Introduction
Berkshire Hathaway Inc. is a major American holding company based in Omaha. Berkshire Hathaway owns several subsidiaries, which deal in different business activities such as property ownership, reinsurance, casualty insurance, energy, finance, utilities, manufacturing, retailing and services. Some of the company’s subsidiaries are major players in different sectors of the economy. For example, GEICO is one of America’s top auto insurers. Warren Buffet acquired the majority shareholding of the company in 1970. Currently, Buffet is the serving CEO and chairman of Berkshire Hathaway Inc. Warren Buffet has acquired several companies over the years and turned them into successful and profitable entities under the Berkshire Hathaway Inc. Warren Buffet has focuses on a company’s potential in terms of growth and profitability before acquiring it. Buffet is either a majority or minority shareholder in every subsidiary of Berkshire Hathaway. One such company is the MidAmerican Energy Company, which is a subsidiary of Berkshire Hathaway Inc. MidAmerican Energy agreed to an Equity Commitment pact with Berkshire Hathaway. The Equity Commitment pact allows Berkshire Hathaway to buy 2 billion dollars’ worth of common equity of MidAmerican Energy Co. The purchase is upon the authorization of the board of directors of MidAmerican Energy Co.
Reasons for the company’s acquisition
MidAmerican Energy Co. is a publicly owned international company based in Lowa. It is a major player in the energy sector where it generates, distributes, transmits and sells natural gas and electricity. A big section of the world’s population relies on natural gas and electricity as their main energy source. MidAmerican Energy’s subsidiaries include Rocky Mountain Power, Pacific Power, Kern River Gas Transmission and Northern Natural Gas companies. Energy is a necessity for heating, cooking, lighting, transportations, entertainment, business and industrial activities. Therefore, investing in an energy company is an assured investment of future growth and continuity. MidAmerican Co. distributes electricity to 700000 users, and distributes gas to another 700000 retail customers. It also transports gas to clients. The company’s large customer base gives it a huge profitability potential hence; this is a lucrative investment.
MidAmerican Energy Company’s principle is to make heavy investments with a view of satisfying future client needs. This implies future returns on investments. Berkshire Hathaway holds an 89.8 percent ownership of MidAmerican Energy Co. the company operates in nine states; Utah, Iowa, Wyoming and six other neighboring states. The wide distribution of a customer base provides huge sales and is also a way of spreading risks. Gas prices in one state could be low but the company makes up for this by maximizing sales in the other states or regions where gas prices are high.
The MidAmerican company was also a lucrative investment for Berkshire Hathaway because of its stellar growth in the past. After its acquisition of the Northern Gas pipeline, MidAmerican Co. started growing slowly. However, the growth rates have picked up drastically in the recent past. The company is ranked second in the gas industry currently. The transformation of the company from average to a top performing company is also an indicator that it had a huge growth potential. It is also an indicator that the employees of the company are dedicated towards ensuring success. The company is highly rated in terms of customer satisfaction, ranked second out of 60 electricity companies. This boosts client loyalty. Furthermore, the company’s venture into clean energy production has enabled it to ensure sustainability of its operations. It has also complied with government laws on clean energy production. The good reputation of the company has helped the company increase customer loyalty and sales. The company invests over $7 billion in wind energy and is looking to invest $3 billion in solar energy production. The company’s heavy investment policy is attributed to the fact that it retains all its earnings rather than paying them out. These reasons made MidAmerican Energy Co. a promising investment for Berkshire Hathaway because of its growth potential and profitability.
MidAmerican Energy Company valuation
Market reaction
Market reaction includes the stock price changes as a result of political or financial information. Market reaction has short and long run implications on the company. When Berkshire Hathaway acquired MidAmerican Company, there was a series of market reactions. The good reputation of Berkshire Hathaway of turning companies into successful and profitable entities caused a positive market reaction. There was a drastic increase in the company’s stock prices. This is because many investors wanted to acquire ownership of MidAmerican Energy hence; pushing stock prices up. However, there were worries from a few analysts and critics who believed that the acquisition would cause a change in the company’s main objectives and performance. The experts who conducted the economic forecasts of MidAmerican Energy’s acquisition concluded that the acquisition would cause stock price appreciation. They were proven right by the gradual appreciation of stock prices. To date, MidAmerican’s prices on the forex market are still on a gradual appreciation because of its high performance standards.
Dividend discount model valuation
The dividend discount valuation model of Berkshire Hathaway Inc. uses several discounted dividend payments to determine the company’s stock price. Based on this model, it is assumed that the value of the company’s stock is equal to the present value of the dividend that the company will pay out in future. The Gordon growth model could be used to determine it as; P= D* 1/(r-g).
Where P= present share price, D- future value of the dividend ( the next year), g- dividend growth rate over the next period and r- the cost of equity. If the value of one stock at MidAmerican Energy is valued at $43.64, g is 2 percent, the dividend is estimated to be $4.80 and r is 13 percent; the following graph, which was obtained from the company’s accounting records.
The company’s dividend discount model influences how the company pays dividend in relation to the returns recorded. This is illustrated in the cumulative returns diagram below. Berkshire Hathaway and MidAmerican Energy Company pay dividends in relation to the price of the shares. When the company performs well, the share price increases hence the valuation is high.
Ratio analysis and valuations
Debt/Equity ratio
MidAmerican Energy Company’s debt/equity ratio determines the investor’s proportion of debt to equity. This is calculated by finding the quotient of debt and equity of data obtained over 5 years.
The debt to equity ratio for the years 200 to 2007 is 0.96:1, 0.98:1, 0.97:1, 0.95:1 and 0.99:1 respectively. This is an indication that the company’s equity is higher that its debt. Therefore, the company’s debt/equity ratio indicates that the company has a good balance of debt and equity ratio.
Earnings
MidAmerican Energy’s earnings are calculated using the gross profit and net profit margins. The profit margin is determined by dividing gross profit with sales. Net profit margin is found by dividing net profit by the company’s total sales.
MidAmerican Energy Company has a net margin profit of 12 percent and a net profit margin of 9 percent between 2007 and 2011 financial years. This indicates that MidAmerican Energy Co. spends less than it generates in revenues. Therefore, the company is financially healthy.
Debt ratio
This ratio determines MidAmerican Energy’s ability to service its debts at the given point in time. It is found by dividing total debt by the total number of assets the company owns.
The company’s debt ratio 3.3:1, 3.1:1, 3:1, 3.2:1, and 2.9:1 from 2011 to 2007 respectively indicate that the company can service its debts comfortably.
Conclusion
References
Abed, I., & Hellyer, P. (2001). The MidAmerican Energy Company. New York: Trident Press Ltd.
Markel's, A. (2007). "How to Make Money the Buffett Way". London: Kaplan Publishers Ltd.
Terterov, M. (2006). Techniques for carrying out a company valuation. London: GMB Publishing Ltd.
