Note to Readers (August 6, 2022)
This post was originally published as a paywalled article on Rational Reflections on April 26, 2022. On August 6, 2022, Berkshire Hathaway disclosed that Greg Abel’s 1% stake in Berkshire Hathaway Energy was purchased by the company for $870 million in June 2022. I decided to unlock the post on Rational Reflections as well as republish it on The Rational Walk. If you find this content worthwhile, please consider becoming a paid subscriber of Rational Reflections to receive future articles as soon as they are published.
Sometimes the most certain investment you can make is to increase your ownership in a business that you already own and have followed for many years. This is straight forward enough when we are dealing with publicly traded stocks, but it is also quite common to buy out business partners in privately held companies. However, entering into a transaction with someone you have been partners with for decades raises some challenges that do not exist when buying stock in the open market.
Many Berkshire Hathaway shareholders do not realize that the company only owns 91.1% of Berkshire Hathaway Energy (BHE). Berkshire Hathaway’s partners in BHE are Greg Abel, Berkshire’s Vice Chairman of non-insurance operations and the estate of the late Walter Scott Jr., a former member of Berkshire’s Board of Directors. Mr. Abel owns 1% of BHE and Mr. Scott’s estate owns a 7.9% interest.1
Walter Scott Jr. passed away on September 25, 2021. Mr. Scott and Warren Buffett were lifelong friends. Mr. Scott joined the board of Berkshire Hathaway in 1988 and he was a significant minority shareholder of MidAmerican Energy at the time Berkshire acquired control of MidAmerican in 2000. MidAmerican was rebranded as BHE several years later. Mr. Scott retained most of his interest in BHE until his death, although he did sell some BHE shares back to Berkshire over the years.
There are reasons to believe that Berkshire Hathaway may be in a position to purchase the remaining minority interests in BHE for a valuation in the range of $5-6 billion. This would represent a major acquisition about half the size of Berkshire’s recent agreement to acquire Alleghany for $11.6 billion.
Let’s take a brief look at what BHE’s valuation looks like today and how a deal with Mr. Scott’s estate and Mr. Abel could be fairly structured.
At various points over the years, Mr. Scott sold portions of his interest in BHE to Berkshire Hathaway, as I first noted in Berkshire Hathaway Energy Valuation Indicators, written in March 2016. As I pointed out in that article, the transactions between Mr. Scott and Berkshire provided valuable information regarding the value of BHE:
“Based on the relationship between Mr. Buffett and Mr. Scott, it is not plausible to think that the valuation assigned to the repurchase would be too far from fair market value. As a result, we can consider $37 billion to be an approximate indicator of what Mr. Buffett thought BHE was worth in February 2015.”
Mr. Scott sold additional shares of BHE to Berkshire Hathaway in subsequent years. The most recent sale took place in early 2020:2
“On March 5, 2020, Berkshire Hathaway Energy repurchased 180,358 shares of its common stock from certain family interests of Mr. Scott for an aggregate cost of $126 million. The per share purchase price was based on a price deemed to represent fair market value and agreed upon by Berkshire, Mr. Abel and Mr. Scott and approved by the Audit Committee.”
This transaction implies that BHE had a value of $698.61 per share as of March 2020. According to BHE’s 10-Q report for the quarter that ended on March 31, 2020, there were 76,368,874 shares of BHE outstanding as of April 30, 2020. This implies that BHE’s estimated intrinsic value, as of March 2020, was approximately $53.4 billion. There were previous transactions with Mr. Scott in February 2019 at a valuation of $654.44 per share and in 2018 at $603.22 per share.
BHE is an unusual energy company because it retains all of its earnings. Most energy companies pay dividends to shareholders, but Berkshire Hathaway has allowed BHE to retain all earnings and reinvest in the business. As a result, we can expect that the valuation of BHE will rise over time.3 Two years have gone by since the March 2020 transaction between Mr. Scott and Berkshire Hathaway, so we cannot assume that the valuation of BHE is still $53.4 billion.
Let’s make a very rough estimate of what BHE’s valuation might look like today based on comparing the $53.4 billion valuation in March 2020 with BHE’s book value at March 31, 2020. According to BHE’s 10-Q report for the quarter that ended on March 31, 2020, shareholders’ equity at March 31, 2020 was $32.4 billion. The $53.4 billion valuation at that time implied a premium to book value of $21 billion.
According to BHE’s most recent 10-K report, shareholders’ equity was $46.7 billion as of December 31, 2021. If we assume the same $21 billion premium to book value, that would imply a current valuation for BHE of $67.7 billion, which we can round up to $68 billion for convenience.4
It is likely that the valuation agreed to by Berkshire Hathaway, Mr. Scott, and Mr. Abel in March 2020 was not based on a simplistic premium to book value, but on various fundamental business factors. It is possible that the valuation of BHE could be materially different from this $68 billion ballpark number, but it is definitely true that the value must be greater than it was two years ago.
Potential Deal Structure
Obviously, a deal between business partners must be acceptable to both sides. Would Mr. Abel want to sell his interest in 1% interest in BHE to Berkshire Hathaway? Would Mr. Scott’s family wish to sell their 7.9% interest?
On May 11, 2021, I wrote an article examining CEO succession issues at Berkshire Hathaway shortly after Charlie Munger appeared to confirm that Mr. Abel was the designated successor to Warren Buffett. As I noted in that article, there are provisions that govern how Mr. Abel might sell his BHE stock to Berkshire:
“Mr. Abel, a director of and the holder of approximately 1% of the voting stock of BHE, also has an agreement with Berkshire with terms similar to the terms of the agreement with Mr. Scott. The major difference between the agreement with Mr. Scott and the agreement with Mr. Abel is that Mr. Abel can also put his shares to BHE (“BHE Put”) and BHE can call Mr. Abel’s shares (“BHE Call”). The purchase price under either a BHE Put or BHE Call shall be payable in cash and determined in the same manner as the purchase price under Mr. Scott’s agreement.”
If my $68 billion ballpark estimate for BHE’s current value is correct, Mr. Abel’s 1% stake would be worth around $680 million. Both Berkshire Hathaway and Mr. Abel have the right to compel a cash transaction to occur.
Although Berkshire Hathaway has the right to compel Mr. Abel to sell his shares, in practice Warren Buffett would not do something like that unless Mr. Abel was agreeable to the transaction. Mr. Abel is Mr. Buffett’s designated successor as CEO of Berkshire, and obviously both parties would need to freely agree to a deal.
The fact that the transaction would be in cash raises tax implications for Mr. Abel that could be problematic. In my May 2021 article, I suggested that Mr. Abel’s BHE stock could be exchanged for Berkshire Hathaway stock to alleviate the tax issues and align Mr. Abel’s economic interests with Berkshire Hathaway as a whole rather than just with BHE.
The situation with Mr. Scott’s estate is unknown to outside observers, but I would note that Mr. Scott’s BHE shares would have received a “step-up” in cost basis at the time of his death. Therefore, it is possible that Mr. Scott’s family would be willing to sell their 7.9% interest, potentially worth ~$5.4 billion, to Berkshire in exchange for cash rather than Berkshire stock.
Berkshire Hathaway is awash in liquidity, with $144 billion of cash as of December 31, 2021. Although small portions of that cash have been spent on publicly disclosed purchases of Occidental Petroleum and HP Inc stock over the first four months of 2022, and $11.6 billion is committed for the purchase of Alleghany later this year, Berkshire still has excessive cash on the balance sheet.
In light of Berkshire’s large cash position, which is melting like an ice cube in the midst of high inflation, I suspect that Warren Buffett would be interested in acquiring the remaining minority interests of Berkshire Hathaway Energy.
Although a transaction with Mr. Abel would be best handled by issuing Berkshire Hathaway stock, it seems at least possible that Mr. Scott’s estate would be willing to sell their interest for cash. If so, that would represent a way for Berkshire to deploy between $5-6 billion into a business that Warren Buffett knows very well.
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- Berkshire Hathaway Energy files financial statements with the SEC. The 2021 10-K contains details regarding ownership of the company.
- Berkshire Hathaway’s 2021 Proxy Statement, page 6
- As of December 31, 2021, BHE owned a $7.7 billion interest in BYD, a Chinese automaker. The value of this interest in BYD has fluctuated significantly in recent years, as it is a publicly traded security. These fluctuations directly impact BHE’s shareholders’ equity.
- Why not infer a 1.65x book value valuation at March 31, 2020 and extrapolate that to a $77 billion valuation today (1.65 x $46.7 billion)? I think that it is more conservative to hold the premium to book constant in dollar terms given the short time period that has elapsed, but opinions on this may differ.