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Author: Bill Parish
Note: Blog Created September 2007 with Updated Comments
Portland, Oregon, July 01, 2005 -- Power Play, Warren Buffet's biggest businesses--insurance and Wal-mart-- are a bad fit for PacifiCorp and local rate payers.
Warren Buffet is a respected and highly successful investor. But his company, Berkshire Hathaway, should not be allowed to purchase PacifiCorp. Berkshire Hathaway subsidiary MidAmerican Energy Holdings has offered $9.4 billion to buy the Portland-based utility from its current owner, Scottish Power.
Berkshire Hathaway calls itself a “holding company in which the most important business is insurance, both primary and reinsurance basis...conducted through more than 50 domestic and foreign-based insurance companies.”
To understand why Buffet wouldn’t be a good steward for PacifiCorp, it’s important to understand Berkshire Hathaway’s unique financial risks as an insurance company, and its unique financial interests as a primary vendor to Wal-Mart. We can also learn a valuable lesson from Buffet's hometown of Omaha, Nebraska, where electric utility rates are 20% below the national average, thanks to its publicly owned utility, Omaha Public Power District.
Berkshire Hathaway pays no dividend and is currently priced at $84,000 per share, roughly the same price as in July of 1998. Even Microsoft, whose founder, Bill Gates, is a Berkshire Hathaway director, now pays a respectable dividend. Buffet is instead sitting on $45 billion in cash, mostly what insurance companies call “float” to cover future insurance claims.
In the quarter ending March 31, 2005, revenues related to insurance and financial products represented 40% of Berkshire Hathaway's gross revenues and 74% of income before taxes. Buffet acknowledges that the reinsurance business — in essence, insuring insurance companies against catastrophic losses — is very risky. His own analysis states that a “single event could produce a loss of $5 billion.”
Other unique Berkshire Hathaway financial risks include Buffet's $21 billion currency bet against the U.S. dollar. He notes that, “We may be wrong and, if so, our mistake will be very public.” Berkshire Hathaway is also the biggest shareholder in Moody's, providing Buffet media clout over all corporations and investment firms.
The second largest revenue producer for Berkshire Hathaway after insurance is McLane, the distribution company for Wal-Mart. Buffet purchased McLane from Wal-Mart in 2003. It now represents one-third of Berkshire Hathaway's gross revenues but generates just 3.5% of net earnings. In addition to supplying Wal-Mart, McLane also serves 58% of the nation’s convenience stores, including 7-Eleven.
The Berkshire Hathaway fund also owns common stock valued at roughly $38 billion, with large holdings in Coca-Cola, Budweiser and Proctor & Gamble. Yet 75% of operating revenues and net earnings come from insurance and financial products, along with keeping the shelves full at Wal-Mart and strip-mall convenience stores nationwide.
Buffet notes that his biggest mistake was not investing directly in Wal-Mart stock. Still, by owning Wal-Mart's delivery system and investing in some of its biggest suppliers, you could say that Buffet is literally bringing Wal-Mart to a neighborhood near you. A critic might say, "Attention Wal-Mart Shoppers,” stock up now so that billionaire investor Warren Buffet can deliver more goods, generate more profits and buy your local utility."
Wal-Mart is controversial in Oregon and other states because it tends to drive out the small- and medium-sized companies that form the backbone of the tax system and support schools and community services.
Although purchasing Wal-Mart's distribution system has helped pump up Berkshire Hathaway's gross sales, it hasn't done much for net profits, since this is a high-volume, low-margin business.
And this is why Buffet wants a captive regulated monopoly like PacifiCorp. Specifically, he wants to become PacifiCorp's bank.
We need only look at MidAmerican, an Iowa-based utility Berkshire Hathaway purchased in 2000, to see how the "Bank of Buffet" works. Since being acquired, MidAmerican has borrowed $1.5 billion from Berkshire Hathaway to finance growth, and is now paying 11.5% annual interest, considerably higher than market rates. This business model has also worked well for Buffet's $10 billion portfolio of manufactured-home loans, with an average interest rate of 12%. Buffet is smart and tough and that has been good for shareholders, but not for ratepayers back in Iowa City.
The smart move for Buffet would be to use PacifiCorp as a base to later acquire either PGE or NW Natural. That might please Berkshire Hathaway directors, including Gates, whose philanthropic foundation collaborated with the Texas Pacific Group in its attempt to purchase PGE. But such utility consolidation wouldn't benefit the region. Rate relief would be unlikely.
Buffet's clarity and dedication to investors is admirable, yet he has the comfort of knowing that when he reaches for the light switch back in Omaha every night, it is public power that powers the switch.
That may indeed be Buffet's most instructive lesson for Oregon's Public Utility Commission. The PUC and Governor Ted Kulongoski should tune out the consultants and lobbyists, and keep PacifiCorp out of the Sage of Omaha’s hands.
Bill Parish (email@example.com) is an independent fee-based investment manager who previously worked as a CPA and financial analyst.
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