no luck in getting me to increase Berkshire’s

offer. But, finally, they caught me in a moment of weakness, and I caved, telling them I would go to

$35.05. With that, I explained, they could tell their client they had wrung the last nickel out of me. At the

time, it hurt.

Later on, in 2002, Berkshire purchased 6,700,000 shares at $60 to help finance the acquisition of

one of our pipelines. Lastly, in 2006, when MidAmerican bought PacifiCorp, we purchased 23,268,793

shares at $145 per share.

In 2007, MidAmerican earned $15.78 per share. However, 77¢ of that was non-recurring – a

reduction in deferred tax at our British utility, resulting from a lowering of the U.K. corporate tax rate. So

call normalized earnings $15.01 per share. And yes, I’m glad I wilted and offered the extra nickel.'

[Shane]

Considering that BRK has a negligiable cost of capital due to their insurance operations, I think these are really very attractive businesses.  They are in industries that enjoy some natural barriers to entry, but even among their few competitors they are now that much more entrenched because they have such low financing costs.

 

In my view WEB is building a cash flow business that will provide money to his charities over time via dividends... I think he has been pretty clear that he won't beat the S&P 500 for inifinity.  In that light, I think these acquisitions make a lot of sense.

 

The reason he might consider the capex attractive is that he knows he will get x return on the capital he invests in capex, that will be independent of interests rates... so they may be more attractive than fixed income.

 

I am of the belief that grain exports could be a major driver of our GDP going forward... I think that BNSF has a long runway of growth ahead of it.  There is only so much railroad capacity out there and with environmental regulation only so much more that can be installed.  The bigger companies will have pricing power in the future and that could be the source of FCF growth.

[twacowfca]

"Mid American isn't such a good investment in my opinion, although they do relatively well in an industry that is tough."

 

Berkshire bought Midamerican for $34/share and now values it at $250/share.  Approximately 16% annual return.

 

I thought Buffett's comments regarding Midamerican at the annual meeting were interesting.  He believes they may have the opportunity to invest $100 billion over the next 10 years in Midamerican.

 

How did he talk about the valuation?  Was it strictly FCF growth of 16%?

 

What will the $100b in investments earn though?  I guess my problem is I do not understand the return characteristics of a utility company.  If you are expecting a 10% return from these investments, I am not that enthused because then you will need a growth in float to get great returns.  If these companies earn a teens return, that's great.

 

Does anyone have a link to a good article describing the shift in capital returns that twacowfca was describing?

 

This is Buffett's discussion of the Mid American valuation in the 2007 annual letter...

 

'We agreed to purchase 35,464,337 shares of MidAmerican at $35.05 per share in 1999, a year in

which its per-share earnings were $2.59. Why the odd figure of $35.05? I originally decided the business

was worth $35.00 per share to Berkshire. Now, I’m a “one-price” guy (remember See’s?) and for several

days the investment bankers representing MidAmerican had no luck in getting me to increase Berkshire’s

offer. But, finally, they caught me in a moment of weakness, and I caved, telling them I would go to

$35.05. With that, I explained, they could tell their client they had wrung the last nickel out of me. At the

time, it hurt.

Later on, in 2002, Berkshire purchased 6,700,000 shares at $60 to help finance the acquisition of

one of our pipelines. Lastly, in 2006, when MidAmerican bought PacifiCorp, we purchased 23,268,793

shares at $145 per share.

In 2007, MidAmerican earned $15.78 per share. However, 77¢ of that was non-recurring – a

reduction in deferred tax at our British utility, resulting from a lowering of the U.K. corporate tax rate. So

call normalized earnings $15.01 per share. And yes, I’m glad I wilted and offered the extra nickel.'

 

Those are great returns, but that was then, and now is now.  MidAm's earnings ex the PacificCorp acquisition have been a hair above flat from 2009 to date. PacificCorp is a little better.  That is more likely to continue than not for quite a while in the deleveraging of the current super cycle.  My questimate is that their incremental return on reinvestment of retained earnings has been below cost of capital in recent years.

 

One problem with reinvestment in the industry is that some capex is actually expense to comply with emissions mandates from a hostile administration.  This type of capex doesn't add to productive capacity.

[redskin]

"Mid American isn't such a good investment in my opinion, although they do relatively well in an industry that is tough."

 

Berkshire bought Midamerican for $34/share and now values it at $250/share.  Approximately 16% annual return.

 

I thought Buffett's comments regarding Midamerican at the annual meeting were interesting.  He believes they may have the opportunity to invest $100 billion over the next 10 years in Midamerican.

 

How did he talk about the valuation?  Was it strictly FCF growth of 16%?

 

What will the $100b in investments earn though?  I guess my problem is I do not understand the return characteristics of a utility company.  If you are expecting a 10% return from these investments, I am not that enthused because then you will need a growth in float to get great returns.  If these companies earn a teens return, that's great.

 

Does anyone have a link to a good article describing the shift in capital returns that twacowfca was describing?

 

This is Buffett's discussion of the Mid American valuation in the 2007 annual letter...

 

'We agreed to purchase 35,464,337 shares of MidAmerican at $35.05 per share in 1999, a year in

which its per-share earnings were $2.59. Why the odd figure of $35.05? I originally decided the business

was worth $35.00 per share to Berkshire. Now, I’m a “one-price” guy (remember See’s?) and for several

days the investment bankers representing MidAmerican had no luck in getting me to increase Berkshire’s

offer. But, finally, they caught me in a moment of weakness, and I caved, telling them I would go to

$35.05. With that, I explained, they could tell their client they had wrung the last nickel out of me. At the

time, it hurt.

Later on, in 2002, Berkshire purchased 6,700,000 shares at $60 to help finance the acquisition of

one of our pipelines. Lastly, in 2006, when MidAmerican bought PacifiCorp, we purchased 23,268,793

shares at $145 per share.

In 2007, MidAmerican earned $15.78 per share. However, 77¢ of that was non-recurring – a

reduction in deferred tax at our British utility, resulting from a lowering of the U.K. corporate tax rate. So

call normalized earnings $15.01 per share. And yes, I’m glad I wilted and offered the extra nickel.'

 

Those are great returns, but that was then, and now is now.  MidAm's earnings ex the PacificCorp acquisition have been a hair above flat from 2009 to date. PacificCorp is a little better.  That is more likely to continue than not for quite a while in the deleveraging of the current super cycle.  My questimate is that their incremental return on reinvestment of retained earnings has been below cost of capital in recent years.

 

One problem with reinvestment in the industry is that some capex is actually expense to comply with emissions mandates from a hostile administration.  This type of capex doesn't add to productive capacity.

 

The $150/share to $250 over last 5 years is approximately 11% annually. 

[twacowfca]

"Mid American isn't such a good investment in my opinion, although they do relatively well in an industry that is tough."

 

Berkshire bought Midamerican for $34/share and now values it at $250/share.  Approximately 16% annual return.

 

I thought Buffett's comments regarding Midamerican at the annual meeting were interesting.  He believes they may have the opportunity to invest $100 billion over the next 10 years in Midamerican.

 

How did he talk about the valuation?  Was it strictly FCF growth of 16%?

 

What will the $100b in investments earn though?  I guess my problem is I do not understand the return characteristics of a utility company.  If you are expecting a 10% return from these investments, I am not that enthused because then you will need a growth in float to get great returns.  If these companies earn a teens return, that's great.

 

Does anyone have a link to a good article describing the shift in capital returns that twacowfca was describing?

 

This is Buffett's discussion of the Mid American valuation in the 2007 annual letter...

 

'We agreed to purchase 35,464,337 shares of MidAmerican at $35.05 per share in 1999, a year in

which its per-share earnings were $2.59. Why the odd figure of $35.05? I originally decided the business

was worth $35.00 per share to Berkshire. Now, I’m a “one-price” guy (remember See’s?) and for several

days the investment bankers representing MidAmerican had no luck in getting me to increase Berkshire’s

offer. But, finally, they caught me in a moment of weakness, and I caved, telling them I would go to

$35.05. With that, I explained, they could tell their client they had wrung the last nickel out of me. At the

time, it hurt.

Later on, in 2002, Berkshire purchased 6,700,000 shares at $60 to help finance the acquisition of

one of our pipelines. Lastly, in 2006, when MidAmerican bought PacifiCorp, we purchased 23,268,793

shares at $145 per share.

In 2007, MidAmerican earned $15.78 per share. However, 77¢ of that was non-recurring – a

reduction in deferred tax at our British utility, resulting from a lowering of the U.K. corporate tax rate. So

call normalized earnings $15.01 per share. And yes, I’m glad I wilted and offered the extra nickel.'

 

Those are great returns, but that was then, and now is now.  MidAm's earnings ex the PacificCorp acquisition have been a hair above flat from 2009 to date. PacificCorp is a little better.  That is more likely to continue than not for quite a while in the deleveraging of the current super cycle.  My questimate is that their incremental return on reinvestment of retained earnings has been below cost of capital in recent years.

 

One problem with reinvestment in the industry is that some capex is actually expense to comply with emissions mandates from a hostile administration.  This type of capex doesn't add to productive capacity.

 

The $150/share to $250 over last 5 years is approximately 11% annually.

 

Is it less % growth from 09 thru present?  Does that also count the about  $1B they got from the break up of the Constellation energy deal?  Also, BV growth for electric utilities can be misleading because some of that growth is for nonproductive investments to comply with government requirements, technically investment, but more like a required expenditure.

[mcliu]

Isn't the idea of WEB buying capital intensive businesses that they earn a return on capital on the marginal dollar of capital invested that's higher than the cost of capital.

 

Hence, each dollar invested will be worth more in the future than it is today.

 

That way, these businesses can absorb the billions flowing into BRK, without him needed to continuously find new investments. Also, there's probably few attractive non-capital intensive businesses at that scale for WEB to invest in.

[racemize]

Isn't the idea of WEB buying capital intensive businesses that they earn a return on capital on the marginal dollar of capital invested that's higher than the cost of capital.

 

Hence, each dollar invested will be worth more in the future than it is today.

 

That way, these businesses can absorb the billions flowing into BRK, without him needed to continuously find new investments. Also, there's probably few attractive non-capital intensive businesses at that scale for WEB to invest in.

 

That was my understanding, though I don't know what the marginal difference is.

[Kiltacular]

1)  I'm not particularly excited by BNSF or MidAmerican.  I don't think any of Berkshire's float is used to fund them.

 

2)  That said, BNSF is likely better than some are painting it.  Buffett likes industries that have "recently" finished a long period of consolidation.  BNSF has that quality and lots of others that have been discussed. 

 

3)  BNSF gets very large and ongoing tax deferral which isn't reflected in the income statement but can be seen in the balance sheet.  Search EDGAR for the relevant filings:  "Burlington Northern Santa Fe, LLC".  Also, this tax deferral -- as mentioned in the VIC write-up posted in this thread -- lasts as long as cap. ex keeps expanding.  If you really think it through, you'll see this must be a big part of Buffett's attraction here.  The rail is more profitable than it looks.

 

4)  MidAmerican has no competition for its electric distribution businesses -- primarily PacificCorp and their U.K. system.  MidAmerican has other businesses.  It has gotten enormous tax breaks for its buildout of wind energy and, now, for its solar deals.  These are very hard to spot just looking at the income statement.  Search EDGAR for: "MidAmerican Energy Holdings Co / New ".

 

5)  When MidAmerican has to, for example, add "scrubbers" for its coal plants, the cost eventually gets added to the rate base -- they end up getting paid a margin for all their cap. ex. even if it doesn't produce anything other than cleaner air.

 

In spite of the positives, these aren't going to be amazing businesses but they may be a bit better than they appear due to the tax advantages that Buffett loves but that don't "appear" at first glance.

[jay21]

Isn't the idea of WEB buying capital intensive businesses that they earn a return on capital on the marginal dollar of capital invested that's higher than the cost of capital.

 

Hence, each dollar invested will be worth more in the future than it is today.

 

 

Can you clarify what you mean by this, maybe with an example?  Has MidAmerican's RoE changed significantly even though they have been investing more marginal dollars?

 

 

[jay21]

 

Plus, everything in Mid Am is dead money for the Holdco to redeploy at extremely attractive rates of return opportunistically in the future in other ways that will certainly pop up.  Thus, Mid American's opportunities are limited to reinvesting in a subpar industry.  This is similar to Net Jets situation, but Net Jets capital and future earnings is much easier to redeploy.  There is an active market for business jets.

 

This seems like a huge negative as the way I view BRK is an asset allocating/money machine. Is there a way around this with inter-company borrowings or some type of financial engineering?

 

 

[Palantir]

Isn't the idea of WEB buying capital intensive businesses that they earn a return on capital on the marginal dollar of capital invested that's higher than the cost of capital.

 

Hence, each dollar invested will be worth more in the future than it is today.

 

 

 

Could you explain this point? Not saying you're wrong, but I'm not clear what you're getting at. Wouldn't a capital light business also do the same?